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Fixed Income Quarterly—Insurance
Viewpoint
Canadian insurance credit has performed relatively in line with the FTSE TMX Canada Corporate Universe in Q1/14 with returns of 1.55%, 3.73% and 6.21% in the short, mid and long ends of the curve, respectively, compared to 1.39%, 3.85% and 6.06% for the FTSE TMX Canada Corporate Universe. However, life insurance credit has underperformed relative to Canadian bank credit in Q1/14, with the spread differential between 5-year average senior life insurance credit and bank sub debt widening to -3 bps compared to -11 bps at the end of 2013. While the fundamental backdrop has improved for the life insurers, we recommend a market weight position in life insurance credit given the significant outperformance over the past year. That being said, we do not expect the insurers to be active in the primary market in 2014, which should bode well for credit spreads.
In terms of relative value, we believe the Sun Life senior fixed- floaters (4.80%/15-35) look attractive relative to the MFC 4.079%/15 at a pick up of ~40 bps. While these securities in- clude a +20-year extension, we believe the risk of extension is very low given that the recent restructuring of their captive reinsurance arrangement eliminates the need for existing se- nior debentures and short-term letters of credit.
From a fundamental perspective, Great-West remains our top pick. The company has excellent market position, strong as- set quality and solid capital. In addition, the company has the lowest sensitivity to equity markets, strong brand recognition and enhanced financial flexibility with excess capital sitting at the holding company. That being said, we believe the pen- sion announcement in the 2014 U.K. budget is negative from a credit perspective given it is expected to significantly reduce sales and margins in its U.K. annuity business. We estimate this business represents ~7% of GWO’s bottom line and ap- proximately one-third of the company’s U.K. earnings.
Key Themes
New Issuance – Similar to last year, the life insurers have not been active on the primary front in 2014, with only Manulife tapping the market with a $500 million 5+5 opco subordinat- ed fixed-floater in February. Manulife also issued a $200 mil- lion rate reset preferred share in February. The proceeds from both these securities are expected to be used to refinance the $1 billion senior holdco maturity in June. Sun Life did not refinance its $500 million sub debt holdco maturity at the end of March; however, we are not surprised given the high amount of excess cash at the holding company level.
For the remainder of 2014, we believe Industrial Alliance could still tap the market to refinance the $150 million sub debt maturity in June. In addition, we believe Manulife could tap the preferred share market again.
Chart 1: LifeCo Senior vs. Bank Sub Debt (5-Year)
(bps) 500
450 400 350 300 250 200 150 100
50 0
As at March 31, 2014
Source: BMO Capital Markets
Lifeco Senior
Big Five Sub Debt
Chart 2: Sun Life Senior (4.80%/15-35) vs. Manulife Holdco Senior Debt (4.079%/15)
(bps) 425
375 325 275 225 175 125
75
SLF 4.8%/15-35
MFC 4.079%/15
102 66
25
Jun-11 Aug-11 Nov-11 Jan-12 Mar-12 Jun-12 Aug-12 Nov-12 Jan-13 Apr-13 Jun-13 Aug-13 Nov-13 Jan-14 Mar-14
As at March 31, 2014
Source: BMO Capital Markets
Table 1: FTSE TMX Canada Universe Bond Index Returns by Sector
Sector
All Corporates Financial - Bank Financial - Insurance
Short
YTD
1.39% 1.32% 1.55%
Mid
YTD
3.85% 3.48% 3.73%
Long
YTD
6.06% 6.12% 6.21%
As at March 31, 2014
Source: PCBond, a business unit of TSX Inc.
Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13