(RTTNews) - Friday, FBR Capital Markets upgraded American Equity Investment Life Holding Co. (AEL: News ) shares to Outperform from Market Perform and increased its price target to $11 from $8.50.

Analyst Randy Binner attributed the upgrade based on favorable risk/reward. AEL trades at 0.5x 2009 third quarter stated book value, versus 1.1x for the peer group, despite steady operating results and 2010 operating ROE of 10.8%, versus the peer group at 10.7%.

The analyst said that AEL carries a discount because there is uncertainty regarding the future distribution of indexed annuities due to proposed SEC Rule 151A; and the second quarter of 2009 pro forma risk-based capital ratio was less than 300%, raising issues on capital adequacy relative to credit exposure and growth. Due to these issues, AEL has lagged the group by 32% over the past three months.

However, the analyst's analysis implies that at the current price, AEL is more than adequately discounted for these risks. The downside should be protected at about $8 per share, based on the analyst's conservative estimate of the runoff value of AEL's book.
On the upside, the analyst estimates that even with a 50% reduction to sales in 2011 and dilution from a further $50 million equity capital raise, assuming there is not a regulatory solution to ratings drift issues, book value should remain above $12 and grow to $17 by 2015.

Bottom line, with shares trading below runoff value and at 50% of third quarter of 2009 stated BV, the risk/reward is favorable even if Rule 151A goes through and the analyst's conservative estimate of credit losses comes through.

Currently, AEL is up $0.50 or 6.98% and trading at $7.66.

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by RTT Staff Writer

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