Scotia Capital, 6 November 2009
Q3/09 Misses on Credit - Significantly lowering EPS
• A miss, once again on larger credit hits than expected. A noisy quarter, with credit hits $0.10 higher than expected and the gain from equity markets $0.07 less than expected.
• Underlying EPS somewhere between $0.67 and $0.72 - our estimate was $0.72. Details are shown in Exhibit 1. SLF management suggests the underlying may be closer to $0.72, claiming an investment underperformance of $0.05 in EPS, that should be made up in the near term as SLF enhances yield.
• Credit woes continue. EPS hits for credit continue to disappoint, but the pace declines, totalling $0.35 in Q3/09, down from $0.78 EPS in Q2/09 and $0.44 in Q1/09. Of concern is a $4.4B structured products portfolio (just 4% of invested assets) which accounted for about half the credit hits in the quarter. This portfolio was 96% investment grade in Q1/09, falling to 95% in Q2/09 and 90% in Q3/09, with a 5% decline in overall market value. Slippage is largest in the non-agency RMBS portfolio (MV $931 million, 83% investment grade, down from $1B and 89% investment grade in Q2/09), and the CDO/Other ABS portfolio (MV $749 million, 76% investment grade, down from $796 million and 85% at Q2/09).
• Significantly reducing 2010E EPS in light of a more conservative credit outlook and management's view of 2010 "normalized" EPS. Management's $2.50-$3.03 2010 "normalized" earnings exercise (which excludes experience gains and assumption changes, which together have averaged about $0.30 EPS annually since 2004) will likely force down consensus from its $3.10 level (in line with our estimate). We outline our approach to a $2.80 2010E EPS estimate in Exhibit 2, which assumes equity markets will end 2010 at S&P 500 of 1,150, up 10% over 2009. We've assumed experience losses of $0.30, primarily credit driven, and no assumption
• U.S. sales were strong - but expect U.S. VA sales momentum to decline as company de-risks product - Canadian sales mixed, but momentum improving. SLF's momentum continued in the U.S. with U.S. domestic VA sales up 128% YOY and 32% QOQ (we expect momentum to turn negative in Q4 as the company de-risks the product, Q3/09 sales were likely strong in anticipation of a price cut), and core U.S. individual life sales up 23% YOY. Canadian sales were somewhat mixed, but momentum is improving, with individual insurance sales flat YOY (top 4 were up 7%) and down 10% QOQ (top 4 were up 3%), and wealth management sales down 13% YOY and down 14% QOQ.
• Solid quarter for MFS. $7.7B in net sales ($1.9B retail and $5.8B institutional) and margins, at 28%, were up from 23% at Q2/09 and 21% at Q1/09.
• Capital position remains strong. We estimate the MCCSR for SLF's Canadian subsidiary, at 219%, can withstand a 35%-40% drop in equity markets before it hits 200%. That said, we can't say the same with confidence about SLF's U.S. subsidiary (about 1/4 the company's total capital and 40% of the company's total equity market risk) which required $1B in capital in late 2008/early 2009. We expect the holdco has some capital, although it will likely decline by $400 million in Q4/09 to pay for Lincoln's U.K. block.
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Q3/09 Misses on Credit - Significantly lowering EPS
• A miss, once again on larger credit hits than expected. A noisy quarter, with credit hits $0.10 higher than expected and the gain from equity markets $0.07 less than expected.
• Underlying EPS somewhere between $0.67 and $0.72 - our estimate was $0.72. Details are shown in Exhibit 1. SLF management suggests the underlying may be closer to $0.72, claiming an investment underperformance of $0.05 in EPS, that should be made up in the near term as SLF enhances yield.
• Credit woes continue. EPS hits for credit continue to disappoint, but the pace declines, totalling $0.35 in Q3/09, down from $0.78 EPS in Q2/09 and $0.44 in Q1/09. Of concern is a $4.4B structured products portfolio (just 4% of invested assets) which accounted for about half the credit hits in the quarter. This portfolio was 96% investment grade in Q1/09, falling to 95% in Q2/09 and 90% in Q3/09, with a 5% decline in overall market value. Slippage is largest in the non-agency RMBS portfolio (MV $931 million, 83% investment grade, down from $1B and 89% investment grade in Q2/09), and the CDO/Other ABS portfolio (MV $749 million, 76% investment grade, down from $796 million and 85% at Q2/09).
• Significantly reducing 2010E EPS in light of a more conservative credit outlook and management's view of 2010 "normalized" EPS. Management's $2.50-$3.03 2010 "normalized" earnings exercise (which excludes experience gains and assumption changes, which together have averaged about $0.30 EPS annually since 2004) will likely force down consensus from its $3.10 level (in line with our estimate). We outline our approach to a $2.80 2010E EPS estimate in Exhibit 2, which assumes equity markets will end 2010 at S&P 500 of 1,150, up 10% over 2009. We've assumed experience losses of $0.30, primarily credit driven, and no assumption
• U.S. sales were strong - but expect U.S. VA sales momentum to decline as company de-risks product - Canadian sales mixed, but momentum improving. SLF's momentum continued in the U.S. with U.S. domestic VA sales up 128% YOY and 32% QOQ (we expect momentum to turn negative in Q4 as the company de-risks the product, Q3/09 sales were likely strong in anticipation of a price cut), and core U.S. individual life sales up 23% YOY. Canadian sales were somewhat mixed, but momentum is improving, with individual insurance sales flat YOY (top 4 were up 7%) and down 10% QOQ (top 4 were up 3%), and wealth management sales down 13% YOY and down 14% QOQ.
• Solid quarter for MFS. $7.7B in net sales ($1.9B retail and $5.8B institutional) and margins, at 28%, were up from 23% at Q2/09 and 21% at Q1/09.
• Capital position remains strong. We estimate the MCCSR for SLF's Canadian subsidiary, at 219%, can withstand a 35%-40% drop in equity markets before it hits 200%. That said, we can't say the same with confidence about SLF's U.S. subsidiary (about 1/4 the company's total capital and 40% of the company's total equity market risk) which required $1B in capital in late 2008/early 2009. We expect the holdco has some capital, although it will likely decline by $400 million in Q4/09 to pay for Lincoln's U.K. block.
