With low interest rates and weak markets hitting their earnings, UBS Securities Canada Inc. is reducing its price targets for the big life insurers.
In the wake of Sun Life Financial’s pre-announcement of a $621 million loss for the third quarter, UBS says in a new report that lower interest rates and global equity markets are expected to result in large experience losses at both Manulife and Sun Life, although securities gains and higher corporate bond spreads should partially offset some of these losses. Nevertheless, UBS is reducing its price targets for the insurers, due to lower growth, returns and the likelihood that rates stay lower for longer.
“Lower macro growth and higher sovereign risks continue to undermine interest rates, and the short to medium-term outlook for lifecos,” it says. While capital positions are still solid, UBS says an adverse market event would put pressure on capital and leverage ratios.
UBS notes that U.S. 10-year bond yields declined 124 basis points during the quarter, and equity markets dropped 14% from the previous quarter. “We project this will result in experience losses of $2.1 billion for Manulife and $800 million for Sun Life,” it says.
Sun Life’s pre-release of much higher than expected losses was “very discouraging” UBS says, given that its much lower projected sensitivities and a more conservative risk culture. With these losses coming on the heels of gains in the second quarter, despite lower rates and equity markets in that period too, UBS suggests this suggests a lack of transparency. “We think this underlines a lack of visibility and non-linear risks,” it says.
“Furthermore, recent actions by the U.S. Fed to extend lower interest rates for longer, dubbed ‘Operation Twist’, have reduced the outlook for growth, increased hedging costs, and further undermined book value upon which long term values are based. This has also further reduced and pushed out ‘normal’ earnings underlining long term valuation,” it says.
UBS says that the ‘lower for longer’ interest rate environment “continues to remain key, as it fundamentally reduces demand for lifeco products, and reduces earnings, book value, and returns, which directly impacts valuation and outlook.”
As a result, its new one year price target for Manulife is $16 (down from $18), and it is reducing its price target for Sun Life from $28.50 to $25.50, noting, “We think it remains difficult to assign a value much over book,” for the insurers.
“We continue to prefer Canadian banks to Canadian lifecos due to higher growth, much higher returns, much stronger capital generation, much stronger capital, and more visible EPS, with lower risk, which is much less dependent on interest rate and equity market forecasts, which remain difficult for us to project,” it says.
However, it says that if interest rates normalize from 2.16% to 4%, Canadian lifeco stocks could start to look better than banks. Higher rates would also allow for higher dividends and capital deployment, once regulatory uncertainty declines, and macro concerns dissipate. “However, this is not apparent today,” it says.