Brookfield Finance Inc. 4.625% Q2 FY2024 earnings call

Bruce's remarks - Economic backdrop: Inflation cooling, short term interest rates declining, risk appetite returning. - Share repurchases: Completed over $800 million of share buybacks since start of year, intend to continue allocating capital to repurchases when makes sense. - Investment philosophy: Built on key principles for over 100 years, has enabled compounding capital, large perpetual capital base, and strong investment track record. - AI opportunity: Significant investment opportunities in AI revolution, combined development pipeline of renewable power and data centers is largest globally. - Investor Day: Look forward to Investor Day on September 10th in New York. ### Nick's remarks - Financial results: Strong financial results in Q2, distributable earnings before realizations $1.1 billion, total distributable earnings $2.1 billion. - Asset management: Strong fundraising, assets under management ~$1 trillion, fee bearing capital $514 billion, 17% higher than 12 months ago. - Wealth Solutions: Another strong quarter, insurance assets over $110 billion, expect spread earnings of AEL business to increase. - Operating businesses: Resilient and growing cash flows, core office portfolio rents on newly signed leases increased by 23% compared to expiring, retail occupancy levels high at 95%. - Monetizations: Increased level of monetization expected, advanced or completed several sales with strong investment returns, realized gain on sale of BAM shares. - Financing: Executed on approximately $75 billion of financings, demonstrating strong interest in businesses aligned with global secular trends. - Capital allocation: Reinvested excess cash flow back into businesses and returned $408 million to shareholders through dividends and share buybacks, expect to continue share repurchases.

Asset management business: Distributable earnings were $636 million or $0.40 per share in the quarter and $2.5 billion or $1.61 per share over the last 12 months. Assets under management are now approximately $1 trillion and fee bearing capital was $514 billion as of June 30th, 17% higher than 12 months ago. Wealth Solutions business: Distributable operating earnings were $292 million or $0.19 per share in the quarter and $1 billion or $0.63 per share over the last 12 months. Excluding American Equity Life (AEL), the net investment spread on assets was consistent with prior quarter at approximately 2%. Operating businesses: Generated distributable earnings of $371 million or $0.24 per share in the quarter and $1.5 billion or $0.93 per share over the last 12 months. Cash distributions are underpinned by high quality earnings. Operating funds from operations in renewable power, transition and infrastructure businesses increased by 7% over prior year quarter, while same store operating FFO in private equity business grew by 17%. Core portfolio in real estate delivered 3% growth in same store net operating income over last 12 months.

- Expect fundraising to ramp up in the back half of the year with closes anticipated for latest flagship funds, resulting in further earnings growth. ### - Anticipate transaction activity to pick up over the coming quarters, positioning well to execute on monetizations and further bolster earnings. ### - Intend to continue to further allocate capital to share repurchases over the remainder of 2024.

- Market volatility: Forward-looking statements subject to known and unknown risks, future events and results may differ materially. ### - Interest rate changes: Impact on financing costs, credit capacity, and investor appetite. ### - Asset quality differences: Initial transaction activity has bias for quality, but impact on monetization of different assets varies.

Q: My first question was on the Wealth segment. They closed their first [SMA] for a third party, I think insurer, to manage the investments in Q2. I'm just wondering if you can talk about the pipeline and the opportunity to do more of these types of transactions, potential timing, fee structures and margins?

A: Listen, happy to comment, and I think we're going to see more of these, and I think the scale will continue to build, and there's a couple of driving forces behind it. One, I think as we grow the insurance business on our books and the appetite that we have to originate credit is growing significantly, and the capability that we have to originate that is really stronger than the asset management business. So we will scale up our capability alongside our capital and then we can bring our clients alongside us as we scale. And we will build these SMEs and they can then invest alongside BN REIT. So I think we signed one in the quarter, you continue to see these scale up because we're able to originate the exact type of credit assets that these clients want to be invested in. The fee structures will evolve over time, but broadly consistent with other credit SMAs. And we should have a lot of operating leverage in that business because we have a lot of the credit sourcing and underwriting capability in place. And I think it should be a strong tailwind of growth for earnings for the asset management business.

Q: And just my other question is, I mean -- and you talked about it earlier. It seems like the general consensus is monetization markets are improving, maybe there's a bit of a quality bias for a high quality business or easier to transact, maybe less so for lower quality businesses. And really, my question is, I'm wondering how this might play out within the real estate space, in particular, when real estate M&A really starts to pick up, do you think there might be some sort of lag effect on when you might be able to monetize assets within the T&D portfolio?

A: Jeff, you're right. The initial transactions have a bias for quality. But I would say that within the T&D, we own high quality assets, there may be not the assets we consider core or once we want to own for a long term but they are high quality. And also remember, they are geographically diverse. So a lot of the transaction activity is returning. We've sold out T&D in Brazil and we're working on transactions across the globe, and we sold one asset in the US. So I think it will be dependent on the assets. But even within T&D, we have high quality assets and we expect that; a, transaction activity picks up; b, it looks like interest rates are going to be coming down, which will be a positive catalyst for credit capacity and investor appetite and valuations, and that should be a strong tailwind for monetizations.

Q: Nick, just sticking to real estate. The core real estate same store NRR growth remains healthy at 3%, but higher debt costs have impacted the FFO. That said, the core flow is showing sequential improvement this quarter. As kind of monetary policy looks like it's going to be easy in the second half of this year. Could you remind us of the FFO kind of sensitivity within BPG to variable debt costs? Like, for example, if rates come down 25 basis points, it could impact your annualized FFO out of BPG by x percent?

A: I think, Mario, you're right, interest rates are coming down. On top of interest coming down, credit spreads have compressed significantly. They're in about 150 basis points in some areas compared to 12 months ago. They're 25, 50 basis points off historical average but we still think there’s further room to compress. So I think that, combined with interest rate cuts with maybe about 30% variable rate debt in the portfolio today, will be a positive catalyst as we work through. Now to give you the exact percentage, it varies, because some -- it depends on when we refinance fixed rate debt into lower rate market and the impact of floating rate but with hedges rolling off. But you are going to see the impact coming through earnings almost immediately as rates start to come down.

Q: My second question is more of a kind of a thematic long term question. I think Bruce highlighted the need to evolve with time with respect to invested capital as when new asset classes emerge. I think, I guess, collectively, how do you think about that concept as it pertains to the BN corporate structure? Do you see the present BN corporate structure with respect to investments in listed subsidiaries fully owning the real estate and the Wealth Solution business, is that something you expect to endure over the next one, five, 10, 20 years, or is the optimal structure still a work in progress? And the genesis or the reason we got in the question is that despite the pretty strong move in share price recently, it still materially lags your estimated intrinsic value?

A: Yes, that's a good observation, Mario. And listen, our primary focus is on being invested in assets that are going to generate attractive long term returns. And in the real estate that we own, the insurance that we own, they are generating excellent returns and insurance is just getting going in has enormous potential. So that's the primary focus. Now as these businesses evolve and as the markets evolve, we do assess the structure real time. And as you saw, as our asset management business grow, great tailwind, a deep public market developed for that business. It reached a scale where we thought it was better served in the public markets. But as we sit here today, the structure we have and the structure that we're planning on having for some time and that may evolve. But right now, the focus primarily is on compounding value in the business. And we may make decisions over time that can improve our access to capital and so it's always going to be an evolution, and we'll see how it plays out.

Q: As you're no doubt very aware, there's been concern raised this quarter about the potential for spread compression in insurance. Can you talk about how you see the trade-off between growth versus maintaining a desired spread and/or ROE in that business going forward?

A: I would just tell you the primary focus on our business is return on equity. So we will stay incredibly focused and disciplined on that, which is why we want to draw out for people that the spread of our pre-existing business this quarter was maintained at 2%. Now AEL comes on at a lower spread but that will gravitate towards 2% as we reposition the investment portfolio. And how we manage that is as the rate environment changes, we are fairly quick to react in changing the rate that we offer annuitants. So as the rate market has evolved and dynamic has changed, we've lowered the rate that we've been offering annuitants by up to 50 basis points in just the last week, and we're matching that against the investment opportunity that we see, with a primary focus on maintaining those 18% to 20% ROE. So our primary focus is going to be return on equity.

Q: And then switching gears a little bit here in terms of the deal pipeline. There's been a so called wall of debt maturities that's been talked about for a while, which Ben touched on in part in the context of real estate yesterday. Maybe you want to expand on that. But can you also touch on what Oaktree sees developing in terms of the potential for a distressed credit cycle at some point?

A: We've not seen the distress yet. We've seen opportunities and gaps in the financing market in certain areas, which is provided the opportunity for us to make pretty attractive loans, but still to good credits. But just for one reason or another, they've fallen out of favor with the capital markets. So maybe stress the opportunity to deleverage provide GAAP capital where the banks have had to take a step back. So it's maybe being driven by regulatory impacts, market dynamics as opposed to necessarily underlying portfolio stress or distress. But without a doubt, there was a lot of leverage added when rates were zero and credit spreads were tight. And as those do come up for renewal, I think across Oaktree and our credit funds, we are going to see the opportunity to provide lending to cover the gaps but still for high quality assets and we have the capital available to participate.

Q: Nick, I just wanted to go back to the answer you gave to the earlier question here on insurance spreads. I mean, 1.5 -- or the credit spread, for the insurance, 1.5% to 2% spread. Like what dictates where on that range you operate, how much of it is kind of macro as opposed to, I don't know, I'll call it a management decision?

A: A lot of the plan with AEL, Sohrab, is just reallocation of the existing investment portfolio. There's no real macro thesis here. It's just we look at the portfolio, a lot of it is held in short term liquid assets that are lower yielding relative to the credit opportunities that we see. So it's really about barbelling the portfolio. They will maintain some liquid but they're overallocated to short term cash and liquid assets. And between that and repositioning similar to the ANICO portfolio, we just see an uplift in the spread without really adding that much risk to the portfolio.

Q: And I just -- maybe just for crystal clarity, because I think I got a little bit confused from the earlier answer. Like you can't -- like you are probably price takers on the rate that the annuitants want, like you can't really price up, too far up market, otherwise, you won't get any volume, right?

A: But that's the point, Sohrab, I think that's exactly the point. We will offer it at a rate that we are comfortable we can earn a spread on it. That means for that quarter, then maybe our sales are a little bit lower, then we are willing to live with that. Now in the current environment, we believe at the rate we've been offered we’re still running about a $15 billion inflow run rate, and we think we can maintain it at these levels. But I think our point is are a price taker but we're going to set at a price where we're comfortable we can earn a good return.

Q: And just on that same topic, 18% to 20% type of ROE that you're targeting for that business is still predicated on around the 10x leverage?

A: Yes, in that range, 8 to 10 times leverage.

Q: We wanted to double click on the realization pipeline. You made some comments today suggesting that transaction activity is due to go up. Those comments were in line with some of what we heard in the BAM call yesterday, especially as pertaining to the renewable sector. With that in mind, is it still the case that your guidance for the year holds at the prior 400 to 500 that you mentioned or is it possible that we might see some upside to that number?

A: Yes, listen, you're right, the comments are consistent with what was said on the BAM call yesterday, and we are seeing sales activity picking up US, Canada and globally. And in the short term, those sales activity, what it means immediately is it means our return of capital at excellent returns, either to be in or our listed affiliates depending on who made the investments. So we have that immediate impact. And then longer term, it turns into carry. But I think I would temper expectations on carry realization because the assets we are monetizing are in later vintage funds, where we are working on returning original capital, working our way through the preferred return. But what it does is it sets us up really well going into 2025 as we execute on these sales and more to come, then you'll start to see that carry realization come through our earnings.