Fitch Affirms Sun Life Financial Inc.'s Ratings; Outlook Stable
Fitch published newly updated insurance notching criteria on July 14, 2015 via an update to its master criteria report, 'Insurance Rating Methodology.' Today's rating actions reflect application of the updated notching criteria to SLF's ratings.
KEY RATING DRIVERS
Fitch's rationale for the affirmation reflects SLF's strong capitalization, improved earnings and operating profile, and disciplined investment strategies that have resulted in strong liquidity and solid asset quality. The ratings also reflect the company's leading market position in Canada, growing asset management business and growth prospects for emerging Asian markets. Offsetting factors include the company's low, albeit improved, fixed-charge coverage.
Fitch views SLF as very strongly capitalized on a risk-adjusted basis, with a minimum continuing capital and surplus requirement (MCCSR) for SLAC of 223% at June 30, 2015. The company's strong balance sheet fundamentals also benefit from modest financial leverage of 12.5% at June 30, 2015. The company's total financing and commitments (TFC) ratio, which includes operating debt, is considered moderate at 0.6x.
SLF reported a 25% increase in operating net income from continuing operations to CAD1.177 billion during first-half 2015. The net effect of market related impacts, primarily interest rates, and assumption changes and management actions increased operating earnings by CAD46 million during this period, compared with CAD3 million in the prior year period.
Underlying earnings, which exclude market factors and assumption changes, increased 20% during first-half 2015. The improvement was driven by continued solid profit on in-force business, but was modestly offset by new business earnings strain. The company benefited from increased fee income, driven by greater average net assets at MFS, and strong earnings from Asia.
SLF took a number of steps to reduce earnings volatility, including the sale of its U.S. variable annuity and certain life insurance businesses in 2013, as well as increasing its interest rate hedging. However, Fitch believes the company's earnings remain susceptible to a continued low interest rate environment.
SLF's fixed-charge coverage, excluding the net impact of market factors and assumption changes, was 7.1x for first-half 2015, which remains below Fitch's guidelines at the current rating level. Favorably, under Canadian regulations, SLF has greater flexibility to upstream dividends from operating subsidiaries without regulatory approval than do most U.S. peers, which, in Fitch's view, enhances holding company liquidity. Additionally, MFS provides a source of unregulated cash flow to the holding company.
Cash at the holding company totaled CAD1.7 billion as of June 30, 2015, compared with management's stated minimum level of CAD500 million. In 2015, SLF announced three modest-sized acquisitions to augment its asset management business, which will likely reduce this balance. Two of the transactions have closed, one in April and one in July.
Fitch views SLF's competitive position as strong in Canada, as one of the three largest insurers that serve more than two-thirds of the insurance market. SLF is a significant competitor among the top three companies in every market and major product line in which it competes in Canada.
MFS reported net outflows for the fourth consecutive quarter in second-quarter 2015. In an effort to protect returns, MFS closed a number of its strategies on the institutional side and new strategies have not yet gained traction. MFS' investment performance remains strong with 82%, 88% and 97% of mutual fund assets ranked in the top half of their respective Lipper categories based on three-, five- and 10-year performance at June 30, 2015. Approximately 80% of AUM is comprised of equities (43%/57% domestic/ international), which exposes the company to volatile global equity market conditions.
Under Fitch's updated notching criteria, Canada is classified as having a 'Group Solvency' style of regulation. However, since more than 30% of SLF's earnings and capital comes from countries outside of Canada, notching from the operating companies to the holding company employs the 'Ring Fencing' notching approach. This resulted in an affirmation of the Sun Life Financial Inc.'s IDR and senior and subordinated debt ratings.
Hybrid ratings experienced both downgrades and affirmations as new notching criteria was applied.
--Non-cumulative perpetual preferred securities of Sun Life Financial, Inc. were downgraded by one notch, based on a baseline recovery assumption of 'Poor' and non-performance risk assumption of 'Moderate'. They are notched down four from the holding company IDR.
--The Sun Life ExchangEable Capital Securities (SLEECS) were affirmed, based on a baseline recovery assumption of 'Below Average' and a non-performance risk assumption of 'Minimal'. They are notched down two from the holding company IDR.
Additionally, Sun Canada Financial Company's subordinated debt was upgraded by one notch reflecting its guarantee by SLAC, which ranks pari passu with other subordinated indebtedness of SLAC. Therefore, the subordinated debt ratings of the two entities have been aligned at the existing SLAC level.
The key rating triggers that could result in an upgrade include:
--Consistent maintenance of fixed-charge coverage, excluding the net impact of market factors, of over 10x;
--Continued improvement in profitability on an underlying and reported basis;
--Stable to improving balance sheet fundamentals.
The key rating triggers that could result in a downgrade include:
--A decline in fixed-charge coverage, excluding the net impact of market factors, to below 6x;
--A sustained drop in the company's risk-adjusted capital position, including the MCCSR ratio falling below 200%;
--An increase in financial leverage to over 25% or an increase in total leverage to over 35%;
--A large acquisition that involves execution and integration risk or impacts the company's leverage and capitalization.
Fitch has downgraded the following ratings:
Sun Life Financial, Inc.
--4.75% noncumulative preferred shares, series 1, to 'BBB-' from 'BBB';
--4.8% noncumulative preferred shares, series 2, to 'BBB-' from 'BBB';
--4.45% noncumulative preferred shares, series 3, to 'BBB-' from 'BBB';
--4.45% noncumulative preferred shares, series 4, to 'BBB-' from 'BBB';
--4.5% noncumulative preferred shares, series 5, to 'BBB-' from 'BBB';
--2.275% noncumulative preference shares series 8R, to 'BBB-' from 'BBB';
--3.9% noncumulative preference shares series 10R, to 'BBB-' from 'BBB';
--4.25% noncumulative preference shares series 12R to 'BBB-' from 'BBB'.
Fitch has upgraded the following rating:
Sun Canada Financial Company
--7.25% subordinated notes due 2015 to 'A' from 'A-'.
Fitch has affirmed the following ratings with a Stable Outlook:
Sun Life Financial, Inc.
--Issuer Default Rating (IDR) at 'A';
--4.8% senior notes due 2035 at 'A-';
--4.95% senior notes due 2036 at 'A-';
--5.7% senior notes due 2019 at 'A-';
--4.57% senior notes due 2021 at 'A-';
--5.4% subordinated debentures due 2042 at 'BBB+';
--5.59% subordinated debentures due 2023 at 'BBB+';
--2.77% subordinated debentures due 2024 at 'BBB+';
--4.38% subordinated debentures due 2022 at 'BBB+'.
Sun Life Assurance Co. of Canada
--IFS ratings at 'AA-';
--IDR at 'A+';
--6.30% subordinated notes due 2028 at 'A'.
Sun Life Capital Trust
--Sun Life ExchangEable Capital Securities (SLEECS), 7.093% series B, at 'A-';
--Sun Life ExchangEable Capital Securities (SLEECS), 5.863% Series 2009-1, at 'A-'.