Scotia Capital, 6 November 2009
Q3/09 Misses but Underlying EPS in Line
• A miss on larger reserve hits than expected (interest and lapse related) - but underlying EPS in line. As expected Q3/09 was noisy. Details are outlined in Exhibit 1. We were relatively impressed that the underlying EPS was in line with our estimate, and was 4% higher QOQ than the underlying EPS of $0.48 in Q2/09. Credit hits continue to be low and very manageable.
• Economic backdrop improves for Q4/09 - could finally be a "noiseless" quarter. With an annual detailed assumption review behind us (proactively putting the lapse issue to bed), long term interest rates rising (corporate yields are up 20 bp since Sep 30), equity markets generally less volatile, and credit hits diminishing ($0.07 EPS in Q3/09, versus $0.13 in Q2/09 and $0.29 in Q1/09), Q4/09 is shaping up to be a much welcomed "quieter" quarter, something all lifecos need to improve earnings visibility.
• Sales were mixed as MFC de-risks and rebalances product mix - we were encouraged by rebound in individual insurance sales - suggest brand and franchise remains strong. Individual insurance sales regained momentum, especially in the U.S., with sales up 19% QOQ (peers up 8%) and down 4% YOY (peers down 10%). In Canada momentum returned as well, with individual insurance sales down 2% YOY (top 4 up 7%) but up 5% QOQ (top 4 up 3%). Asia remains impressive with Japan individual insurance sales up 22% YOY and Asia (ex Japan) individual insurance sales up 11%. YOY. Wealth management sales excluding variable annuities were impressive, up 51% YOY in Asia and down just 2% YOY in Canada (slightly better than the industry). The U.S. and Japan VA sales remain weak as MFC de-risks its portfolio, down 63% YOY in the U.S. and down 68% YOY in Japan.
• 30% of total VA book is now hedged. MFC took advantage of attractive terms and hedged another $3.8B (in Canada), as the percentage of the total VA book now hedged climbed from 20% at Q4/08 to 30% as at Q3/09. We believe a 100% hedge undertaking is far too costly in this current environment, and essentially throws a lot of money at what could possibly be yesterday's problem. We believe the company is providing a far less costly and more shareholder friendly solution through de-risking the product mix, opportunistically hedging, and minimizing sensitivity of its capital base through a subsidiary reorganization. Maybe somewhere down the road up to 70% of the book may be hedged, but certainly not at these market levels.
• Sub-reorg reduces capital sensitivity. We estimate that after the sub-reorganization, the consolidated MCCSR would be 226% (including $1B at holdco), with each 10% move in equity markets hurting the MCCSR by 11 points. That means this consolidated MCCSR will not fall below 200% unless the S&P500 falls to 790.
• Decreasing 2010E EPS by $0.10 to reflect credit a modest expected $0.10 EPS credit hit. We've made similar credit adjustments across all the big three Canadian lifecos, as we're moving to a more conservative stance. Exhibit 2 outlines the development of our 2010E $2.20 EPS estimate. We essentially see a 2% quarterly increase in underlying EPS each quarter (conservatively less than the 4% in Q3/09) commensurate with a 2% quarterly increase in equity markets, with net experience gains of $0.05 in EPS, in part due to equity markets expected to be up 10% next year. Experience gains/assumption changes have generally averaged $0.59 annual EPS since 2004.
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Q3/09 Misses but Underlying EPS in Line
• A miss on larger reserve hits than expected (interest and lapse related) - but underlying EPS in line. As expected Q3/09 was noisy. Details are outlined in Exhibit 1. We were relatively impressed that the underlying EPS was in line with our estimate, and was 4% higher QOQ than the underlying EPS of $0.48 in Q2/09. Credit hits continue to be low and very manageable.
• Economic backdrop improves for Q4/09 - could finally be a "noiseless" quarter. With an annual detailed assumption review behind us (proactively putting the lapse issue to bed), long term interest rates rising (corporate yields are up 20 bp since Sep 30), equity markets generally less volatile, and credit hits diminishing ($0.07 EPS in Q3/09, versus $0.13 in Q2/09 and $0.29 in Q1/09), Q4/09 is shaping up to be a much welcomed "quieter" quarter, something all lifecos need to improve earnings visibility.
• Sales were mixed as MFC de-risks and rebalances product mix - we were encouraged by rebound in individual insurance sales - suggest brand and franchise remains strong. Individual insurance sales regained momentum, especially in the U.S., with sales up 19% QOQ (peers up 8%) and down 4% YOY (peers down 10%). In Canada momentum returned as well, with individual insurance sales down 2% YOY (top 4 up 7%) but up 5% QOQ (top 4 up 3%). Asia remains impressive with Japan individual insurance sales up 22% YOY and Asia (ex Japan) individual insurance sales up 11%. YOY. Wealth management sales excluding variable annuities were impressive, up 51% YOY in Asia and down just 2% YOY in Canada (slightly better than the industry). The U.S. and Japan VA sales remain weak as MFC de-risks its portfolio, down 63% YOY in the U.S. and down 68% YOY in Japan.
• 30% of total VA book is now hedged. MFC took advantage of attractive terms and hedged another $3.8B (in Canada), as the percentage of the total VA book now hedged climbed from 20% at Q4/08 to 30% as at Q3/09. We believe a 100% hedge undertaking is far too costly in this current environment, and essentially throws a lot of money at what could possibly be yesterday's problem. We believe the company is providing a far less costly and more shareholder friendly solution through de-risking the product mix, opportunistically hedging, and minimizing sensitivity of its capital base through a subsidiary reorganization. Maybe somewhere down the road up to 70% of the book may be hedged, but certainly not at these market levels.
• Sub-reorg reduces capital sensitivity. We estimate that after the sub-reorganization, the consolidated MCCSR would be 226% (including $1B at holdco), with each 10% move in equity markets hurting the MCCSR by 11 points. That means this consolidated MCCSR will not fall below 200% unless the S&P500 falls to 790.
• Decreasing 2010E EPS by $0.10 to reflect credit a modest expected $0.10 EPS credit hit. We've made similar credit adjustments across all the big three Canadian lifecos, as we're moving to a more conservative stance. Exhibit 2 outlines the development of our 2010E $2.20 EPS estimate. We essentially see a 2% quarterly increase in underlying EPS each quarter (conservatively less than the 4% in Q3/09) commensurate with a 2% quarterly increase in equity markets, with net experience gains of $0.05 in EPS, in part due to equity markets expected to be up 10% next year. Experience gains/assumption changes have generally averaged $0.59 annual EPS since 2004.
