Category: Issue Comments

Issue Comments

IAG Silent on Regulatory Change

Industrial Alliance has released its third quarter financials, and managed to do so without mentioning any prospects for regulatory change. This is the same policy as was followed with the 2Q10 Shareholders’ Report.

However, it was another good quarter:

Top-line growth in the third quarter continued to show strong momentum. Premiums and deposits increased 15% to $1.4 billion and the value of new business rose 44% to $41.4 million. For the nine-month period, premiums and deposits were up 31% over 2009 and 7% over 2007 – the Company’s record year. This growth is fuelled primarily by the Individual Wealth Management sector that continues to benefit from stock market gains and high net sales.
…
Top-line growth in the third quarter continued to be strong for the fourth quarter in a row. Almost all sectors contributed to this growth, with Individual Wealth Management in the lead as a result of the upswing in equity markets. For the period ended September 30th, this sector had gross sales of $686.7 million, up 29% over the previous year, and net sales of $243.3 million, up 52% over 2009. For the first nine months of 2010, Industrial Alliance ranked second in Canada for net sales of segregated funds, with a 34.1% market share, and fifth in terms of net mutual fund sales.

There are a few changes planned for their asset mix and hedging practice:

Management has taken a number of initiatives to reduce its sensitivity to interest rate risk. These initiatives are in the process of being implemented and will include a 5% increase in the proportion of stocks backing long-term liabilities. Had these initiatives been in place at September 30, 2010, the Company expects that it would be able to absorb a 15% decline in equity markets and that provisions for future policy benefits would not have to be strengthened as long as the S&P/TSX remains above 10,500 points.

Additionally, as part of its risk management process, the Company has implemented a dynamic hedging program to manage the equity risk related to its guaranteed annuity (GMWB) product, effective October 20th, 2010. The GMWB portfolio represents approximately $1.5 billion of assets under management, including $900 million in equities. The Company also entered into a reinsurance agreement during the third quarter to share 60% of the longevity risk related to its $2.5 billion insured annuity block of business.

As far as current sensitivities are concerned:

The Company’s sensitivity analysis varies from one quarter to another according to numerous factors, including changes in the economic and financial environment and the normal evolution of the Company’s business. The results of these analyses show that the leeway the Company has to absorb potential market downturns remains very high overall.

At September 30, 2010, the analysis was as follows:

  • Stocks matched to the long-term liabilities – The Company believes that it will not have to strengthen its provisions for future policy benefits for stocks matched to long-term liabilities as long as the S&P/TSX index remains above 9,400 points.
  • Solvency ratio – The Company believes that the solvency ratio will stay above 175% as long as the S&P/TSX index remains above 7,650 points, and will stay above 150% as long as the S&P/TSX index remains above 6,450 points.
  • Ultimate reinvestment rate (“URR”) – The Company estimates that a 10 basis point decrease (or increase) in the ultimate reinvestment rate would require the provisions for future policy benefits to be strengthened (or would allow them to be released) by some $44 million after taxes.
  • Initial reinvestment rate (“IRR”) – The Company estimates that a 10 basis point decrease (or increase) in the initial reinvestment rate would require the provisions for future policy benefits to be strengthened (or would allow them to be released) by some $25 million after taxes.

They estimate that a sudden 10% decline in equity markets would take $18-million off their net income; unfortunately, they neither provide pro-forma figures reflecting the asset mix changes, nor provide estimates of the effect of larger equity market declines – which will, of course, not be proportional to the adverse effect of such a normal correction.

Issue Comments

SLF Coy on Capital Rule Changes

Sun Life Financial has released its 3Q10 Financials. They had a decent – not great – quarter, but I’m more interested in their commentary on the capital rules:

In Canada, the Office of the Superintendent of Financial Institutions Canada (OSFI) is considering a number of changes to the insurance company capital rules, including new guidelines that would establish stand-alone capital adequacy requirements for operating life insurance companies, such as Sun Life Assurance, and that would update OSFI’s regulatory guidance for non-operating insurance companies acting as holding companies, such as Sun Life Financial Inc.

These proposals from the US Treasury (hopping mad about AIG) are now over a year old and can’t be implemented too soon according to me. Julie Dickson alluded to the possibility in a speech.

In addition, OSFI may change the definition of available regulatory capital for determining regulatory capital to align insurance definitions with any changed definitions that emerge for banks under the proposed new Basel Capital Accord.

Presumably this (mainly) refers to efforts to make the loss-absorption potential of regulatory capital more explicit (although the proposals are framed in such a way that it simply represents a regulatory-political end-run around the bankruptcy courts).

OSFI is considering more sophisticated risk-based modeling approaches to Minimum Continuing Capital and Surplus Requirements (MCCSR), which could apply to segregated funds and other life insurance products. In particular, OSFI is considering how advanced modeling techniques can produce more robust and risk-sensitive capital requirements for Canadian life insurers. This process includes internal models for segregated fund guarantee exposures. On October 29, 2010 OSFI released a draft advisory, for consultation with the industry and other stakeholders, setting out revised criteria for determining segregated fund capital requirements using an approved model. It is proposed that the new criteria, when finalized, will apply to qualifying segregated fund guarantee models for business written on or after January 1, 2011. The Company is in the process of reviewing the advisory to determine the potential impact of the proposed changes, and will continue to actively participate in the accompanying consultation process.

It is very disappointing that they are not more specific, given that implementation is two months’ away.

In particular, the draft advisory on changes to existing capital requirements in respect of new segregated fund business may result in an increase in the capital requirements for variable annuity and segregated fund policies currently sold by the Company in the United States and Canada on and after the date the new rules come into effect. The Company competes with providers of variable annuity and segregated fund products that operate under different accounting and regulatory reporting bases in different countries, which may create differences in capital requirements, profitability and reported earnings on these products that may cause the Company to be at a disadvantage compared to some of its competitors in certain of its businesses. In addition, the final changes implemented as a result of OSFI’s review of internal models for in-force segregated fund guarantee exposures may materially change the capital required to support the Company’s in-force variable annuity and segregated fund guarantee business.

Scary words, but no meat in the sandwich.

Similar was their commentary on the proposed rules regarding hedging:

On July 30, 2010 the International Accounting Standards Board (IASB) issued an exposure draft for comment, which sets out recognition, measurement and disclosure principles for insurance contracts. The insurance contracts standard under IFRS, as currently drafted, proposes that liabilities be discounted at a rate that is independent of the assets used to support those liabilities. This is in contrast to current rules under Canadian GAAP, where changes in the measurement of assets supporting actuarial liabilities is largely offset by a corresponding change in the measurement of the liabilities.

The Company is in the process of reviewing the exposure draft, and is working with a number of industry groups and associations, including the Canadian Life and Health Insurance Association, which submitted a comment letter to the IASB on October 15, 2010. It is expected that measurement changes on insurance contracts, if implemented as drafted, will result in fundamental differences from current provisions in Canadian GAAP, which will in turn have a significant impact on the Company’s business activities. In addition, the IASB has a project on accounting for financial instruments, with changes to classification, measurement, impairment and hedging. It is expected the mandatory implementation of both these standards will be no earlier than 2013.

The IASB continues to make changes to other IFRSs and has a number of ongoing projects. The Company continues to monitor all of the IASB projects that are in progress with regards to the 2011 IFRS changeover plan to ensure timely implementation and accounting.

The proposed new standard has been discussed on PrefBlog. The CLHIA letter does not appear to have been made public by the CLHIA but has been published by IFRS. I can’t say I find the CLHIA arguments – or those of the sell-side analysts quoted in the appendix – particularly convincing. It boils down to another round of the market-value vs. historical cost debate, but they spend more time discussing why fair value will be so inconvenient than on why it is inferior.

As far as earnings are concerned:

Sun Life Financial reported net income attributable to common shareholders of $453 million for the quarter ended September 30, 2010, compared to a loss of $140 million in the third quarter of 2009. Net income in the third quarter of 2010 was favourably impacted by $156 million from improved equity market conditions, and $49 million from assumption changes and management actions. The Company increased its mortgage sectoral allowance by $57 million, which reduced net income by $40 million, in anticipation of continued pressure in the U.S. commercial mortgage market, however overall credit experience continued to show improvement over the prior year. The net impact from interest rates on third quarter results was not material as the unfavourable impact of lower interest rates was largely offset by favourable movement in interest rate swaps used for asset-liability management.
…
In its interim MD&A for the third quarter of 2009, the Company provided a range for its “estimated 2010 adjusted earnings from operations”(2) of $1.4 billion to $1.7 billion. Based on the assumptions and methodology used to determine the Company’s estimated adjusted earnings from operations, the Company’s adjusted earnings from operations for the third quarter of 2010 were $353 million and $1,087 million for the nine months ended September 30, 2010. Additional information can be found in this news release under the heading Estimated 2010 Adjusted Earnings from Operations.

So it looks like, at best, they’re going to just squeeze in to the bottom of that range.

Q3 2010 adjusted earnings from operations

($ millions) Q3’10
————————————————————————-
Adjusted earnings from operations(1) (after-tax) 353
Adjusting items:
Net equity market impact 156
Management actions and updates to actuarial estimates and
assumptions 49
Tax 16
Sectoral allowance in anticipation of continued pressure in
the U.S. commercial mortgage market (40)
Net interest rate impact (15)
Currency impact (6)
Other experience gains (losses) (includes $32 million
unfavourable mortality/morbidity experience and $4 million
unfavourable credit impact) (60)
————————————————————————-
Common shareholders’ net income 453
————————————————————————-

and

Market risk sensitivities

September 30, 2010
————————————————————————-
Changes in Net income(3)
interest rates(1) ($ millions) MCCSR(4)
————————————————————————-
1% increase 225 – 325 Up to 8 percentage points increase
1% decrease (375) – (475) Up to 15 percentage points decrease
————————————————————————-

Changes in equity markets(2)
————————————————————————-
10% increase 75 – 125 Up to 5 percentage points increase
10% decrease (175) – (225) Up to 5 percentage points decrease
————————————————————————-
————————————————————————-
25% increase 125 – 225 Up to 5 percentage points increase
25% decrease (575) – (675) Up to 15 percentage points decrease
————————————————————————-

Given that the Globe & Mail reports .. :

[UBS analyst Peter] Rozenberg calculated that the weighted average equity markets in the United States, Canada, Japan and Hong Kong increased 9.7 per cent quarter over quarter.

… it is a bit disappointing not to see a better match-up between the published sensitivity to a 10% equity market decline and the adjusting entry in the derivation of operating earnings.

It is also disappointing to see that their commentary on potential regulatory changes is so similar to their commentary in the 2Q10 report.

Issue Comments

SPL.A Wound Up

Mulvihill Pro-AMS RSP Split Share Corp. has announced:

that its shareholders approved a special resolution amending the Articles of the Fund to terminate the Fund in advance of the redemption date originally scheduled for December 31, 2013. As a result of such approval, the Fund will redeem all Class A Shares and Class B Shares on October 29, 2010 for the redemption amounts to which holders are entitled. It is expected that the last trading day for the shares will be October 28, 2010 and the proceeds from the redemption of the Class A Shares and Class B Shares are expected to be paid in approximately 10 business days from the redemption date. No action need be taken by holders of Class A Shares or Class B Shares to receive their redemption amounts.

Given the small size of the Fund, operating costs are becoming a greater burden on the net asset value while
trading liquidity has been significantly reduced. Redeeming all Class A Shares and Class B Shares on October 29, 2010 will preserve value for shareholders. As a result of the redemption, the Class A Shares and Class B Shares of the Fund will be de-listed by the Toronto Stock Exchange.

The NAV of SPL.A was 8.49 as of October 29. As of the June 30, 2010, financial statements the fund value was $8.92-million.

SPL.A was last mentioned on PrefBlog when its credit rating was discontinued by DBRS. SPL.A was tracked by HIMIPref&trades;, but was relegated to the Scraps index at the October 2002 rebalancing on volume concerns. It was downgraded to Pfd-3 by DBRS as of April 9, 2003.

Issue Comments

Best & Worst Performers: October 2010

These are total returns, with dividends presumed to have been reinvested at the bid price on the ex-date. The list has been restricted to issues in the HIMIPref™ indices.

October 2010
Issue Index DBRS Rating Monthly Performance Notes (“Now” means “October 29”)
BAM.PR.O OpRet Pfd-2(low) -1.59% Now with a pre-tax bid-YTW of 3.60% based on a bid of 26.00 and optionCertainty 2013-6-30 at 25.00.
PWF.PR.A Floater Pfd-1(low) -1.13%  
BAM.PR.R FixedReset Pfd-2(low) -0.84% Now with a pre-tax bid-YTW of 4.35% based on a bid of 26.00 and a limitMaturity.
CU.PR.B Perpetual-Premium Pfd-2(high) -0.54% Now with a pre-tax bid-YTW of 4.35% based on a bid o 25.76 and a call 2011-7-1 at 25.25.
SLF.PR.G FixedReset Pfd-1(low) -0.51% Now with a pre-tax bid-YTW of 3.45% based on a bid of 25.28 and a limitMaturity.
… … … … …
BNS.PR.L Perpetual-Discount Pfd-1(low) +4.32% Now with a pre-tax bid-YTW of 5.03% based on a bid of 22.46 and a limitMaturity.
BNS.PR.M Perpetual-Discount Pfd-1(low) +4.55% Now with a pre-tax bid-YTW of 5.02% based on a bid of 22.50 and a limitMaturity.
GWO.PR.I Perpetual-Discount Pfd-1(low) +4.78% Now with a pre-tax bid-YTW of 5.41% based on a bid of 21.03 and a limitMaturity.
BNS.PR.K Perpetual-Discount Pfd-1(low) +5.17% Now with a pre-tax bid-YTW of 5.07% based on a bid of 23.75 and a limitMaturity.
BMO.PR.J Perpetual-Discount Pfd-1(high) +6.49% Now with a pre-tax bid-YTW of 4.91% based on a bid of 22.89 and a limitMaturity.
Issue Comments

BAM.PR.T Debuts Soft on Subdued Volume

Brookfield Asset Management has announced:

the completion of its previously announced Preferred Shares, Series 26 issue in the amount of CDN$250-million. The offering was underwritten by a syndicate of underwriters led by CIBC, RBC Capital Markets, Scotia Capital Inc. and TD Securities Inc.

Brookfield Asset Management issued 10,000,000 Preferred Shares, Series 26 at a price of $25.00 per share, for aggregate gross proceeds of CDN$250,000,000. Holders of the Preferred Shares, Series 26 will be entitled to receive a cumulative quarterly fixed dividend yielding 4.50% annually for the initial period ending March 31, 2017. Thereafter, the dividend rate will be reset every five years at a rate equal to the 5-year Government of Canada bond yield plus 2.31%. The Preferred Shares, Series 26 will commence trading on the Toronto Stock Exchange on October 29, 2010 under the ticker symbol BAM.PR.T.

The net proceeds of the issue will be added to the general funds of Brookfield Asset Management and be used for general corporate purposes.

BAM.PR.T is a FixedReset, 4.50%+231, announced October 21. The issue traded 229,985 shares in a range of 24.60-90 before closing at 24.83-86, 300×200.

Vital statistics are:

BAM.PR.T FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-29
Maturity Price : 23.03
Evaluated at bid price : 24.83
Bid-YTW : 4.16 %
Issue Comments

PIC.PR.A: Capital Units to be Consolidated

Premium Income Corporation has announced:

a consolidation of the Class A shares effective the opening of trading on November 1, 2010. The consolidation will ensure that an equal number of Class A shares and Preferred shares are outstanding subsequent to the special retraction. Each shareholder will receive 0.738208641 new Class A shares for each Class A share held. The total value of a shareholder’s investment will not change, however, the number of Class A shares reflected in the shareholder’s account will decline and the net asset value per share will increase proportionately. Investors are advised that the CUSIP number will change to 740910302. No fractional shares will be issued and shareholders are not required to take any action for the consolidation to be effective.

This is very significant news. The implication is that at least one-quarter of the outstanding PIC.PR.A were retracted – possibly more, depending on how many of the PIC.A capital units were also retracted.

The current Capital Unit NAV is $5.98 as of October 21, so after consolidation will become about $8, implying that Asset Coverage is now in excess of 1.5:1. Credit quality on the preferreds just got a whole lot better!

I confess to being surprised by the size of the retraction given that the month low for the preferreds was 14.90, just a dime under the retraction price. I would have thought more people would sell. One possible explanation is that a large portion of the retraction was by very large holders who were hesitant to unwind a large position in the market; another possibility is that holders with high transaction costs (e.g., clients of full service brokerages) took that into consideration.

PIC.PR.A was last mentioned on PrefBlog when it was downgraded to Pfd-5 last Friday; at that time, downside protection was about 27%. They might want to bump that up a notch now that the retraction implies (given a projected Capital Unit value of $8) downside protection of 35%!

PIC.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

Issue Comments

LFE.PR.A: Warrants Expire Out-of-the-Money

I haven’t seen a press release yet, but LFE.WT, which was issued in January, expired today way, way, way, WAY out of the money.

Exercise price for full units of Canadian Life Companies Split was 15.65, while the NAVPU on October 15 was 13.64.

LFE.PR.A was last mentioned on PrefBlog when the warrant offering was announced. LFE.PR.A is tracked by HIMIPref™, but is relegated to the Scraps index on credit concerns.

Issue Comments

PIC.PR.A: DBRS Downgrades to Pfd-5

DBRS has announced that it:

has today downgraded the rating of the Preferred Shares issued by Mulvihill Premium Canadian Bank (the Company) to Pfd-5 from Pfd-4 (high).

The Company is a split share corporation that initially raised gross proceeds of $100 million in 1996 by issuing Preferred Shares and Class A Shares. The Company invests in a portfolio of common shares (the Portfolio) issued by Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and The Toronto-Dominion Bank.

The Preferred Shares and Class A Shares that are currently outstanding were issued in September 2003 and September 2004, and were scheduled to terminate on November 1, 2010. On August 20, 2010, the Company announced a proposal to extend the term of the Company for an additional seven years. On September 29, 2010, the Company announced that its shareholders had approved a reorganization to extend the term of the Company.

DBRS has completed its review of the Company’s reorganization. The rating of the Preferred Shares has been downgraded to Pfd-5, based on a number of factors:

– The income earned on the Portfolio, net of Company management fees and expenses, does not fully cover the distribution paid to the Preferred Shares. Furthermore, the Company intends to continue to pay quarterly cash distributions on the Class A Shares of $0.15 per share. As a result, there is an annual grind on the net asset value (NAV) of the Portfolio of more than 4%, absent share price appreciation (if any).

– The downside protection available to the Preferred Shares is approximately 27% (as of October 14, 2010). When adjusted to reflect the annual grind on the Portfolio, the downside protection is significantly lower than protection levels commensurate with preferred share ratings in the Pfd-4 rating category.

– There is not a NAV test that suspends distributions to the Class A Shares if the NAV drops below a specified value. Canadian split share companies generally include a NAV test if they pay regular distributions to the Class A Shares (or capital shares) greater than the excess income of the split share company.

The factors above existed prior to the reorganization of the Company; however, the extension of the term of the Company by seven years has increased the length of time for which holders of the Preferred Shares are exposed to grind on the NAV as well as common share price volatility.

PIC.PR.A was last mentioned on PrefBlog when the term extension was approved. There is a retraction right exercisable November 1, but I’m not sure what the notice period is and in any case it will vary according to dealer. However, those wishing to unload will note that the issue closed today at 14.94-99, 5×6, so if you missed it you haven’t missed much.

PIC.PR.A is tracked by HIMIPref™ but is relegate to the Scraps index on credit concerns.

Issue Comments

BPO.PR.P Steady on Heavy Volume

Brookfield Office Properties has announced:

the completion of its previously announced Preferred Shares, Series P issue in the amount of C$300 million. The offering was underwritten by a syndicate led by RBC Capital Markets, CIBC, Scotia Capital Inc. and TD Securities Inc.

Brookfield Office Properties issued 12.0 million Preferred Shares, Series P at a price of C$25.00 per share yielding 5.15% per annum for the initial 6 ½-year period ending March 31, 2017. Net proceeds from the issue will be added to the general funds of Brookfield Office Properties and be used for general corporate purposes, including the possible redemption or repayment of corporate or other obligations. The Preferred Shares, Series P will commence trading on the Toronto Stock Exchange on October 21, 2010 under the ticker symbol BPO.PR.P.

$300-million! Boy, I haven’t seen such an appetite for junk since high-school!

This issue is a FixedReset, 5.15%+300, announced October 13 with an original issue size of $200-million with a $50-million greenshoe; it was biggie-sized to $300-million on the day of announcement.

BPO.PR.P traded 421,226 shares in a range of 24.90-04 before closing at 25.00-01, 15×9.

Vital statistics are:

BPO.PR.P FixedReset YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-21
Maturity Price : 23.09
Evaluated at bid price : 25.00
Bid-YTW : 4.88 %
Issue Comments

WFS.PR.A Downgraded to Pfd-4(low) by DBRS

DBRS has announced that it:

has today downgraded the rating of the Preferred Shares issued by World Financial Split Corp. (the Company) to Pfd-4 (low) from Pfd-4 (high). The rating has been removed from Under Review with Negative Implications, where it was placed on August 12, 2010.
…
The NAV and the dividend income of the Portfolio have declined significantly over the past few years because of the high Portfolio concentration in global financial institutions. The Portfolio does not generate enough income to cover the Preferred Share distributions; however, less than one year remains until the termination of the Company, mitigating the negative impact of the shortfall.

On August 12, 2010, DBRS placed the rating of the Preferred Shares Under Review with Negative Implications, noting that the resolution of the Under Review status would depend on the performance of the Portfolio during August and September. The NAV of the Company generally continued to fluctuate between $11 and $11.50, a significant decline from earlier in 2010. As of September 30, 2010, the NAV of the Company was $11.25, providing downside protection of approximately 11% to the Preferred Shares. As a result of the decreased protection available to the Preferred Shares, the rating has been downgraded to Pfd-4 (low) from Pfd-4 (high).

The final redemption date for both classes of shares issued is June 30, 2011

WFS.PR.A was last mentioned on PrefBlog when it was placed on review-negative by DBRS. WFS.PR.A is tracked by HIMIPref™ but is relegated to the Scraps index on credit concerns.