Friday, May 08, 2009

Manulife Q1 2009 Earnings

  
Scotia Capital, 8 May 2009

• EPS of negative $0.67 missed our negative $0.40 estimate. Consensus was negative $0.35.

Implications

• $0.17 EPS commercial real estate hit (an increase in actuarial provision for default) accounted for the bulk of the miss, and we put underlying EPS at $0.52. Sales were mixed.

• Despite the miss on credit, credit is still very good. The commercial real estate hit related to an increase in capitalization rates extrapolated across the entire portfolio, and was not due to any change in risk profile. Bulk of the other credit hit ($0.12, versus our $0.08 estimate) was due to increase in provision for default related to RMBS portfolio, as company uses much more conservative ratings than those used by Moody's/S&P.

• Management is focused on de-risking the company, while, we believe, not losing market share in the process, and continuing to improve an already strong capital position. MCCSR of 228% at Q1/09, likely over 250% at current market levels.

Recommendation

• Attractive valuation at 8.1x 2010E EPS, minimal credit exposures and the most torque by far to improving equity markets; we reiterate 1-SO.

Q1/09 Misses On Higher Credit Hits

• EPS missed at negative -0.67; we peg underlying EPS at $0.52. EPS loss of $0.67 versus our negative $0.40 estimate and consensus of negative $0.35. A $0.17 EPS commercial real estate hit accounted for the bulk of the miss, and we put underlying EPS at $0.52 (see Exhibit 1). Source of Earnings Analysis puts underlying earnings at $0.48 (Exhibit 4).

• Despite the miss on credit, credit is still very good. The $0.17 commercial real estate hit was the result of an accelerated review, which extrapolated the rise in capitalization rates conservatively across the entire portfolio (which is only $6.5B or 3% of invested assets, 60% of which is in the U.S.), resulting in an increase in actuarial provisions for default (entirely cap rate related as there has been no change in characteristics of commercial real estate portfolio, with occupancy rates unchanged at 93%, virtually no leverage, mostly high quality urban office towers, average lease term 5.6 years). The remainder of miss was due to slightly larger than expected credit hits ($0.12 versus our $0.08 estimate). The bulk of the credit hits in Q1/09 were due to increased actuarial provisions for default related to the RMBS portfolio (which in total is just $750 million or just 0.4% of invested assets) as a much tougher internal ratings standard than S&P/Moody's was applied. Credit continues to look good at MFC. The concentration of fixed income securities trading below 80% of cost for more than six months is just 1.4%, significantly below GWO (5.6%) and SLF (4.9%) and in line with IAG at 1.3%. Gross unrealized losses on fixed income securities are just 8% of the carrying value (as opposed to 11% for GWO and 18% for SLF).

• Focus is on de-risking the company for now. MFC is getting its house in order in terms of minimizing its higher than average sensitivity to equity markets through product changes and hedging initiatives. We certainly agree this is prudent. A strategic review of how to accelerate growth in core businesses, as well as new markets/geographies, is in early stages. We do not believe the company will lose market share or distribution shelf space as it, like most other current financial institutions, gets its house in order. MFC's organic growth and acquisition track record have been exceptional.

• We may not see 16% ROE until 2011 - the same story for all lifecos. We see 15% ROE next year, below MFC's 16% hurdle rate in 2010E (Exhibit 3). With weaker equity markets than historically (we're assuming equity markets end 2009 with the S&P 500 at 950, and then climb just 8% to 1,025 in 2010, still below levels at the end of 2003), a significantly lower level of realized gains, the drag from significant excess capital, and no share buyback to lift EPS and ROE, we expect ROE's for all lifecos to remain under historical averages in 2010. Until we see long term average ROE's we expect P/E multiples for the group will be below average. Long term average forward P/E multiples are 11.8x for the group and about 12.7x for MFC. At 8.1x 2010E MFC is at 65% of its long term average, and we suspect it could lift to about 85% of its long term average, or about 10.8x 2010E one year out, for a target of $30.

• Sales mixed. Canadian individual life sales were down 4%, in line with the market, U.S. VA sales were down 19%, better than the market (down 29%), Canadian individual wealth management sales were up 6% (better then peers), U.S. individual insurance sales were down 43% over a very good Q1/08, but were flat versus Q1/07. We do not believe efforts to de-risk the company's variable annuity and segregated fund products have in any way diminished relative market share positioning.

• Capital position very strong. 228% MCCSR, above our 218% estimate, and likely at 257% based on current markets (suggests about $4.5B in excess capital above 200%). A reinsurance deal in the quarter boosted the ratio by 8 points. We estimate the S&P 500 would have to srop below 600 before the ratio would fall below the bottom end of its 180%-200% target range.
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The Globe and Mail, Tara Perkins, 5 May 2009

With Manulife Financial Corp. disclosing another $1-billion-plus loss, its new chief executive officer says the worst of the stock market plunge is over but he will boost the insurer's financial cushion nevertheless.

Donald Guloien, who picked up the reins of North America's biggest insurer yesterday, is signalling that the company has learned lessons from the bruising it is taking because of its massive exposure to global stock markets.

He said in an interview yesterday that he wants to see the company's capital ratio increase further until it is clear that the global economy has stabilized.

His focus on building high capital levels for a rainy day marks a slight departure from his predecessor, Dominic D'Alessandro, who has retired. While Mr. D'Alessandro oversaw the raising of $4.3-billion of debt and equity to shore up Manulife's capital base when markets plunged in the fourth quarter, he also railed against what he deemed to be the too-strict capital requirements of regulators.

At the company's annual meeting yesterday, he described the calculations Manulife is required to make. “We must, for regulatory capital purposes, assume that markets will decline by a further 25 per cent with no recovery for 10 years,” Mr. D'Alessandro said. “The regulatory treatment of exposures related to what are essentially individual pension plans is very harsh, in my opinion.”

Manulife was hurt again this quarter by the large stock portfolio it holds as a result of its variable annuity and segregated funds business.

(Those products are akin to private pension plans for individual investors, in which Manulife takes a customer's money, invests it, and promises payments down the road. When markets drop, the insurer must build up capital and reserves to protect against any shortfall in the amount it has promised to pay customers in the future.)

Since late last year, the shortfall between the amount it has guaranteed customers and its portfolio supporting the business has widened, growing to $30-billion at the end of March. As a result, Manulife boosted its reserves to $7.7-billion. (Most of the payments are not due for decades.) Mr. D'Alessandro emphasized that the money the company is putting aside may be returned to the profit column if markets improve. That could bode well for Mr. Guloien, who until yesterday was the company's chief investment officer.

“The main cause of pressure on earnings and capital – weak equities – has reversed and the outlook for [the second quarter] is much brighter,” RBC Dominion Securities Inc. analyst André-Philippe Hardy said in a note to clients.

Mr. Guloien said he thinks “the economy will continue to be challenged for a bit longer period of time, but that the stock market is pretty much bouncing off a bottom.”

While that doesn't mean it won't dip, he believes the general trend will be upwards. “Certainly when it hit around 700 it was hitting the bottom for sure,” he said, referring to the S&P 500 benchmark U.S. stock index. Economic recovery will come next.

“But in terms of capital management and other activities, we can't take that for granted,” he quickly added.

The S&P 500 fell 12 per cent in the first quarter, and the TSX/S&P composite index ended the period down 2 per cent. Manulife posted a loss of $1.9-billion in the fourth quarter of last year when equity markets had steeper declines.

Rival Sun Life Financial Inc. reported a $213-million loss Thursday, down from a year-ago profit of $533-million.Great-West Lifeco Inc. earned $326-million, down from $654-million. All were hit by stock market declines.

The key measure of an insurer's financial cushion, known as its MCCSR ratio (minimum continuing capital and surplus requirements), must stay above 150 per cent. Manulife said its ratio was 228 per cent at the end of March. Great-West's was 205 per cent and Sun Life's was 223 per cent.

Manulife's overriding emphasis on capital levels will not prevent it from making acquisitions, Mr. Guloien said. “It obviously means the funding of acquisitions would have to be more heavily oriented towards the equity side than it would normally be. It's not like we have excess capital sloshing around that we could use for an acquisition.”

“Our first priority in these unsettled times is to ensure our financial position continues to be strong,” he told shareholders at the annual meeting. “But we also have an unparalleled opportunity over the next five years to be the consolidator, taking advantage of the current disorder amongst financial institutions worldwide.”
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The Globe and Mail, 5 May 2009

Canadian life insurance companies could lose up to $1.6-billion in 2009, CIBC World Markets estimates, but they should remain adequately capitalized with the worst already behind them.

“We are approximately 80 per cent confident in our conclusion that lifecos are well capitalized for difficult equity/credit markets,” analyst Darko Mihelic wrote in a report. “Even if lifecos need some extra capital, we believe it would not be overly material to investors unless the environment was in a truly catastrophic state.”

CIBC put the companies through two stress-test scenarios, with the $1.6-billion in losses forming the “worst case.” This would translate into a 33-per-cent hit in the expected profits from Manulife Financial, Sun Life Financial Inc., Great-West Lifeco Inc. and Industrial Alliance Insurance And Financial Services Inc.

Under the slightly more optimistic “bad case,” he forecast the insurers would lose $890-million – which would account for 18 per cent of expected 2009 earnings.

“Our analysis suggests that the Canadian lifecos might have seen the worst year in 2008 from a credit losses perspective,” Mr. Mihelic said.

Here are five highlights from his report:

1) All of the company's passed the test. Mr. Mihelic used “minimum continuing capital and surplus requirements” ratios as a measure of health, with a rating of 100 meaning an insurer has adequate capital to meet its obligations. Regulators want the company's to have a target above 150 per cent. Under the worst-case scenario, Manulife's reading would be 173 per cent, Industrial Alliance's would be 176 per cent, Great-West would be at 188 per cent and Sun Life's would be at 214 per cent

2) Credit downgrades and impairment charges may not hit the worst-case number, but “the most likely scenario” would mean losses of $1.3-billion – 25 per cent of estimated 2009 earnings. The companies lost a collective $1.5-billion in 2008.

3)The losses in 2008 were made worse by the fall of Lehman Brothers, AIG and Washington Mutual, which should suggest 2009 will be a slightly “better” year. “We estimate that in 2009 loss rates will decrease for all of the lifecos with Sun Life and Industrial Alliance posting the largest decrease and Great-West experiencing only a very modest drop in loss rates.”

4) The Canadian lifecos have better credit quality than their U.S. counterparts. “As a result, the Canadian lifecos might be better positioned to ‘survive' this credit crunch. Additionally, the Canadian lifecos have some accounting flexibility that is not permitted [in the U.S.].”

5) Industrial Alliance's investments have the highest level of credit quality, he said. “Perhaps surprisingly, it is difficult to distinguish between Sun Life's and Manulife's invested assets credit quality. History hurts Sun Life, but when viewed solely on exposure and assuming some degree of reversion to the mean, Manulife's portfolio appears weaker. Industrial Alliance, however, currently has the lowest capital ratio.”

First-quarter earnings for Manulife (an expected loss of 33 cents a share), Sun Life (a loss of 1 cent) , and Great-West (a profit of 47 cents) are out Thursday, while Industrial Alliance reports Friday (a profit of 57 cents). All estimates for from ThomsonOne Analytics.
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