Friday, November 07, 2008

Manulife Q3 2008 Earnings

RBC Capital Markets, 7 November 2008

Manulife's regulatory capital position is stronger than we expected, which in our view should be more positive than what was reflected in the stock's move relative to Canadian peers yesterday as regulatory capital strength was the biggest source of near term uncertainty.

• The October 31 pro-forma MCCSR was 225% - well in excess of the regulatory minimum of 150% and Manulife's 180%-200% target, reflecting (1) the recent OSFI regulation change related to reserves for segregated funds, (2) the positive impact of a new $3 billion term loan, (3) the negative impact of equity markets since the quarter began, and (4) the positive impact of a review on policyholder behavior on segregated funds.

• Overall leverage has increased, which lowers financial flexibility but strengthening regulatory capital was a priority in our view. S&P reaffirmed its rating while Moody's maintained its rating but changed its outlook to negative.

EPS Had Many Moving Parts

Q3/08 core EPS of $0.33 was above our $0.29 estimate but below the consensus estimate of $0.39. The moving parts were numerous: (1) the after-tax impact of movements in equities on EPS was $0.38 per share, (2) the after-tax impact of credit on EPS was $0.17 per share, (3) after-tax earnings benefited from the release of reserves related to interest rates (by $0.38 per share), which were more than offset by $0.43 per share in increases due to equities, and (4) the company benefited from unusually large investment related gains ($0.21 per share).

• We have maintained our EPS estimates for Q4/08 and 2009 but will review our equity and credit assumptions as part of our industry review (with our bias being negative especially for Q4/08).

• Our 2009(E) EPS of $2.85 was well below the mean estimate of $3.10 going into the quarter.

Maintain Sector Perform Rating

We view Manulife's near term outlook as below average given relatively greater exposure to equities, and a relatively high valuation (8.9x 2009(E) P/E, 1.54x P/B). However, we think Manulife has an above average outlook in 2009 as the company is best positioned to benefit from the strength in the U.S. dollar and a likely more benign environment for equities.
The Globe and Mail, Tara Perkins, 6 November 2008

In September, Manulife Financial Corp. chief executive officer Dominic D'Alessandro seemed poised to spend his final months on the job negotiating a blockbuster acquisition, with the company feasting on U.S. assets crippled by the credit crisis.

Within weeks, his own company's financial health was compromised and he found himself asking Canadian regulators to ease up on the insurer's capital requirements, then going hat-in-hand to the big banks for a $3-billion loan.

The dramatic reversal in fate had Mr. D'Alessandro facing a public grilling from analysts on Thursday, after the company announced a 50-per-cent drop in third-quarter profit.

But the chief executive officer later defended his company's record in an interview, saying “we handled the turmoil in exactly the right way,” and the company is now “stronger, better capitalized than ever.”

Manulife is still in a position to take advantage of acquisition opportunities, he added. “The company is very comfortably capitalized and there's no reason it shouldn't look at opportunities.”

During a conference call with analysts, Mr. D'Alessandro acknowledged he had asked the Office of the Superintendent of Financial Institutions, which regulates banks and insurers in Canada, to change certain capital rules as the firm faced the prospect of having to tap equity markets for an infusion.

The problem was Manulife's large exposure to global stock markets, which shaved $574-million off of its earnings this quarter.

The insurer has significant exposure to global equity markets because of its significant variable annuity and segregated funds business. It sells products that are roughly equivalent to private pension plans for individual investors, where Manulife takes customers' money, invests it in market funds, and promises payments and guaranteed benefits down the road in return for a fee.

When markets drop, Manulife must build up reserves to protect against any potential shortfall in the amount it has promised to pay customers in the future.

If markets turn around, it can reverse that.

The company's executives decided to stop hedging its exposure to stock markets in 2004.

OSFI decided last week to grant Manulife's request and change the rules that govern how much money insurers must put aside to support their segregated funds businesses, giving Manulife's capital levels a lift. The prior rules were “severe,” Mr. D'Alessandro said, requiring the company to sock away high levels of money now for payments that wouldn't come due for decades.

The changes put Manulife's capital levels at the high end of its target range, but not at a level the insurer would be comfortable with if markets continued to drop, he said in the interview: “We wanted to be well capitalized beyond anybody's doubts.”

So the company arranged a $3-billion five-year loan from Canada's big six banks, which it plans to fully draw down by Nov. 20.

Citibank analyst Colin Devine lobbed tough questions at Mr. D'Alessandro about the company's risk management systems on a conference call on Thursday.

“You're entitled to your view, Colin, that it was a breakdown,” Mr. D'Alessandro said. “We didn't expect the volatility in the markets that actually transpired, we didn't expect the markets to be as unsettled as they turned out, we didn't expect all of these financial institutions to fail. In one week we had a massive reorganization of the financial sector. Maybe you guys saw it at Citibank, but we didn't see it.”

Manulife estimates that its “minimum continuing capital and surplus requirements” ratio, or MCCSR, is now at about 225 per cent.

That's above its target range of 180 to 200 per cent, and the regulatory minimum of 150 per cent.

Mr. D'Alessandro said the firm could withstand a drop of 25 to 30 per cent in global equity markets before touching its target range.

He noted that navigating the proper capital levels is a tough decision.

“If we had had twice the capital at the beginning of this, people would have been criticizing that we're under-deploying and inefficient in managing [shareholders'] money,” he said.

The company chose to hold its risk in equity markets, he added.

“All in all, we've come out of this a heck of a lot better than just about anybody in our industry, frankly.”