19 September 2008

Implications of AIG's Woes

Scotia Capital, 19 September 2008

Great-West Lifeco Discloses AIG Exposure


• This morning GWO disclosed what we believe to be very manageable LEH and AIG exposure.

What It Means

• In total we estimate LEH and AIG exposure will amount to a $0.14 EPS hit for GWO (versus $0.16-$0.18 for MFC, $0.44 for SLF, and $0.05 for IAG).

• GWO's $101 million LEH bond exposure, with a 75% write-down assuming one-half senior (60% write-down) and one-half sub debt (90% write-down) translates into a $0.05 EPS hit.

• AIG holdco bond exposure, assuming a 60% write-down, translates into a $0.06 EPS hit and its $116 million AIG op.co. bond exposure, at a 40% writedown, translates into a $0.03 EPS hit. We believe the estimated write-downs on AIG are very conservative especially given that FNM/FRE (also rescued by the Fed) are trading above 80 cents on the dollar.

• GWO also disclosed $85 million AIG credit derivatives "in the money," which could be interest rate swaps, and likely are not CDS related.

Manuife Discloses AIG Exposure


• Based on the company disclosure we estimate a $0.10-$0.12 EPS hit for MFC for LEH, and a $0.04 EPS hit for AIG (not far off our $0.07 and $0.02 original pre-disclosure estimates).

What It Means

• LEH bond exposure is $380 million (our original estimate was $260 million). If 1/2 subordinate, 1/2 senior, a 75% write-down is a $0.10-$0.12 EPS hit.

• For AIG, just $47M in bonds at the troubled holdco, and $212M at the "healthy and solvent" (as per NAIC) operating insurance companies. Conservatively assuming a 60% write-down for holdco bonds and 40% writedown for op. co. bonds (FNM/FRE bonds are 80 cents/dollar post Fed rescue) gives $0.04 EPS hit. MFC also has $85M in AIG derivatives, largely interest rate swaps and not toxic CDS.

• SLF LEH bond exposure, at $334M, disclosed Monday, translates into a $0.28 hit. Wamu bond exposure, downgraded to junk yesterday by S&P, is $41M (as per MFC disclosure or $0.01 EPS hit), but NAIC filings show $227M ($0.13 EPS hit) for SLF, which remains silent on AIG and Wamu. GWO, no disclosure yet, looks relatively clean, based on NAIC filings.

Sun Life Discloses AIG Exposure


• We estimate a $0.16 EPS hit from the company's AIG exposure, which combined with a $0.28 hit from Lehman exposure, could result in a $0.44 EPS hit in Q3/08.

What It Means

• Using the same metrics as we outlined for MFC we get a $0.16 EPS hit (as opposed to $0.04 for MFC). That takes a 60% write-down on SLF's AIG holdco bond exposure of $88 million, and a 40% write-down on SLF's AIG operating company bond exposure of $227 million.

• Release also cites deminimus AIG derivative exposure

• No word of Washington Mutual bond exposure yet from SLF where NAIC filings show $227 million, which, assuming a 50% write-down translates into an additional $0.13 EPS hit. MFC has disclosed $41 million in Washington Mutual bonds, with a 50% write-down translating into a $0.01 EPS hit.

• Estimated Lehman and AIG EPS hits for MFC are $0.04 and $0.10-$0.12, respectively.
The Globe and Mail, Boyd Erman & Tara Perkins, 16 September 2008

Manulife Financial Corp., moving to reassure investors nervous about its links to teetering insurer American International Group Inc., said late Tuesday that it has $343-million of investments and derivatives linked to AIG.

Speculation had intensified about Manulife's exposure, along with that of Great-West Life, because the two firms had not responded Tuesday to questions about it, while rival Sun Life Financial Inc. disclosed on Monday that it has $334-million (U.S.) in Lehman Brothers Holdings Inc. bonds.

Manulife, in a release late Tuesday, said that in addition to the exposure to AIG, it had $395-million of bonds and derivatives related to Lehman Brothers Holdings Inc., which filed for bankruptcy on Monday, and $41-million of exposure to Washington Mutual.

Manulife said the exposures in total represent 0.5 per cent of the company's $164-billion in assets.

“In avoiding the perils of many other parts of the capital market, we made the decision to invest in what were deemed to be highly-rated, sophisticated and regulated financial institutions,” said Donald Guloien, Manulife's chief investment officer and the CEO-designate. “While these developments are extremely disappointing, to date we have avoided the worst problems in the credit markets and our track record remains exemplary.”

The relatively small exposures will likely be viewed as good news by the market, especially if Manulife is also successful in buying businesses from AIG as it tries to raise cash.

“The ideal outcome for [Manulife] would be one in which the company's exposure to AIG and [Lehman] is modest (no more than $300-$400-million to each) and the company successfully bids for AIG's annuity business or certain Asian businesses,” Genuity Capital Markets analyst Mario Mendonca wrote in a note to clients Tuesday.

BMO Capital Markets analyst John Reucassel said in a note to investors that Manulife may hold as much as $1.36-billion in debt sold by American International Group Inc. and three other troubled financial institutions, according to a Bloomberg report.

Separately, a spokesman for Fairfax Financial Holdings confirmed Tuesday the Toronto-based insurance conglomerate holds credit default swaps on AIG.

The swaps are essentially bets that AIG's financial condition will worsen, and have been rising in value. Fairfax had made numerous similar bets on financial institutions, a move that has proved profitable as the credit crunch has played out.
Bloomberg, Sean B. Pasternak, 16 September 2008

Manulife Financial Corp., Canada's largest insurer, may hold as much C$1.36 billion ($1.27 billion) in debt sold by American International Group Inc. and three other ``troubled'' U.S. financial institutions, according to BMO Capital Markets.

The holdings, based on 2007 filings, represent about 0.8 percent of Manulife's invested assets, BMO Capital Markets analyst John Reucassel wrote today in a note to investors. The figure includes investments in Lehman Brothers Holdings Inc., Washington Mutual Inc. and Wachovia Corp., he said.

Canadian banks plunged for a second day following the bankruptcy of Lehman Brothers and the credit downgrade of AIG, the country's biggest insurer. Canadian insurers including Manulife, Sun Life Financial Inc. and Great-West Lifeco Inc. also declined, though the Canadian firms have escaped with few debt writedowns.

``While the Canadian lifecos cannot avoid all of these problems, we continue to expect them to outperform their global peers,'' Reucassel wrote in the note.

Manulife fell C$1, or 2.7 percent, to C$36 at 4:10 p.m. trading on the Toronto Stock Exchange. Sun Life fell 40 cents to C$38.91. Great-West dropped 20 cents to C$31.51.

Manulife's debt holdings at Dec. 31 included C$196 million with AIG, C$328 million with Lehman and C$727 million at Wachovia.

Sun Life, the country's third-largest insurer, disclosed yesterday it may report a charge in the third quarter from C$334 million in bond securities and C$15 million in derivatives contracts linked to Lehman.

Toronto-based Sun Life also owns about 400,000 Lehman Brothers shares and about 1 million AIG shares through its MFS unit, while Great-West, based in Winnipeg, Manitoba, holds 12 million Lehman shares and 14 million AIG shares through its Putnam Investments unit, the BMO Capital analyst said.

Sun Life spokesman Steve Kee declined to comment on specific holdings, while Manulife spokeswoman Laurie Lupton and Great-West spokeswoman Marlene Klassen didn't return calls seeking comment.

Toronto-Dominion Bank, the country's second-largest lender by assets, said its investments tied to AIG won't impact the Toronto-based bank.

``Our exposure is within reasonable limits and a potential failure of AIG would have no material impact'' on the overall operations, spokesman Nicholas Petter said in an e-mailed statement.

Royal Bank of Canada, the country's largest lender, had its biggest decline in almost a month, dropping C$1.60, or 3.3 percent, to C$46.50. The stock earlier plunged as much as 6.2 percent.

``We manage and diversify our exposures in a variety of ways, including limiting our exposure to any single name and to any single sector,'' Royal Bank spokeswoman Beja Rodeck said in an e-mailed statement.

Toronto-based Manulife and other Canadian insurers may be in a position to buy assets disposed by AIG, Lehman Brothers and others, RBC Capital Markets analyst Andre-Philippe Hardy said yesterday.

``Manulife is in a strong position to acquire these assets, in our view, given its existing expertise and scale in the market, and would likely be interested,'' Hardy wrote.

Still, Canadian insurers may be in no rush to buy troubled U.S. assets, said Gavin Graham, director of investments at BMO Asset Management in Toronto, which manages about C$54 billion in assets, including insurers.

``I can't imagine there's any urgency on the part of any potential purchaser,'' Graham said. ``Especially if things continue to unwind, you might be able to buy those in a few weeks anyway."
Scotia Capital, 16 September 2008


• From what we can gather the Canadian lifecos have immaterial exposure to AIG bonds or any AIG counterparty risk. FFH stands to benefit significantly from AIG's woes.

What It Means

• Risk to AIG bonds and any counterparty appears to be very insignificant for Canadian lifecos with U.S. statutory year end filings showing zero for SLF and GWO and less than $10 million for MFC in bonds and less than $20 million in counterparty risk on what appears to be swaps on treasuries written through AIG's Financial products division.

• Industrial-Alliance though has $15.8 million in AIG bonds ($0.13 after-tax in EPS), disclosed by the company this morning.

• We believe Fairfax has $1 billion (notional amount) in AIG CDS, with a market value of $300 million, up from $135 million at June 30, 2008. That increase translates into $6 per FFH share in Q3/08.
Dow Jones, 16 September 2008

Royal Bank of Canada leading Canadian peers lower as worries about the health of AIG sparks fear the banks could have to take charges on their exposure to AIG as a counterparty. Genuity Capital Markets says RY stands out as credit spreads widen because of its large US credit trading business. And RBC Capital Market says if the banks are exposed to price movements on a notional C$441B in CDOs, "trading losses would very likely follow and risk weighted assets would jump as finding a counter-party to take on exposure to CDOs at this time would be much more difficult."