The Company believes that such properties, including the equipment located therein, are suitable and adequate to meet the requirements of its businesses.
NET INVESTMENT INCOME, which is the spread between the income earned on invested assets and the interest paid on fixed annuities and other interest-bearing liabilities, increased to $679.4 million in 1997 from $492.8 million in 1996 and $365.6 million in 1995. These amounts equal 3.26% on average invested assets (computed on a daily basis) of $20.86 billion in 1997, 3.43% on average invested assets of $14.36 billion in 1996 and 3.69% on average invested assets of $9.90 billion in 1995. The invested assets associated with the Acquisitions were primarily high-grade corporate, government and government/agency bonds and cash and short-term investments, which are generally lower yielding than a significant portion of the invested assets that comprise the remainder of the Company's portfolio. As a result of the Acquisitions, net investment income as a percent of average invested assets in 1997 and 1996 has declined. However, on a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1994, net investment income on related average invested assets would have been 3.14% in 1997, 2.97% in 1996 and 2.75% in 1995.
Net investment spreads include the effect of income earned on the excess of average invested assets over average interest-bearing liabilities. This excess amounted to $1.15 billion in 1997, $1.06 billion in 1996 and $741.2 million in 1995. The difference between the Company's yield on average invested assets and the rate paid on average interest-bearing liabilities (the "Spread Difference") was 2.95% in 1997, 3.01% in 1996 and 3.25% in 1995. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1994, the Spread Difference would have been 2.91% in 1997, 2.82% in 1996 and 2.71% in 1995.
Investment income (and the related yields on average invested assets) totaled $1.80 billion (8.61%) in 1997, compared with $1.25 billion (8.74%) in 1996 and $905.8 million (9.15%) in 1995. Investment income and the related yields reflect the effects of the Acquisitions from their respective dates of acquisition. On a pro forma basis, assuming the Acquisitions had been consummated on October 1, 1994, the yields on related average invested assets would have been 8.53% in 1997, 8.37% in 1996 and 8.16% in 1995. This increased yield (on a pro forma basis) in 1997 reflects a partial reallocation of lower yielding invested assets acquired as part of the Acquisitions into generally higher yielding asset classes in which the Company has historically invested a portion of its portfolio. In addition, the John Alden Acquisition increased the proportion of mortgage loans in the Company's portfolio. On average, mortgage loans have higher yields than that of the Company's overall portfolio. Increased investment income in 1997 and 1996 also reflects higher returns from the Company's investments in partnerships and total return bond swap agreements (the "Total Return Agreements"), as well as increases in average invested assets (in excess of those acquired through the Acquisitions).
The Company has enhanced investment yield from time to time through Total Return Agreements. The Company recorded income of $35.4 million on Total Return Agreements in 1997, compared with $32.5 million recorded in 1996 and $13.0 million recorded in 1995. The improved results in 1997 and 1996 reflect improved overall performance of the non-investment-grade bonds underlying the Total Return Agreements and increases in the average notional principal amount of the Total Return Agreements. (See "Asset-Liability Matching" for additional discussion of Total Return Agreements.)
GROWTH IN AVERAGE INVESTED ASSETS since 1995 primarily reflects the impact of the Acquisitions. As part of the Acquisitions, the Company acquired $722.5 million of invested assets of CalAmerica on December 29, 1995, $3.10 billion of invested assets of Ford Life on February 29, 1996, $908.8 million of invested assets associated with the Central National Annuity Contracts on April 1, 1996 and $5.00 billion of invested assets associated with the John Alden Acquisition on March 31, 1997. The Company intends to continue to pursue a strategy of enhancing its internal growth with complementary acquisitions.
The GICs issued by the Company generally guarantee the payment of principal and interest at a fixed rate for a fixed term of three to five years. In the case of GICs sold to pension plans, certain withdrawals may be made at book value in the event of circumstances specified in the plan document, such as employee retirement, death, disability, hardship withdrawal or employee termination. The Company generally imposes surrender penalties in the event of other withdrawals prior to maturity. GICs purchased by banks and asset management firms for their long-term portfolios, certain trusts or state and local governmental entities either prohibit withdrawals or permit scheduled book value withdrawals subject to the terms of the underlying indenture or agreement. GICs purchased by asset management firms for their short-term portfolios either prohibit withdrawals or permit withdrawals with notice ranging from 90 to 270 days. In pricing GICs, the Company analyzes cash flow information and prices accordingly so that it is compensated for possible withdrawals prior to maturity.
NET REALIZED INVESTMENT LOSSES totaled $29.2 million in 1997, $30.3 million in 1996 and $33.0 million in 1995. Net realized investment losses include impairment writedowns of $65.3 million in 1997, $34.9 million in 1996 and $42.7 million in 1995. Therefore, net gains from sales of investments totaled $36.1 million in 1997, $4.6 million in 1996 and $9.7 million in 1995.
The Company sold invested assets, principally bonds and notes, aggregating $13.90 billion, $7.88 billion and $4.85 billion in 1997, 1996 and 1995, respectively. Sales of investments result from the active management of the Company's investment portfolio. Because sales of investments are made in both rising and falling interest rate environments, net gains from sales of investments fluctuate from period to period, and represent 0.17%, 0.03% and 0.10% of average invested assets for 1997, 1996 and 1995, respectively. Active portfolio management involves the ongoing evaluation of asset sectors, individual securities within the investment portfolio and the reallocation of investments from sectors that are perceived to be relatively overvalued to sectors that are perceived to be relatively undervalued. The intent of the Company's active portfolio management is to maximize total returns on the investment portfolio, taking into account credit and interest-rate risk.
NET RETAINED COMMISSIONS are primarily derived from commissions on the sales of nonproprietary investment products by the Company's broker-dealer subsidiaries, after deducting the substantial portion of such commissions that is passed on to registered representatives. Net retained commissions totaled $64.9 million in 1997, $49.8 million in 1996 and $33.7 million in 1995. Broker-dealer sales (mainly sales of general securities, mutual funds and annuities) totaled $17.52 billion in 1997, $12.78 billion in 1996 and $7.41 billion in 1995. The increases in sales and net retained commissions reflect a greater number of registered representatives, higher average production per representative and generally favorable market conditions. The greater number of registered representatives was primarily due to acquisitions, including the January 22, 1997 acquisition of The Financial Group, Inc., which, through its subsidiary, Keogler Morgan & Company, licensed more than 400 independent registered representatives at date of acquisition; and the January 3, 1996 acquisition of Advantage Capital Corporation, a Houston-based broker-dealer, which licensed approximately 1,000 independent registered representatives at date of acquisition. Increases in net retained commissions may not be proportionate to increases in sales primarily due to differences in sales mix.
GENERAL AND ADMINISTRATIVE EXPENSES totaled $265.7 million in 1997, compared with $210.7 million in 1996 and $165.4 million in 1995. General and administrative expenses in 1997 and 1996 reflect the impact of acquisitions from their respective dates of occurrence. General and administrative expenses in 1997 include a $15.0 million provision for estimated programming costs associated with the year 2000. Management believes that this provision is adequate and does not anticipate any
At September 30, 1997, the Bond Portfolio (at amortized cost, excluding $136.4 million of redeemable preferred stocks) included $17.28 billion of bonds rated by Standard & Poor's Corporation ("S&P"), Moody's Investors Service ("Moody's"), Duff & Phelps Credit Rating Co. ("DCR"), Fitch Investors Service, L.P. ("Fitch") or the National Association of Insurance Commissioners ("NAIC"), and $707.2 million of bonds rated by the Company pursuant to statutory ratings guidelines established by the NAIC. At September 30, 1997, approximately $16.10 billion of the Bond
At September 30, 1997, the Bond Portfolio included $1.89 billion (at amortized cost with a fair value of $1.97 billion) of bonds that were not investment grade. Based on their September 30, 1997 amortized cost, these non-investment-grade bonds accounted for 5.3% of the Company's total assets and 7.9% of its invested assets. In addition to its direct investment in non-investment-grade bonds, the Company has entered into Total Return Agreements with an aggregate notional principal amount of $439.1 million at September 30, 1997 (see "Asset-Liability Matching").
Non-investment-grade securities generally provide higher yields and involve greater risks than investment-grade securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment-grade issuers. In addition, the trading market for these securities is usually more limited than for investment-grade securities. The Company had no material concentrations of non-investment-grade securities at September 30, 1997.
The following table summarizes the Company's rated bonds by rating classification as of September 30, 1997 (dollars in thousands):
While the trading market for Secured Loans is more limited than for publicly traded corporate debt issues, management believes that participation in these transactions has enabled the Company to improve its investment yield. As a result of restrictive financial covenants, Secured Loans involve greater risk of technical default than do publicly traded investment-grade securities. However, management believes that the risk of loss upon default for its Secured Loans is mitigated by such financial covenants and the collateral values underlying the Secured Loans. The Company's Secured Loans are rated by S&P, Moody's, DCR, Fitch, the NAIC or by the Company, pursuant to comparable statutory ratings guidelines established by the NAIC.
securities and real estate), plus a level of illiquidity, which is mitigated, to some extent, a) for the affordable housing partnerships by the marketability of the tax credits they generate; and b) in the case of many of the other partnerships, by the existence of contractual termination provisions.
ASSET-LIABILITY MATCHING is utilized by the Company to minimize the risks of interest rate fluctuations and disintermediation. The Company believes that its fixed-rate liabilities should be backed by a portfolio principally composed of fixed-rate investments that generate predictable rates of return. The Company does not have a specific target rate of return. Instead, its rates of return vary over time depending on the current interest rate environment, the slope of the yield curve, the spread at which fixed-rate investments are priced over the yield curve, and general economic conditions. Its portfolio strategy is constructed with a view to achieve adequate risk-adjusted returns consistent with its investment objectives of effective asset-liability matching, liquidity and safety. The Company's fixed-rate products incorporate surrender charges, two-tiered interest rate structures or other restrictions in order to encourage persistency. Approximately 87% of the Company's fixed annuity and GIC reserves had surrender penalties or other restrictions at September 30, 1997.
As a component of its asset and liability management strategy, the Company utilizes interest rate swap agreements ("Swap Agreements") to match assets more closely to liabilities. Swap Agreements are agreements to exchange with a counterparty interest rate payments of differing character (for example, variable-rate payments exchanged for fixed-rate payments) based on an underlying principal balance (notional principal) to hedge against interest rate changes. The Company typically utilizes Swap Agreements to create a hedge that effectively converts floating-rate assets and liabilities into fixed-rate instruments. At September 30, 1997, the Company had 39 outstanding Swap Agreements
There are risks associated with some of the techniques the Company uses to provide liquidity, enhance its spread income and match its assets and liabilities. The primary risks associated with Total Return Agreements are the credit risk on the underlying non-investment-grade bonds, the risk of potential loss due to bond market fluctuations and the risk associated with counterparty nonperformance. The primary risk associated with the Company's Reverse Repos and Swap Agreements is counterparty risk. The Company believes, however, that the counterparties to its Total Return Agreements, Reverse Repos and Swap Agreements are financially responsible and that the counterparty risk associated with those transactions is minimal. In addition to counterparty risk, Swap Agreements also have interest rate risk. However, the Company's Swap Agreements typically hedge variable-rate assets or liabilities, and interest rate fluctuations that adversely affect the net cash received or paid under the terms of a Swap Agreement would be offset by increased interest income earned on the variable-rate assets or reduced interest expense paid on the variable-rate liabilities. The primary risk associated with MBSs is that a changing interest rate environment might cause prepayment of the underlying obligations at speeds slower or faster than anticipated at the time of their purchase. As part of its decision to purchase an MBS, the Company assesses the risk of prepayment by analyzing the security's projected performance over an array of interest-rate scenarios. Once an MBS is purchased, the Company monitors its actual prepayment experience monthly to reassess the relative attractiveness of the security with the intent to maximize total return.
INVESTED ASSETS EVALUATION routinely includes a review by the Company of its portfolio of debt securities. Management identifies monthly those investments that require additional monitoring and carefully reviews the carrying values of such investments at least quarterly to determine whether specific investments should be placed on a nonaccrual basis and to determine declines in value that may be other than temporary. In making these reviews for bonds, management principally considers the adequacy of any collateral, compliance with contractual covenants, the borrower's recent financial performance, news reports and other externally generated information concerning the creditor's affairs. In the case of publicly traded bonds, management also considers market value quotations, if available. For mortgage loans, management generally considers information concerning the mortgaged property and, among other things, factors impacting the current and expected payment status of the loan and, if available, the current fair value of the underlying collateral.
$22.9 million of mortgage loans. At September 30, 1997, defaulted investments constituted 0.2% of total invested assets. At September 30, 1996, defaulted investments totaled $28.7 million, including $16.7 million of bonds and notes and $12.0 million of mortgage loans, and constituted 0.2% of total invested assets.
SOURCES OF LIQUIDITY are readily available to the Company in the form of the Company's existing portfolio of cash and short-term investments, Reverse Repo capacity on invested assets and, if required, proceeds from invested asset sales. At September 30, 1997, approximately $15.87 billion of the Company's Bond Portfolio had an aggregate unrealized gain of $458.8 million, while approximately $2.25 billion of the Bond Portfolio had an aggregate unrealized loss of $60.0 million. In addition, the Company's investment portfolio currently provides approximately $184.7 million of monthly cash flow from scheduled principal and interest payments. Further, $3.23 billion remains available to the Company to issue securities under a shelf registration statement filed in July 1997 (see Note 6 of Notes to Consolidated Financial Statements). Historically, cash flows from operations and from the sale of the Company's annuity and GIC products have been more than sufficient in amount to satisfy the Company's liquidity needs.
On a parent company stand-alone basis, SunAmerica Inc. (the "Parent"), at September 30, 1997, had invested assets with a fair value of $2.51 billion and outstanding senior indebtedness of $1.14 billion, comprising all of the Company's outstanding senior indebtedness. In October 1997, subsequent to its fiscal year-end, the Company issued $100 million of 6.75% notes due October 1, 2007 (the "6.75% Notes"). (See Note 6 of Notes to Consolidated Financial Statements.) Additionally, as of September 30, 1997, the Parent had three GICs purchased by local government entities which aggregated $227.0 million.
The Company has transferred to third-party investors certain of its interests in various partnerships that make tax-advantaged affordable housing investments. As part of these transactions, the Parent has agreed to advance monies to support the operations of the underlying housing projects, if required, and has guaranteed that the transferred partnerships will provide, as of the transfer date and under then current tax laws, a specified level of associated tax credits and deductions to the third-party investors. Based on an evaluation of the underlying housing projects, management does not anticipate any material cash payments with respect to the guarantees.