July 25, 2010 / 2:34 PM / 7 years ago

BAY STREET-Rough sailing for Canadian insurers' results

* Weak equity markets, lower yields seen hitting earnings

* Stocks could feel feel further downward pressure

By Cameron French

TORONTO, July 25 (Reuters) - Investors hoping for improved results from Canada’s insurers may want to brace for disappointment, with weak stock markets and lower bond yields seen taking take a bite out of quarterly earnings.

Analysts said the weaker results expected for the second quarter could further pressure shares in a sector that steadily underperformed the broader market in recent months. Though some think the gloominess may be largely baked into stock prices.

Canada’s insurers are highly levered to the performance of financial markets. They hold billions in assets to cover off future obligations such as settlements and annuities.

If those assets decline in value, insurers are forced to build up reserves using cash taken directly from earnings.

The second quarter “is going to be messy for Canadian life insurers,” TD Securities analyst Doug Young said in a note.

“Falling equity markets and declining interest rates created the ‘perfect storm’ for (insurance) business models.”

Sector heavyweights Manulife Financial (MFC.TO), Sun Life Financial (SLF.TO), and Great-West Lifeco (GWO.TO) enjoyed strong results in the first quarter, as stock markets surged while economic optimism boosted sales.

The big players also have wealth management businesses that benefit from higher fees when stock market returns are strong.

But the upward trend has appeared to have stalled, with the Toronto Stock Exchange’s S&P/TSX composite index .GSPTSE down 6.2 percent during the quarter.

“The gyrations in the markets, I think have affected opportunities in the market place,” said Brenda Lum, a financial services analyst at rating agency DBRS.

“That plays in specifically for companies that rely on mark to market returns or flow business.”

Another challenge for the insurers has been a decline in Canadian and U.S. bond yields on demand from investors seeking safer assets.

While the trend benefits their existing bond holdings, it also means returns going forward are likely to be lower. And insurers that hold bonds to pay for future liabilities would now have to buy more of them.

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FLURRY OF CUTS

TD’s Young is one of several analysts that have cut stock ratings and price targets on the sector in recent weeks to take into account the market’s drop during the quarter.

He cut stock targets on all three big players last week, and downgraded Great-West and Manulife -- Canada’s largest insurer -- to “hold” from “buy”.

He also adjusted his second-quarter estimate on Manulife to a loss of 95 Canadian cents a share, compared with his previous forecast of a profit of 30 Canadian cents.

Manulife is seen as the insurer most tied to equity prices and interest rates, while smaller Industrial Alliance (IAG.TO) -- Canada’s No. 4 player, which kicks off results on Tuesday -- is seen the least vulnerable to markets.

Canaccord Genuity analyst Mario Mendonca expects Manulife to take a C$1 billion ($960 million) charge related to the weaker equity markets, and a C$300 million charge due to declining long-term corporate bond yields.

CIBC World Markets analyst Robert Sedran chopped his price targets on Great-West and Manulife, while also downgrading Manulife and predicting a loss.

Like other analysts, he said Canada’s banks were likely a better investments for buyers seeking financial stocks.

HOPE AMID THE GLOOM

However, Sedran said insurers’ stocks may already be reflecting the gloomy news and could get a boost if the results aren’t as bad as many are now predicting.

“You have to assume the market is expecting a bad result, so a less bad result will probably be good for the stocks,” he said.

Manulife’s shares have fallen 25 percent since the end of the first quarter and are trading at less than half their value from before the 2008 market crash.

Sun Life and Great-West, which are each expected to report profits, are down 17 percent and 16 percent, respectively, since the end of March. Industrial Alliance is down 1 percent.

The broader market is down 3 percent in that time.

Desjardins Securities analyst Michael Goldberg said in a note that the insurers are trading at a significant discount to their normal valuations. He maintained Manulife as a “top pick” despite the expected weak results. He has Sun Life at “buy” and rates Great-West a “hold”.

$1=$1.04 Canadian Reporting by Cameron French, additional reporting by Euan Rocha; Editing by Jeffrey Hodgson and Rob Wilson

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