Is the Manulife dividend cut cause for larger concern?

Posted by admin on August 10, 2009 in Investment Information

Manulife Financial Corporation surprised the investing world last week by cutting its dividend by 50% in order to use the money saved to build “fortress levels of capital.” Given that this dividend cut caught most people by surprise, commentators began to raise a whole series of other questions. Specifically, some speculated that Manulife’s move could signal another round of dividend cuts as it becomes clearer every day that the recovery will be slow and long.

Is this just idle speculation or is there something more to this? Let’s address the dividend cut and its larger implications step-by-step.

Why the dividend cut?

Manulife faces the same issue as all of its financial sector peers. The good times are over. The cheap money is gone and the era of easy double-digit EPS growth are probably a distant memory (as I blogged recently, ROI from the insurance sector in normal times is relatively low). But Manulife’s dividend cut is also company specific.

In simple terms, it used premiums collected from its variable-annuity sales and bet on the market- unhedged- and lost (Canadian Capitalist allowed me to guest post on Manulife’s variable annuity problem last December if you want some more detail). How badly did it lose? $22.42 billion. In relative terms, this is over 5 years of profit based on Q2 2009 earnings. This figure is the gap between what it has to pay its variable annuity customers and what it has set aside. The gap fluctuates since the better the market does, the less the shortfall since Manulife invested the premium money into the market which leads us to the larger discussion…

What does the dividend cut say about the market in general?

The press release announcing the Q2 results had this interesting tidbit: “our capital planning must anticipate more conservative scenarios than we are experiencing…”

This raises the interesting question- considering how bad the market has been the last 12 months, how much more of a conservative scenario could Manulife be projecting? Are they predicting even worse negative growth?

Before you re-visit buying gold bars again, remember that Manulife has a company specific issue and an industry wide issue. The only way to cover their $22 billion problem is for the markets to get back to the pre- September 2008 levels. The financial sector industry can experience returns from circa 2003-2007 if many of the same factors- cheap credit, consumers who lost their mind consuming, real estate bubble- exist.

Let’s assume neither will happen any time soon. Is the exercise in building fortress levels of capital spin for implicitly admitting they calculated badly and it will take years to correct the problem? Are the conservative projections going forward an implicit admission that stock market returns will now return to normal single digit returns? I believe it is a little of both.

The good news (if there is any) is that it appears the financial services sector are beginning to regain their sanity and think like conservative bankers and insurers again.

Will other financial services firms cut dividends (again)?

Manulife approached its capital shortage issue a little differently than the banks. Rather than issuing preferred shares to replenish its capital, it borrowed money first from a syndicate of banks then, in December 2008, it raised $2.125 billion in an equity raise. However, institutional investors bought almost half of the common share issuance.

In other words, Manulife has not, to a great extent, gone to the retail investor to bail itself out. As such, it does not have as entrenched a retail shareholder base as other financial services firms and may not have to cater as much to this constituency.

A large retail shareholder constitency does not impede a corporation from slashing its dividend per se. But, contextually, there are two things to consider. Firstly, as Andrew Willis remarked, it would have been worse if Manulife raised equity from retail investors to pay dividends and then subsequently slashed it. Secondly, with the economy improving and the banks being bailed out, it would be a curious (and potentially politically suicidal) for banks to have raised money from investors, taken government aid and then slashed its dividend.

In many respects, I am not sure the banks could slash their dividend today without triggering a much larger negative reaction than a mere hit in the share price (the window of opportunity has most likely closed). Given that banks are often treated by government like public utilities, there are large political hurdles to pass if a bank, after billions of bail-out money, tried to slash its dividends. Insurers, who typically fly under the public’s radar, may be able to get walk away relatively unscathed.

3 Comments on Is the Manulife dividend cut cause for larger concern?

By Four Pillars on August 10, 2009 at 9:15 am

What bailout are you referring to? I wasn’t aware that Cdn banks received any actual bailout money.

It’s clear that Manulife has no predictive ability when it comes to the market – at this point they are trying to manage their risk.

By Canadian Capitalist on August 10, 2009 at 11:30 am

The Manulife dividend cut tells me how difficult it is to value today’s financial giants. You never know how good their risk control process is until it is too late. So, investors should diversify broadly and make sure a mis-step in one of their holdings will not wipe them out.

By admin on August 10, 2009 at 11:41 am

FP- the Canadian government bought $75 billion of mortgages off the banks books last fall when (most likely) there would not have been any appetite to buy those pools on the street; those loans coming off the books gave the banks wiggle room. It was not a direct bailout like the U.S. Banks.