UBS Securities Canada Inc. is downgrading its view on Canadian life insurers following the U.S. Federal Reserve Board’s suggestion that it will keep rates low through 2014.
In a new research report UBS has gone from a ‘buy’ to a ‘neutral’ call on the big Canadian life insurers, Manulife Financial and Sun Life Financial. And it also reduced its price target on Manulife.
UBS notes that sovereign risk, low economic growth, and global imbalances continue to undermine interest rates, which, in turn, is impairing the outlook for insurers. The Fed’s announcement that it will be maintaining interest rates at exceptionally low levels until at least late 2014, “has negative implications for our earnings and book value”, it says, adding that it expects lower interest rates and increased hedging costs to continue to negatively impact growth, earnings, capital and valuation.
“In general, we think it’s hard to value lifecos over book value given a 10-11% implied return, and asymmetric risks due to rates and markets. However, medium-term there could be more upside should rates improve or conversely downside should markets decline,” it says.
UBS adds that it continues to prefer Canadian banks to Canadian life insurers, “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.”
However, it adds that if interest rates normalize from 2% currently to 4%, Canadian lifeco stocks could look better than banks, as bank growth slows, provisions for credit loss stabilize or increase from below normal levels, and higher rates underpin higher lifeco EPS, returns, and valuations. This could, in turn, underpin higher dividends and capital deployment, once regulatory issues become more certain, and macro concerns dissipate, it says. “However, this is not apparent today,” it notes.