Canadian Lifecos: Credit the Thing to Watch - TD Newcrest

Credit, not equity markets, will be the thing to watch in what is expected to be an interesting second quarter for the Canadian life insurance industry, says Doug Young, TD Newcrest analyst.

He said strong equity markets likely resulted in reserve releases for segregated fund and variable annuity businesses.

Those releases, however, could be "mopped up" by required reserve increases in other areas, he added, due to weaker credit conditions, contracting bond yields, and the lapse rate for segregated and variable annuity businesses that fall below expectations.

"In our view, the variable to watch is credit, especially given corporate bond rating downgrades," Mr. Young wrote in a research report.

For companies under coverage, Mr. Young maintained his current ratings and price targets. noting valuations remain attractive.

"As conditions return to normal we see attractive upside for the group," he told clients.

However, we acknowledge that lower valuations justifiably discount tough economic and credit conditions that are likely to persist through 2009, uncertainty around dividends and what capital level regulators are likely to require the group hold, which could weigh on ROEs going forward.

In order for these stocks to outperform the market, Mr. Young said equity markets must show sustained improvement, government and corporate bond yields need to increase and more evidence is required that the credit meltdown is over.

He rates Manulife Financial Corp. (MFC) a BUY with a C$28 price target; Great-West Lifeco (GWLOF.PK) is also a BUY with a C$26 price; Sun Life Financial (SLF) is rated HOLD with a C$32 price target and Industrial Alliance (IDLLF.PK) is recommended as a HOLD with a C$29 price target.