Financial Fallout: How It Affects Canadian Companies Sun Life and CIBC

Two Canadian financial names involved in the turmoil south of the border should see a significant impact if things progress the way they appear to be.

Sun Life Financial Inc. (SLF) has disclosed C$270-million in exposure to Washington Mutual Inc. (WM) bonds and will not recover any of this now that the largest U.S. savings and loan has failed, according to RBC Capital Markets. Analyst Andre-Philippe Hardy cut his third quarter earnings estimate by 58% from C$0.53 per share to C$0.22 as a result. This follows a C$0.04 per share reduction as a result of weak equity markets, and C$0.14 and C$0.26 cuts as a result of credit exposures to AIG (AIG) and Lehman Brothers (LEH), respectively.

Mr. Hardy told clients:

The greatest near term risks to earnings related to credit are downgrades on financial services holdings (which represent approximately 28% of Sun Life’s bond portfolio) and their impact on reserves. If bonds held by Sun Life start seeing more downgrades in ratings, it would force them to strengthen their reserves (which has an earnings impact) even if there is no default or impairment.

The analyst does feel Sun Life shares offer appealing upside and rates them at “outperform” with a C$47 price target.

He is also growing more bullish on CIBC (CM), which faces plenty of downside risk due to its structured financed holdings hedged with financial guarantors. However, Mr. Hardy said that the U.S. government’s Troubled Asset Relief Program could lead to stabilization in the value of these assets, as they could be bought for more than market value.

The analyst said:

If the value of structured finance assets indeed stabilizes, we believe CIBC’s stock should benefit, as a key source of uncertainty would be reduced.

He upgraded CIBC to “sector perform” from “underperform” and boosted his price target to C$65 per share from C$62. However, C$1-billion in writedowns before tax are expected from the bank in the fourth quarter as a result of wider credit default swap spreads of guarantors compared to the end of July.