Disappointing earnings, a worsening economic outlook and the damage inflicted by low interest rates have put Sun Life Financial Inc. ’s dividend under heightened scrutiny.
Sun Life’s recent assurances that its cash levels are strong enough to support the payout have not erased the worries of investors, especially as the European sovereign debt crisis shows no signs of easing. While Canada’s banks have already begun raising dividends in the wake of the 2008 financial crisis, investors are not certain that the worst is over for life insurers.
The sentiment also illustrates how market fears are beginning to shift from Manulife Financial – which slashed its dividend in half in 2009, and also issued billions in equity – to Sun Life, following surprisingly bad earnings from the latter insurer.
Sun Life posted a $621-million loss for the July-to-September period, and saw the key measure of its capital levels, called the Minimum Continuing Capital and Surplus Requirements ratio, fall to 210 per cent from 231 per cent in the previous quarter.
Investors are also concerned that its dividend yield, which compares its dividend payments to its market value, is 7.8 per cent – a level that suggests a cut could be on the way. Adding to those worries is a major change at the top: Sun Life chief executive officer Don Stewart is stepping down this week, having turned 65, and will be replaced by Dean Connor.
On Sun Life’s quarterly conference call with analysts earlier this month, chief financial officer Colm Freyne said the insurer has a strong level of cash to finance its dividend payment and other obligations. “These levels overall are an indication of our solid capital position, and support the maintenance of the dividend at current levels,” Mr. Freyne said.
Mr. Stewart added that Sun Life’s capital levels, while lower than the previous quarter, are higher than they were a year ago. “The dividend will be decided each and every quarter going forward by the board, in the full knowledge that it is a very important aspect of our value proposition to our shareholders,” he said.
But those statements have done little to calm investors, as low interest rates and volatile stock markets continue to hit life insurers. There has been little evidence to suggest better times are ahead. Julie Dickson, head of Canada’s banking and insurance regulator, cautioned life insurers at an industry conference this month that “the environment will likely be getting more difficult in the coming years.”
Canaccord Genuity analyst Mario Mendonca believes there’s a better than 50/50 chance that Sun Life will cut its payout. He said the odds of that happening increase as the macro-environment, including events in Europe, deteriorates.
CIBC analyst Rob Sedran said in a note to clients that he is not forecasting a cut in the dividend, “although we note that with the payout ratio forecast to be over 50 per cent next year, the potential for the dividend to be addressed remains a real risk,” he wrote.
“Indeed, it may even be the right thing to do ... to secure the long-term health of the company after the structural decline in earnings and profitability compared with the pre-downturn performance,” he said.
But a dividend cut is a lousy way to raise equity, he said. For one thing, it takes a long time to do the job, as the company starts socking away the savings each quarter. When Manulife cut its dividend in 2009, it said it expected to save about $800-million a year.
Another problem, Mr. Sedran noted, is that it alienates long-term investors. When Manulife slashed its dividend it became the first major Canadian financial institution to do so since the early 1990s, and the move sent its stock tumbling 15 per cent in one day.