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Investors in Canadian financial stocks are favoring banks over insurers more than at any other time in 22 years, rewarding lenders for avoiding the worst of the credit crisis and punishing insurers for their U.S. losses.

The S&P/TSX Bank Index of eight bank stocks and one trust company has risen to 1,949.57, more than double the level of the S&P/TSX Insurance Index, which closed yesterday at 921.89. In April 2008, the bank index’s premium versus the measure of eight insurers was 7.2 percent, the lowest in almost six years. Both indexes were set at 1,000 almost a decade ago.

“Most of the banks are well-run” Sadiq S. Adatia, chief investment officer for Russell Investments Canada, which manages about C$12 billion ($11.3 billion), said in a telephone interview. “They’ve done the right things along the way. They are looking at opportunities well into the future, whereas insurance companies are still trying to recover.”

Canadian banks, which began reporting first-quarter results today, may increase operating earnings per share by 9 percent, the biggest gain in 10 quarters, Macquarie Capital Markets analyst Sumit Malhotra said in a note. Lenders are forecast to boost profit by 22 percent in 2010, compared with the 0.9 percent decrease among insurers, according to average analyst estimates compiled by Bloomberg.

Lenders including Toronto-based Royal Bank of Canada and Toronto-Dominion Bank have remained profitable amid the worst financial crisis since the 1930s. Manulife Financial Corp. and Sun Life Financial Inc., which account for more than half the insurance index, have posted three and four quarterly losses, respectively, since mid-2008. That underscores the insurers greater dependence on U.S. revenue as well as their vulnerability to lower interest rates.

Canadian Western

Canadian Western Bank of Edmonton, Alberta, the country’s eighth-largest bank, may post year-over-year operating profit growth of 40 percent, the largest increase in the group, Malhotra said. Bank of Montreal, based in Toronto, said today profit more than doubled to a record C$745 million, or C$1.26 a share, topping estimates.

While capital-markets revenue may decline 3 percent for the six largest banks, that could be offset by a 4.3 percent decline in provisions for loan losses, according to CIBC World Markets analyst Robert Sedran.

Canada’s banks have returned 6.7 percent with dividends this year while insurers lost 6.9 percent. Bank shares cost 51 percent more per dollar of profit from the past year than insurance stocks.

Bank of Canada

The correlation coefficient, a measure of the similarity in price fluctuations for two assets, has fallen to 0.47 from 0.90 in May 2009 for the bank and insurance stock indexes, using 120 days of data, according to Bloomberg. A level of 1 would mean they moved in lockstep.

Lenders will benefit from higher mortgage fees and consumer-banking income, analysts said. The Bank of Canada will probably raise its benchmark lending rate to 0.5 percent from 0.25 percent on June 1, according to 17 of 18 economists surveyed by Bloomberg.

Canadian banks suffered less from mortgage defaults than their U.S. peers, largely because subprime loans never accounted for more than 5 percent of the Canadian market. Each of the eight banks is diversified, with no more than 32 percent of its revenue coming from investment banking.

The banks got about 18 percent of their combined revenue from the U.S. in 2009. Manulife and Sun Life, Canada’s largest and third-largest insurers, each got almost half of their revenue from the U.S. last year.

Low Rates

The advantage for banks over insurance companies is a reflection of low interest rates, Murray Leith, who helps manage C$7.5 billion at Odlum Brown Ltd. in Vancouver, said in a phone interview. Lower lending rates reduce the return on investments that insurers make with premiums collected from customers.

“Because interest rates are lower than what was expected when a lot of policies were put on the books, they’re being forced to take charges and set aside reserves because returns on the portfolio are not what they thought they were going to be” Leith said.

Canadian insurers have also suffered from their own decisions, especially those made by Manulife, which accounts for 35 percent of the insurance index.

Manulife

North America’s third-largest insurer promoted variable annuities with guaranteed minimum returns during the 2002-08 bull market in equities, Adatia said.

When stocks posted the biggest losses since the 1930s, the company had to increase reserves, leading to record net losses. Manulife cut its dividend in August for the first time as a publicly traded company. Its shares plunged 24 percent over the next three months, while Sun Life dropped 25 percent. Manulife also had to sell C$2.5 billion in stock in November to bolster its balance sheet.

The C$4.2 billion BMO Dividend Fund added shares of Royal Bank, Toronto-Dominion and CIBC in the three months that ended April 30, while selling shares of Manulife and insurance holding company Power Financial Corp.

“Banks are an easier sell story mentally” said David Graham, manager of the C$6.43 billion CIBC Monthly Income Fund, whose top three equity holdings at March 31 were banks. “Life insurance companies really benefit when rates rise, and I don’t think anyone here is expecting a big increase in interest rates.”