Protect Your Investment In Manulife With This Note

| About: Manulife Financial (MFC)


Despite remarkable business expansion in Asian countries, Manulife lost roughly $20 billion in revenue and $1.3 billion in net earnings in 2015 as compared to 2014.

Ongoing exposure to oil and gas sectors, credit and currency headwinds, and potential reserve shortages in long-term care insurance may continuously overshadow their core performance.

As a short- to mid-term solution, holding senior debenture notes may help investors steer a downside risk while exposing an upside potential.

Click to enlarge

Manulife Financial Corporation (NYSE:MFC) ("Manulife") is a reputable insurance company offering products including annuities, pension products, and life insurance to customers in 22 countries and territories worldwide. Manulife has successfully expanded its business footprint in Asian countries through a series of acquisitions and agreements with renowned firms, such as Standard Chartered and DBS Bank Ltd., and has achieved robust growth in global insurance sales and net wealth inflows in 2015. However, the company failed to keep up its momentum by losing roughly $20 billion in revenue and $1.3 billion in net earnings in 2015 as compared to 2014. According to the management, this result was heavily driven by losses in oil and gas investments which will be a growing concern for current investors as management expressed that the targeted annual investment gains of $400 million in 2016 will unlikely be achieved if oil and gas prices remain depressed.

Additionally, the US dollar is under pressure against other major currencies, including the Canadian dollar (their reporting currency), due to a modest growth in the economy and a low US interest rate. As such, given the fact that an increase of $325 million in core earnings was attributed by the strengthening US dollar in 2015, the company may take an additional hit on its earnings in 2016 if a weaken US dollar is realized.

Click to enlarge

Source: Manulife Financial Corporation 2015 Annual Report

Click to enlarge

Source: Bloomberg

Without a doubt, Manulife's outstanding performance in core earnings in 2015 and more than $935 billion AUM are impressive enough to build confidence in investors. Moreover, a persistent low rate environment (or perhaps a modest increase in rates in the future due to rising inflation rates particularly in North America) and steady acceleration in dividend payment are another selling-point for mid- to long-term investors to keep their faith in this insurance giant.

Nonetheless, management has expressed their concerns and investors should be wary of the anticipated impact of lower oil and gas prices, credit and FX headwinds, and potential reserve shortages in long-term care insurance (i.e., Manulife's ratio of actual to expected claims surged to 116%, which can cause a charge in the hundreds of millions, according to an analyst from Canaccord Genuity). Furthermore, Manulife's rocky recovery in equity since the financial crisis in 2008 and notable deterioration of ROE, ROA, and ROC in 2015, which pulled them back to a pre-2013 level may have caused many investors to remain pessimistic.

For this reason, I'd like to introduce the following senior debenture notes (also known as a hybrid security which is considered "preferred shares" from a regulator's point of view) as one of many defensive investment tactics investors can utilize.


Manulife Fin Cap TR II


7.405% (Semi-annual)




$1,150.58 (on 4/15/16)







Frequency of Coupon


Year to Maturity


Click to enlarge

Source: Bloomberg

This financial instrument, as illustrated above, was issued $1 billion via Manulife Financial Capital Trust II, a wholly owned subsidiary of the Manufacturers Life Insurance Company, on July 10, 2009, agreeing to pay a generous coupon rate of 7.405% annually (payable semi-annually). Although Manulife has offered several attractive bonds to investors over the last several years for the purpose of acquiring liquid assets for fulfilling future retirement liabilities, owning this note can be special due to the following reasons:

Current yield is higher than dividend yield: If the primary motive for investing in Manulife common shares at this moment is to earn excessive dividend yield, investing in such notes can be a better option for you. At present, the current yield (e.g., coupon/price of note) for the notes is at 6.44%, which is higher than the 5.21% dividend yield (e.g., dividend/price of share) for common shares. Assuming the price of stock remains at the present level (between $14 and $15) throughout the year and the tax liability imposed for both instruments are equal, investors can take full advantage of receiving higher yield through investing in the notes.

For instance, say you invest $1,158.58 into Manulife common shares. Purely from the dividend return, you will end up receiving $60.37 USD annually if the dividend per quarter remains at $.185 per common share. However, if you invest the same amount in the above-mentioned notes, you will end up collecting $74.05 USD annually as long as the coupon rate remains the same (pre-tax return for both financial instruments). Be aware that the notes are non-cumulative preferred shares (i.e., non-cumulative coupon) so there's no carry forward for unpaid coupon payment. However, this scenario may be unlikely given the fact that the company just raised 1.5 cents in dividend per common share and preferred shares have priority in collecting dividends over common stockholders. Furthermore, the payment for preferred share dividends comprises only 5.29% of net income attributed to shareholders in 2015 (see below), so a chance of missing dividends for the notes would perhaps be extremely low.

Click to enlarge

Source: Manulife Financial Corporation 2015 Annual Report

Exposure to upside return while limiting your downside risk: One of the many reasons this note can be useful at this juncture is because it has an invisible price protection. Currently the price of the note is traded above par and the current bid/ask yield for this note is 3.186/2.840, respectively. Given the fact that the current coupon rate is far higher than the bid/ask yield, it is unlikely that the yield to maturity will rise beyond 7.405% in the short term (i.e., the note will be traded at a discount from the par value). Also, the company, with the prior approval of the regulator, may redeem the notes, in whole or in part, at the redemption price per $1,000 principal equal to the greater of par or the fair value of the debt based on the yield on uncallable Government of Canada bonds to the next interest reset date (i.e., starting on December 31, 2019 and on every fifth anniversary after such date, the rate of interest on the notes will be reset to the yield on five year Government of Canada bonds plus 5.2%) plus (A) 1.0325% if the redemption date is any time prior to December 31, 2019, or (B) 2.065% if the redemption date is any time after December 31, 2019, together with accrued and unpaid interest. As such, if the company wishes to redeem the notes, assuming that the interest rate is falling, which incentivizes the company to refinance at a lower cost, investors are able to exchange their notes for cash above par while collecting a higher regular income.

Source: Understanding Preferred Shares - BMO

Some of investors may have noticed that the pattern of price in such notes has been closely mimicking the pattern of daily equity price but with slightly less volatility (see screenshots below). During the period between June 2015 and the present, the price of the bond has dropped almost as equally as the price of the stock. Based on the observed correlation, it is possible to assume that if the price of the stock rises going forward then the price of the notes will rise correspondingly, though to a lesser extent. On the flip side, if the price of the stock falls, then the price of the note will decrease as well, but again, to a lesser degree. Also, it is important to note that, besides the correlation between two financial instruments, if the yield of the notes itself decreases in the future, the price of the notes will also rise correspondingly but may be less than what it should be due to the "callable" feature embedded in the notes. As such, the notes can be seen as holding less volatile underlying shares with downside protection and with a higher regular income.

Source: Bloomberg

Tier 1 Capital meets "well-capitalized" rating: In case you are wondering about the credit quality of this note besides its "A" rating by S&P and DBRS, the issued notes are qualified as 'Tier 1 Capital' (i.e., common stock, retained earnings, non-cumulative preferred stock, etc.) of the Manufacturers Life Insurance Company for regulatory reporting purposes. In accordance with the Financial Performance and Regulatory Disclosures Q2 2015, Tier 1 Capital ratio (shareholder's equity and retained earnings divided by risk-weighted assets) of Manulife was 22.3%, which is well-capitalized beyond the minimum Tier 1 Capital ratio requirements of 6% imposed by Basel III. Usually financial institutions with less than 2% of capital requirement are subject to prohibition of paying dividends to shareholders. Also note that according to the Short Form Prospectus for Manulife Financial Capital Trust II on July 6, 2009, it is stipulated that pursuant to the Preferred Share Guarantee Agreement, Manulife Financial Corporation will pay The Manufacturers Life Insurance for any outstanding dividend payments or redemption amount that The Manufacturers Life Insurance declares and fails to pay.

In conclusion, holding either common shares or notes will certainly be advantageous for any investor. However, depending on your risk appetite and investment timeframe, the investment decision may vary. Personally, as a value investor, I would consider acquiring both financial instruments to diversify my holdings in Manulife as the company carries some great potential over the long haul but has the possibility for immediate pains ahead. To reiterate my previous views, I am thoroughly impressed with the rapid expansion they achieved in 2015 especially in Asia and US and to a certain extent, I do agree with management that the core operation figures are immensely overshadowed by the heavy investment losses in oil and gas. Given that, to weather the anticipated short-term volatility, acquiring notes may perhaps be the right move to play defensively at this juncture before becoming a shareholder with voting power.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.