Cross-pillar deals unlikely: Experts

(June 23, 2004) The Canadian financial services industry is in good shape, but investors shouldn’t get too excited about the rumours of insurance firms buying up banks, according to the Standard & Poor’s Canadian Financial Institutions Sector Briefing.

Even if regulators were inclined to approve so-called “cross-pillar” consolidation plays, they are unlikely to happen any time soon, largely because of the cultural differences between banks and insurers.

“Insurance companies have made an entire career and built much of their organizational structure around product differentiation,” says Robert Swanton, managing director of Standard & Poor’s financial services ratings group in New York. “You really have to change the cultural sales practices of the institutions if you want to get synergies.”

He says the costs involved in such a merger would be better spent on expanding distribution and better differentiation.

“The synergies are not obvious,” said Donald Chu, director of the financial services ratings group at Standard & Poor’s in Toronto, prefacing his comments by pointing out such discussion is purely speculative. “You’re not allowed to sell life insurance products through a bank. They have different products sold through different channels.”

Add to that, this type of consolidation would make the participating insurance company a second-tier player in both markets.

A more likely scenario is the continuation of the trend set by Manulife Financial, where Canadian insurers take on foreign targets of similar size in an attempt to reach tier-one status on the global stage.

Manulife’s deal to buy Hancock has already made it the world’s fifth largest insurer with a market cap of just over $30 billion. European insurers Credit Suisse and AXA are both under $40 billion, and ING Groep is just shy of $50 billion. While that may sound impressive, U.S.-based AIG overshadows them all — even combined — with its market cap of $191 billion.

This relatively high ranking on the global stage far surpasses the Canadian banks’ standing in the North American banking sector. The big five banks combined might take the number three spot, based on “tier one capita,” but separately they are small players. RBC Financial is at the top, ranking 11th, while TD Bank is the smallest, taking the number 21 spot.

Since the insurance companies enjoy higher ratings than the banks, such a cross-pillar consolidation transaction would likely have an impact on those ratings. Since the insurance companies know they will eventually need to make large payouts, they tend to carry higher quality assets than the banks. As a result, the insurance firms’ tend to carry ratings about two points higher than the banks.

But the outlook on individual insurance companies’ ratings are mixed, with Sun Life and Great-West Life carrying a “negative” notation after their AA+ and AA (respectively) ratings.

The banks are classed as “stable” for the most part, with the Bank of Nova Scotia being the exception with a “positive” outlook.

Both the insurance and banking industries enjoy significantly higher ratings than their U.S. counterparts. The regionally fragmented banking sector in the U.S., with its many small banks, is largely rated below A-, while the majority of Canadian banks are A+ or higher.

The insurance sectors are a closer match, but no Canadian firm rates lower than A. The U.S. market includes firms below investment grade. Standard & Poor’s also identified Canada’s “strong and diligent” Office of the Superintendent of Financial Institutions as an asset to the insurance industry, since American firms face 50 different state regulators.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com