Issue Comments

SLF Placed on Credit Watch Negative by S&P

Standard & Poors has announced:

it placed its ratings, including its ‘AA-‘ counterparty credit rating, on Sun Life Financial Inc. (TSX: SLF; Sun Life Financial) and its insurance operating subsidiaries (Sun Life) on CreditWatch with negative implications. Its key insurance operating subsidiaries would include Sun Life Assurance Co. of Canada and Sun Life Assurance Co. of Canada (U.S.).

“The CreditWatch placement reflects the deteriorating business and macroeconomic conditions that in our opinion are putting increasing pressure on the group’s earnings, investments, and capital adequacy position,” said Standard & Poor’s credit analyst Donald Chu.
…
While we believe that the sale of Sun Life Financial’s 37% stake in CI for C$2.3 billion has allowed it to strengthen its balance sheets at an opportune time, we believe that its fixed-charge coverage ratio is under pressure, and that it has limited room to issue debt or hybrids within the current rating category.

SunLife was recently downgraded by Moody’s following its 4Q08 Results.

SunLife has the following preferreds outstanding: SLF.PR.A, SLF.PR.B, SLF.PR.C, SLF.PR.D & SLF.PR.E.

PrefLetter

February Edition of PrefLetter Released!

The February, 2009, edition of PrefLetter has been released and is now available for purchase as the “Previous edition”. Those who subscribe for a full year receive the “Previous edition” as a bonus.

As previously announced, PrefLetter is now available to residents of British Columbia and Manitoba, as well as Ontario and to entities registered with the Quebec Securities Commission.

Until further notice, the “Previous Edition” will refer to the February, 2009, issue, while the “Next Edition” will be the March, 2009, issue, scheduled to be prepared as of the close March 13 and eMailed to subscribers prior to market-opening on March 16.

PrefLetter is intended for long term investors seeking issues to buy-and-hold. At least one recommendation from each of the major preferred share sectors is included and discussed.

Note: PrefLetter, being delivered to clients as a large attachment by eMail, sometimes runs afoul of spam filters. If you have not received your copy within fifteen minutes of a release notice such as this one, please double check your (company’s) spam filtering policy and your spam repository. If it’s not there, contact me and I’ll get you your copy … somehow!

Note: There have been scattered complaints regarding inability to open PrefLetter in Acrobat Reader, despite my practice of including myself on the subscription list and immediately checking the copy received. I have had the occasional difficulty reading US Government documents, which I was able to resolve by downloading and installing the latest version of Adobe Reader. Should you have a similar problem, I will:

  • eMail you another copy
  • place it on a website for download without eMail
  • try to get it to you as an image file
  • Fax you a copy
  • Mail the damn thing!

Also, note that so far, all complaints have been from users of Yahoo Mail. Try saving it to disk first, before attempting to open it.

Interesting External Papers

Dudley Speaks on TIPS

William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, gave a speech at the Federal Reserve Bank of New York Inflation-Indexed Securities and Inflation Risk Management Conference, New York on 10 February 2009.

He addressed the problems of ex-ante vs. ex-post calculations of the costs of TIPS issuance:

Over the long run – and I mean the very long run – there should be roughly as many downward surprises in inflation performance as upward surprises. But within any relatively short period, such as the last decade, this certainly does not need to be the case. In other words, over such a short period, the outcome of an ex-post analysis can be heavily influenced by which of the two sides – the Treasury or investors – was the lucky recipient of the net inflation surprise that occurred over the period in question. For example, in countries such as the United Kingdom, where inflation declined following the inception of an inflation-linked debt program, ex-post studies generally suggest that these programs have reduced financing costs for these countries.
The fact that the Treasury saved or lost money ex-post is thus not a very reliable guide as to whether the strategic decision to implement a TIPS program has been a good idea. The relevant question is whether the Treasury obtained the financing it needed at a lower ex-ante cost. If the experiment were to be run thousands of times drawing from the underlying distribution of possible inflation outcomes, would Treasury’s costs have been lower, on average, with TIPS or with nominal Treasuries? To conclude on the basis of one coin flip or roll of the dice as ex-post analysis essentially does surely is not the best way to evaluate the respective costs of TIPS issuance versus nominal Treasuries.

… and examined the factors affecting TIPS pricing:

There are two primary factors underlying the relative cost differences:
1) the compensation investors require to hold a security that is less liquid than its nominal counterpart, termed the illiquidity premium, and
2) the insurance value they attach to obtaining protection against inflation risk, known as the inflation risk premium.

[footnote]In addition to these primary factors, TIPS yields also reflect the taxation difference between TIPS and nominal issues, the convexity difference between real and nominal yields and the price of the embedded deflation floor.

… and refers to some Fed analysis:

To determine the impact of the illiquidity premium and inflation risk premium on these results, we decomposed our ex-ante analysis, comparing the breakeven rate of inflation excluding the illiquidity premium in TIPS yields to the SPF forecast. This comparison yields an estimate of the premium investors were willing to pay for inflation protection at previous TIPS auctions. We found an average risk premium estimate of 47 basis points over our sample period. This suggests that the TIPS program does satisfy a real demand that is not met by nominal Treasuries.

It also suggests that if the Treasury were to take steps to shrink the illiquidity premium by, for example, improving secondary market trading in TIPS, this would shift the cost-benefit analysis more firmly in TIPS direction.

[Footnote] We used the illiquidity premium in TIPS yields estimated in D’Amico, Kim and Wei (2008). D’Amico, Kim and Wei calculated the liquidity component for five- and ten-year TIPS yields, which we used to adjust the auction prices for 5- and 10-year TIPS issues. For twenty- and thirty-year TIPS issues, we assumed that the liquidity component is equal to the component for a ten-year security, which in the event that these securities are less liquid than the ten-year note, understates this effect and thus underestimates the risk premium at this horizon. For further information, see Dudley, Roush and Steinberg Ezer (2008).

… and refers to some external studies of extremely hard to quantify benefits:

A few studies have found that an increase in supply in a particular segment of the Treasury yield curve has contributed to a rise in yields. As a result, by issuing securities in a segmented TIPS market, the Treasury may keep realized yields on bill and nominal coupon securities lower than they otherwise would have been.

and, importantly, hints at a process involving larger issues of longer dated TIPS:

I would be willing to make two modest suggestions here. First, it may make sense to emphasize longer-dated TIPS issuance rather than shorter-dated issuance. Analytically, the logic goes as follows. Inflation uncertainty is likely to increase at longer time horizons. Thus, investors are likely to pay a greater premium for inflation protection at longer-time horizons. This implies that the cost savings associated with TIPS are likely to be greater for longer maturities rather than shorter maturities.

This prediction is supported by empirical studies that have examined the premium that investors pay for inflation protection both in the United States and elsewhere. For example, a study by Brian Sack of Macroeconomic Advisors finds that forward breakeven inflation rates increase as maturity lengthens. In contrast, the level of survey-based measures of inflation expectations is quite constant beyond a time horizon of a few years. This means that the difference between forward breakeven inflation and inflation expectations climbs as the time horizon extends. This strongly suggests that the premium investors pay for inflation protection increases as maturities lengthen.

Second, it may make sense to structure the TIPS program in a way that would help reduce the illiquidity premium associated with TIPS relative to on-the-run nominal Treasuries. Some of the current illiquidity premium is likely to shrink as financial markets stabilize. However, further improvements may require a change in either the structure of the TIPS program or the secondary market trading environment.

The notion that issuance of 5-Year TIPS might be halted has been discussed on PrefBlog, as has a BoE Working Paper on the term-structure of inflation indexed bonds.

Reader Initiated Comments

Pref Market Inefficiency Shocks New Player

A newly Assiduous Reader who is also new to the market writes in and says:

Today, RY.PR.P did not trade AT ALL until after 12:00! Is the market for prefs that illiquid? The price also swung from being below the value of RY.PR.R to ending above the value for R. In my opinion ONLY, the price for R should be higher then the price for P if you are a long term investor. Therefore I question my understanding of pricing in this marketplace!

You and me both, brother, you and me both.

This month’s edition of PrefLetter (currently at the Graphic Artist’s Spa, having its hair done and nails manicured) will contain a section with a new pricing model for Fixed-Resets … so I won’t discuss it here. Instead, I will refer to my last post on Sloppy, Sloppy Markets and take another look at a not-entirely-randomly chosen example of market inefficiency in the Pereptual Discount sector.

BMO PerpetualDiscounts
Closing, Feb 13
Issue Annual
Dividend		 Quote Bid Yield-to-Worst Ask Yield-to-Worst
BMO.PR.J 1.125 16.76-80 6.75% 6.74%
BMO.PR.K 1.3125 18.81-94 7.02% 6.97%
BMO.PR.H 1.325 21.46-70 6.21% 6.13%
BMO.PR.L 1.45 20.57-96 7.10% 6.94%

This table presents a difficult question to Efficient Market zealots – who implicitly presume infinite liquidity as part of their efficient market. How on earth is it possible to rationalize the quotation on BMO.PR.H?

We’ll review a little … I estimated in my 2007 essay on convexity that being 15% or more away from the call price was worth about 15bp in yield; that is, a PerpetualDiscount trading at around $21.75 should yield about 15bp less than a similar issue from the same issuer trading at par; the higher coupon / higher price issue should yield more since any gains from a decline in yields should be expected to be called away, while the lower priced issue has a higher potential for capital gains.

We can argue for as long as we like regarding details such as:

  • 15bp yield difference?
  • 15% price range of effect?
  • straight line or curved effect?

but there definitely should be an effect and this effect should be positive. In June of 2008 this relationship went negative … while the curve returned to normal after a little while, it certainly resulted in a poor month for the fund I manage. It is these episodes in which the market defies common sense that make leverage such a dangerous game!

Note also that the ModifiedDuration of PerpetualDiscounts (which is a measure of price sensitivity to yield changes) is – to a first approximation – dependent solely upon the yield of the instrument. Any PerpetualDiscount with a given yield has the same yield risk as any other PerpetualDiscount with the same yield, except as distorted by the potential for calls taking away your winnings. So we can’t use yield-sensitivity as an argument.

In sum, I have to advise my newly Assiduous Reader to relax and enjoy the market inefficiency. Once you have a decent model for prices, you can make good money by exploiting transient anomalies and waiting for them to correct. This will increase your turnover and therefore your commission cost (which concerns a lot of people who are inspired by regulatory emphasis on the Trading Expense Ratio), but all moneymaking endeavors have some kind of cost.

Further examples of inefficiency and pricing models for PerpetualDiscounts will be presented at the seminar on February 26. Or, if you don’t want to do it yourself, you can always consider an investment in my fund, which uses many pricing models to check each other and is always on the prowl for anomalies.

Banking Crisis 2008

Willem Buiter on Bank Guarantees

Willem Buiter once again provides an entertaining analysis of the crisis, with a blog post titled Save banking, not the bankers or the banks; the case of ING. The source of his ire is a Dutch bail-out of ING, which he terms a “guarantee”:

The assistance takes the form of a back-up guarantee facility for a portfolio of $39bn (face value) worth of securitised US Alt-A mortgages. Under the deal, the state shares with ING any gains and losses on this portfolio relative to a benchmark value for the portfolio of $35.1 bn. The shares of the state and ING in any gains/losses are 80% and 20% respectively.

The bank pays a guarantee fee to the state. The state document I saw did not specify the magnitude of the guarantee fee, or how it was arrived at.

The state pays ING a management and funding fee. Again, I don’t know the amount or how it was arrived at (it would be cute, however, if the guarantee fee and the management and funding fee just happened to cancel each other out!).

The other relevant conditionality is that ING is to provide 25 bn euro of additional credit to businesses and households and that there will be no bonuses for 2009 and until a new remuneration policy is adopted. The CEO was told to fall on his sword.

I strongly disagree with the characterization of the facility as a guarantee. According to me, a guarantee will have an asymmetrical reward profile, whereas this has a payoff diagram that looks a whole lot more like 80% ownership. This isn’t a guarantee: this is a futures contract.

Buiter has complaints about the strike price of the contract:

The guarantee is a good deal for ING and a bad deal for the tax payer because the market valuation of the Alt-A portfolio did not imply the 10% discount (from $39 bn to $ 35.1 bn) that was used to define the reference value for the guarantee, but a 35% discount (from $39 bn to $25.4bn). It is possible that the hold-to-maturity value of the portfolio (the present discounted value of its current and future cash flows, discounted at an interest rate that is not distorted by illiquidity premia, is $35.1 bn or more. Possible, but not likely.

It is possible that the guarantee fee appropriately prices the risk assumed by the state. Until I see the numbers and can verify the assumptions on which they are based, I consider it possible but not likely.

Dr. Buiter prefers a good bank / bad bank solution, blithely skipping over the question of asset value determination:

The good bank would take the deposits of ING and purchase any of the good assets of ING it is interested in.

The valuation of these good assets would not represent a problem, because part of the definition of ‘good asset’ is that there either is a liquid market price for it or, in the case of non-traded assets, that the buyer can determine their value in a straightforward and transparent manner. It is possible that none of the existing assets of ING would be bought by New ING. In that case, the assumption of ING’s deposit liabilities by New ING would be effected by a loan from the state to ING, and the asset-side counterpart on New ING’s balance sheet to the deposits acquired from ING could be a matching amount of government debt.

This, to me, misses the point. As I see it, the problem is not so much that certain assets have gone bad, but that banks are over-levered and – more importantly – confidence has been lost. It is the problem of overleverage that the contract addresses, in an attempt to restore confidence.

I agree with him wholeheartedly, however, on the dangers of social engineering and political grandstanding:

Often government financial assistance to banks imposes conditionality, costs and constraints on the bank’s management and existing shareholders without taking full ownership and control of the bank. Examples are; onerous financial terms; constraints on bonuses and other aspects of executive and board remuneration; constraints on dividend pay-outs and share repurchases; constraints on new acquisitions and on foreign activities; guidance and direction on how much to lend and to whom. All these encumbrances last until the state has had its stake repaid.

This creates terrible incentives encouraging banks that are already in hock to the government to hoard liquidity and hold back on new lending activities to get rid of the government’s interference.

PrefLetter

February Edition of PrefLetter Now in Preparation!

The markets have closed and the February edition of PrefLetter is now being prepared.

PrefLetter is the monthly newsletter recommending individual issues of preferred shares to subscribers. There is at least one recommendation from every major type of preferred share with investment-grade constituents (two of them recently added); the recommendations are taylored for “buy-and-hold” investors.

PrefLetter is available to residents of Ontario, British Columbia and Manitoba as well as Quebec residents registered with their securities commission.

The February issue will be eMailed to clients and available for single-issue purchase with immediate delivery prior to the opening bell on Monday. I will write another post on the weekend advising when the new issue has been uploaded to the server … so watch this space carefully if you intend to order “Next Issue” or “Previous Issue”! Until then, the “Next Issue” is the January Issue.

Market Action

February 13, 2009

In an encouraging sign, an increasing amount of loans from banks are being converted into term junk debt:

High-yield, high-risk bond sales almost tripled to $2.38 billion this week, the most in seven months, as borrowers took advantage of a rally in corporate debt to increase cash reserves and pay down credit lines.
…
Borrowers concerned that a weakening economy and deteriorating earnings may shut off their access to the debt markets are taking advantage of the lowest yields since October relative to Treasuries to issue debt. Companies see an opportunity to raise cash and repay credit lines, said Pete Brady, managing director of high-yield bond trading at Broadpoint Capital Inc.
…
Junk-rated companies paid as little as 15.98 percentage points more than Treasuries on debt this week, down from a peak of 21.82 percentage points on Dec. 15, and the lowest since Oct. 30, according to Merrill’s U.S. High Yield Master II index. Overall yields narrowed two basis points to 18.03 percentage points from 18.05 on Feb. 6.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices
Values are provisional and are finalized monthly
Index Mean
Current
Yield
(at bid)		 Median
YTW		 Median
Average
Trading
Value		 Median
Mod Dur
(YTW)		 Issues Day’s Perf. Index Value
Ratchet 5.28 % 3.73 % 23,521 17.90 2 -0.1019 % 859.9
FixedFloater 7.25 % 6.80 % 70,221 14.14 7 0.5525 % 1,384.3
Floater 5.17 % 4.24 % 29,095 16.92 4 0.5945 % 1,015.7
OpRet 5.23 % 4.70 % 138,962 3.99 15 0.0000 % 2,054.3
SplitShare 6.28 % 9.46 % 67,136 4.05 15 -0.6916 % 1,776.0
Interest-Bearing 7.02 % 8.71 % 33,024 0.84 2 1.0423 % 2,015.1
Perpetual-Premium 0.00 % 0.00 % 0 0.00 0 -0.0687 % 1,562.5
Perpetual-Discount 6.89 % 7.01 % 195,634 12.53 71 -0.0687 % 1,439.1
FixedReset 6.05 % 5.70 % 621,623 13.99 27 0.3989 % 1,820.6
Performance Highlights
Issue Index Change Notes
LFE.PR.A SplitShare -3.11 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2012-12-01
Maturity Price : 10.00
Evaluated at bid price : 8.72
Bid-YTW : 9.46 %
LBS.PR.A SplitShare -3.05 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2013-11-29
Maturity Price : 10.00
Evaluated at bid price : 7.95
Bid-YTW : 11.07 %
FBS.PR.B SplitShare -2.96 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2011-12-15
Maturity Price : 10.00
Evaluated at bid price : 7.20
Bid-YTW : 18.33 %
ELF.PR.F Perpetual-Discount -2.01 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 15.10
Evaluated at bid price : 15.10
Bid-YTW : 8.94 %
SBN.PR.A SplitShare -1.93 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 9.15
Bid-YTW : 7.10 %
POW.PR.C Perpetual-Discount -1.66 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 20.16
Evaluated at bid price : 20.16
Bid-YTW : 7.31 %
POW.PR.A Perpetual-Discount -1.43 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 20.05
Evaluated at bid price : 20.05
Bid-YTW : 7.09 %
SLF.PR.E Perpetual-Discount -1.29 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 15.25
Evaluated at bid price : 15.25
Bid-YTW : 7.52 %
SLF.PR.C Perpetual-Discount -1.23 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 15.30
Evaluated at bid price : 15.30
Bid-YTW : 7.41 %
MFC.PR.C Perpetual-Discount -1.20 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 16.50
Evaluated at bid price : 16.50
Bid-YTW : 6.96 %
WFS.PR.A SplitShare -1.18 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2011-06-30
Maturity Price : 10.00
Evaluated at bid price : 8.35
Bid-YTW : 14.09 %
MFC.PR.B Perpetual-Discount -1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 17.30
Evaluated at bid price : 17.30
Bid-YTW : 6.86 %
DF.PR.A SplitShare -1.08 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 9.17
Bid-YTW : 7.11 %
PWF.PR.F Perpetual-Discount -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 18.81
Evaluated at bid price : 18.81
Bid-YTW : 7.06 %
BNS.PR.P FixedReset 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 22.32
Evaluated at bid price : 22.40
Bid-YTW : 4.73 %
TRI.PR.B Floater 1.19 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 12.75
Evaluated at bid price : 12.75
Bid-YTW : 4.16 %
RY.PR.I FixedReset 1.29 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 22.66
Evaluated at bid price : 22.70
Bid-YTW : 4.59 %
NA.PR.P FixedReset 1.59 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-17
Maturity Price : 25.00
Evaluated at bid price : 25.60
Bid-YTW : 6.15 %
RY.PR.L FixedReset 1.91 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 23.91
Evaluated at bid price : 23.95
Bid-YTW : 5.10 %
BNA.PR.C SplitShare 2.06 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2019-01-10
Maturity Price : 25.00
Evaluated at bid price : 12.41
Bid-YTW : 14.21 %
BNA.PR.B SplitShare 2.08 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2016-03-25
Maturity Price : 25.00
Evaluated at bid price : 21.55
Bid-YTW : 7.73 %
BCE.PR.Z FixedFloater 2.75 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 25.00
Evaluated at bid price : 15.68
Bid-YTW : 6.80 %
FIG.PR.A Interest-Bearing 2.97 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-31
Maturity Price : 10.00
Evaluated at bid price : 7.62
Bid-YTW : 12.34 %
BAM.PR.B Floater 3.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 7.85
Evaluated at bid price : 7.85
Bid-YTW : 6.80 %
Volume Highlights
Issue Index Shares
Traded		 Notes
DF.PR.A SplitShare 98,000 YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2014-12-01
Maturity Price : 10.00
Evaluated at bid price : 9.17
Bid-YTW : 7.11 %
BNS.PR.X FixedReset 67,295 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.25
Bid-YTW : 6.13 %
RY.PR.R FixedReset 66,557 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 25.31
Bid-YTW : 6.07 %
MFC.PR.B Perpetual-Discount 56,972 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2039-02-13
Maturity Price : 17.30
Evaluated at bid price : 17.30
Bid-YTW : 6.86 %
WFS.PR.A SplitShare 56,000 YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2011-06-30
Maturity Price : 10.00
Evaluated at bid price : 8.35
Bid-YTW : 14.09 %
CM.PR.R OpRet 51,000 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2009-05-30
Maturity Price : 25.60
Evaluated at bid price : 25.77
Bid-YTW : 3.34 %
There were 24 other index-included issues trading in excess of 10,000 shares.
Issue Comments

SLF Preferreds Downgraded by Moodys

Moody’s has announced:

Moody’s Investors Service downgraded the credit ratings of Sun Life Financial Inc. (SLF; TSX: SLF) and the insurance financial strength (IFS) ratings of its operating companies to Aa3 from Aa2, as well as the ratings of its other affiliates. As part of this action, preferred shares issued by the holding company, SLF, were downgraded to Baa2 from Baa1. The Aa3 IFS ratings apply to SLF’s primary operating companies — Sun Life Assurance Company of Canada (SLA) and Sun Life Assurance Company of Canada U.S. (Sun Life US). This action follows the release of the company’s fourth quarter 2008 results. The rating outlook for SLA and its affiliates has been returned to stable. The outlook on Sun Life US and its affiliates remains at negative.
…
Regarding the future direction of SLF’s ratings, one or more of the following developments could lead to an additional downgrade: (1) SLA’s MCCSR ratio falls below 200% for a sustained period; (2) Sun Life US’s regulatory capital ratio (NAIC RBC) falls below 300% for a sustained period; (3) SLF’s financial leverage rises above 30%; or (4) SLF’s earnings coverage falls below 8x and cash coverage below 5x for a sustained period.

S&P has not commented on the 4Q08 Results; neither has DBRS.

SunLife has the following preferreds outstanding: SLF.PR.A, SLF.PR.B, SLF.PR.C, SLF.PR.D & SLF.PR.E.

Issue Comments

DBRS Downgrades 26 Split-Share Preferreds

At last! The DBRS mass reviews of Split-Share preferreds announced in October and December have been resolved. DBRS has announced:

today downgraded 26 ratings of structured Preferred Shares issued by various split share companies or trusts. Each of these split share companies or trusts has invested in a portfolio of securities (the Portfolio) funded by issuing two classes of shares – dividend-yielding preferred shares or securities (the Preferred Shares) and capital shares or units (the Capital Shares). The Preferred Shares benefit from a stable dividend yield and downside protection on their principal via the net asset value (NAV) of the Capital Shares.

On October 24, 2008, and on December 19, 2008, DBRS placed the Preferred Shares listed below (among others) Under Review with Negative Implications. Each of the Preferred Shares has experienced considerable declines in downside protection during the past number of months amidst tremendous volatility in global equity markets. DBRS has today taken final rating action on these 26 Preferred Shares ratings based on longer-term trends being established for the NAVs of the affected split share companies. Ratings assigned are also dependent on structural features benefiting the Preferred Shares and the credit quality and management of the Portfolios. For many of the split share companies listed below, distributions to holders of the Capital Shares are now suspended due to the failure of asset coverage tests. This feature ensures greater excess income for the Company and decreases the reliance on other income-generating methods such as option writing when downside protection has been significantly reduced.

In the future, DBRS will continue to closely monitor changes in the credit quality of these Preferred Shares. If the various Portfolios appreciate in value significantly, rating upgrades may be considered. However, any upward movement may be constrained depending on the possibility of increased distributions to the holders of the Capital Shares.

I have not yet reviewed the changes … more later.

Later:

DBRS Review Announced 2008-10-24
Ticker Old
Rating		 Asset
Coverage		 Last
PrefBlog
Post		 HIMIPref™
Index		 New
Rating
FBS.PR.B Pfd-2(low) 1.0+:1
1/12		 Review-Negative SplitShare Pfd-4
ASC.PR.A Pfd-2(low) 0.7+:1
2/13		 Downgrade
11/6		 Scraps Pfd-5
11/6
ALB.PR.A Pfd-2(low) 1.1-:1
2/12		 Dividend Policy SplitShare Pfd-4
BSD.PR.A Pfd-2(low) 0.9-:1
2/6		 Issuer Bid InterestBearing Pfd-5
12/5
CIR.PR.A Pfd-4(low) 0.5+:1
2/13		 Downgrade
11/6		 None Pfd-5
11/6
CBW.PR.A Pfd-5 0.7+:1
10/24		 Downgraded
11/6		 None Pfd-5
11/6
DF.PR.A Pfd-2 1.4-:1
1/30		 Review-Negative Scraps Pfd-3(low)
DGS.PR.A Pfd-2 1.3+:1
2/12		 Review-Negative None Pfd-3(low)
ES.PR.B Pfd-3(high) 1.0-:1
2/12		 Review-Negative None Not Resolved
FCS.PR.A Pfd-2 1.2-:1
2/12		 Partial Redemption None Pfd-4
GFV.PR.A Pfd-2 1.4+:1
2/12		 Dividend Policy None Pfd-3
GBA.PR.A Pfd-5 0.4-:1
2/12		 Dividend Policy None Pfd-5(low)
11/6
HPF.PR.A Pfd-2(low) Their Numbers Note Calculation Dispute Issuer Bid Scraps Affirmed
12/5
HPF.PR.B Pfd-4 Their Numbers Note Calculation Dispute Issuer Bid Scraps Pfd-5(low)
12/5
FIG.PR.A Pfd-2 1.1-:1
2/12		 Rights Offer Cancelled InterestBearing Pfd-5
PIC.PR.A Pfd-3(high) 1.1-:1
2/5		 Review Negative Scraps Pfd-5
NBF.PR.A Pfd-2(low) 1.1-:1
2/12		 Downgrade None Pfd-4(low)
12/23
SLS.PR.A Pfd-2(low) 0.9-:1
2/12		 Partial Redemption None Pfd-4(low)
12/5
SNH.PR.U Pfd-3(high) N/A Maturity None Pfd-5(high)
12/5
SNP.PR.V Pfd-2(low) 1.2+:1
2/12		 Review-Negative None Pfd-4(high)
YLD.PR.A Pfd-3 0.8-:1
1/30		 Downgraded Scraps Pfd-5
11/6
TXT.PR.A Pfd-3(high) 1.1+:1
2/5		 Review-Negative None Pfd-4(low)
WFS.PR.A Pfd-2(low) 1.1+:1
2/5		 Issuer Bid SplitShare Pfd-4(low)

DBRS Review Announced 2008-12-19
Ticker Old
Rating		 Asset
Coverage		 Last
PrefBlog
Post		 HIMIPref™
Index		 New
Rating
ABK.PR.B Pfd-2(low) 1.3-:1
2/12		 Review-Negative None Pfd-3
TDS.PR.B Pfd-2(low) 1.4-:1
2/12		 Review-Negative Scraps Pfd-3
FTN.PR.A Pfd-2 1.2+:1
1/30		 Dividend Policy SplitShare Pfd-4
BMT.PR.A Pfd-2(low) 1.1+:1
2/12		 Dividend Policy Scraps Not Resolved
MST.PR.A Pfd-2(low) 1.3+:1
12/18		 Review Negative Scraps Not Resolved
FFN.PR.A Pfd-2(low) 1.1-:1
1/30		 Review-Negative SplitShare Pfd-5(high)
EN.PR.A Pfd-2(low) 1.5-:1
2/12		 Review-Negative Scraps Pfd-3
BXN.PR.B Pfd-2(low) 1.8+:1
2/12		 Review-Negative None Pfd-3(high)
PPL.PR.A Pfd-2 1.3+:1
1/30		 Review-Negative SplitShare Pfd-3
LSC.PR.C Pfd-2 1.2+:1
2/12		 Dividend Policy None Pfd-3
BSC.PR.A Pfd-2(low) 1.5-:1
2/12		 Review-Negative None Pfd-3
SBC.PR.A Pfd-2 1.4-:1
2/12		 Review-Negative SplitShare Pfd-3
PDV.PR.A Pfd-2 1.4-:1
1/30		 Review-Negative None Pfd-3
SOT.PR.A Pfd-2(low) 1.5+:1
2/12		 Review-Negative None Pfd-3(high)
BBO.PR.A Pfd-2 1.6-:1
2/13		 Review-Negative None Pfd-3(high)
LBS.PR.A Pfd-2 1.3-:1
2/12		 Dividend Policy SplitShare Pfd-3(low)
RBS.PR.A Pfd-2(low) 1.1-:1
2/12		 Review-Negative None Not Resolved
LCS.PR.A Pfd-2 1.1+:1
2/12		 Review-Negative None Pfd-4
Regulatory Capital

MFC 4Q08 Results

Manulife has issued its 4Q08 Press Release, which includes the entertaining line:

During the quarter, the Company successfully raised $4,275 million of new capital, consisting of $2,275 million of common shares and $2,000 million of term loans.

Inablility to discern a difference between term loans and capital might go a long way towards explaining their problems!

Of the $2,920 million equity related loss, $2,407 million is due to the post tax increase in segregated fund guarantee liabilities, comprised of $1,805 million for the reduction in the market value of the funds being guaranteed and $602 million because the sharp drop in swap interest rates reduced the discount rates used in the measurement of the obligation. The remaining $513 million of the equity related loss is on equity investments supporting non-experience adjusted policy liabilities ($196 million), reduced capitalized future fee income on equity-linked and variable universal life products ($100 million), impairments on equity positions in the Corporate and Other segment ($158 million) and lower fee income ($59 million).
…
Regulatory capital adequacy is primarily managed at the insurance operating company level (MLI and JHLICO). MLI’s Minimum Continuing Capital and Surplus Requirements (“MCCSR”) ratio of 233 as at December 31, 2008 has increased by 40 points from 193 per cent as at September 30, 2008. The increase in MLI’s new capital, funded largely by MFC’s common equity issuance and $2 billion term loan, plus the changes OSFI made to the capital requirements were in excess of the fourth quarter loss, dividends to its parent MFC and capital increases in segregated fund guarantees as a result of the equity market declines. JHLICO’s Risk-Based Capital (“RBC”) ratio is calculated annually and is estimated to be 400 per cent at December 31, 2008 compared to a regulatory target of 200 per cent.

Page 9 of their presentation slides is comprised of the following table:

MFC Notable 4Q08 Earnings Items
CAD Millions
Segregated Fund and other equity items ($2,920)
Credit Impairments & downgrades (128)
Changes in actuarial methods & assumptions 321
Tax related provisions for leveraged lease investments (181)
Tax related gains arising from Canadian tax changes 181
Total ($2,727)

Page 36 shows that they have a net unrealized loss of $5.2-billion on a fixed income portfolio of $112.6-billion, a decline of 8%.

What I am trying to obtain is a view as to how well their default assumptions reflect credit spreads. Given that an unrealized loss of $5,200-million translated into impairment charges of $128-million (a transmission rate of just under 2.5%), it appears to me that they are (probably!) relying totally on credit ratings as an estimator of default risk. For an unleveraged and diversified investor, this is not entirely unreasonable (subject to sanity checks!); for a leveraged investor – such as MFC and any other insurer – it is … somewhat suspect.