BMO's ex-CEO Barrett to Retire from Barclays

Reuters, Steve Slater and Jane Merriman, 31 August 2006

Barclays Plc, Britain's third-biggest bank, has named veteran investment banker Marcus Agius as its new chairman, replacing Matthew Barrett who retires at the end of December after seven years at the helm.

Agius, currently chairman of investment bank Lazard's London business, had been tipped to take over from Barrett, 62 next month, who became Barclays chairman two years ago after arriving as chief executive in October 1999.

Barrett's going adds to several Barclays board departures in the past year. Talk in August that a change was likely stoked speculation Barclays may be a takeover target.

More fuel was added by consolidation among European banks and a report that Bank of America, linked to Barclays in the past, might be on the hunt for a "transformational" deal.

Agius, 60, will become a non-executive director at Barclays from September before taking over the top job in January when he leaves Lazard, the bank said on Thursday.

Agius began his investment banking career at Lazard almost 35 years ago.

An old-style merchant banker whose charm and discretion won him the trust of top corporate clients, Cambridge-educated Agius made his name working on a string of multimillion pound M&A deals for top UK clients, including Pearson, Halifax, British Land and ITV.

In 2001, he became chairman of the London arm of Lazard, which operated as a semi-autonomous unit alongside Lazard in France and New York.

That changed in 2002 when Wall Street dealmaker Bruce Wasserstein took control of Lazard and put the firm on course for a stock market flotation in New York, which took place last year. Since Wasserstein's arrival, the firm's powerbase and focus has shifted more towards New York.

Agius has been in the spotlight this summer as non-executive chairman of BAA, where he helped defend the airport operator in a bid battle that ultimately saw BAA sold to Spain's Ferrovial for about 10 billion pounds ($19 billion). He became a non-executive director of BAA in 1995.

He will stay on as chairman of Lazard in London until the end of the year.

A Bad Book, Karma, and a Ponytail

Chairman and chief executive of Bank of Montreal before joining Barclays, Irish-born Barrett has increasingly taken a back-seat role behind Chief Executive John Varley since he moved up to chairman two years ago.

But his seven years at Barclays have been eventful. He helped the bank shed a staid reputation, and profits have grown, hitting a record 3.7 billion pounds in the first half of 2006.

His purchases of Spain's Zaragozano and a majority stake in Absa in South Africa have been well received, but the 5.4 billion-pound deal for UK mortgage bank Woolwich six years ago has been widely criticised.

Growth in core UK retail banking has been sluggish in recent years, but this has been more than offset by accelerating growth at the Barclays Capital investment bank business, the fund management arm, and other international units.

Barrett has faced criticism from shareholders of one of the biggest salaries in UK banking, and will be remembered for comments three years ago saying he did not use credit cards as they were too expensive.

But analysts said he often won over critics with charm and forged a good relationship with the City.

He has said in the past his retirement plan was "to write a bad book, find my karma and grow a ponytail".

Agius will have a base salary of 750,000 pounds on becoming chairman but is not eligible to participate in bonus or long-term incentive schemes.

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BMO Plans Shanghai Corporate Bank Branch

Bloomberg, Sean B. Pasternak, 31 August 2006

Bank of Montreal plans to open its first corporate-banking branch in Shanghai to take advantage of China's surging economy, said Yvan Bourdeau, chief executive officer of BMO Capital Markets.

The investment banking unit of Canada's fourth-biggest bank opened a ``representative'' office in Shanghai in 2002, which can refer corporate clients to its full-fledged branches in Beijing, Hong Kong and Guangzhou. Bourdeau declined to say when the bank may win approval for a Shanghai branch, which would allow the bank to offer more services in China's biggest city.

``We're positioning ourselves for the next five, 10 years and we believe that is the right investment to do on our part,'' Bourdeau, 58, said in an interview yesterday from his Toronto office. ``At one point in time, it will pay dividends for us.''

Bank of Montreal wants to increase the number of loans, money-market and foreign-exchange products it can offer to about 22 million people in Shanghai, Bourdeau said. The Toronto-based lender has been operating in China since 1982 and has 150 staff there, part of a strategy to diversify earnings from its Canadian base.

China's economy last year expanded 10.2 percent, the fastest pace since 1995, the National Bureau of Statistics said on its Web site yesterday.

Bourdeau has traveled to China seven times since October, meeting potential clients and lobbying for additional growth opportunities.

BMO Capital Markets was one of six investment banks, and the lone Canadian lender, that managed the $11.2 billion initial public offering this year for Bank of China Ltd., the nation's second-largest lender.

That mandate may help win more underwriting business, such as the proposed IPO by Industrial & Commercial Bank of China, the country's biggest bank, Bourdeau said.

``Everything is so well thought out in that country that they will not appoint someone without having the broad endorsement,'' Bourdeau said. Managing the Bank of China IPO ``is very helpful,'' he said.

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Sun Life's MFS Unit

Boston Globe, Steven Syre, 31 August 2006

What does the stock price of Canadian insurance giant Sun Life Financial Inc. say about the future of big Boston mutual fund manager MFS Investment Management?

Sun Life shares hit their lowest price of the year four weeks ago, dragged down by the reaction to the company's quarterly financial report and news its president was quitting. Then Sun Life stock turned on a dime, climbing from $37.35 to nearly $41 in a few weeks. One explanation: rumors the company was about make some kind of deal involving MFS, a business it has owned for 24 years.

``The intense speculation on the subject, as well as our observation that management has gone completely silent, leads us to believe that something could be in the works," analyst Mario Mendonca of Genuity Capital Markets wrote in a report last week. He added that ``the market is quickly pricing in a meaningful probability that a deal is forthcoming."

That speculation, noted this week in the trade publication Investment News, may or may not turn out to be true. But the future of MFS as a unit of Sun Life has been the subject of growing public debate this year. The consensus prediction: Sun Life is most likely to merge MFS with another big asset management company, sooner rather than later.

Sun Life hasn't really gone silent, but it isn't saying much on the subject. A spokesman wrote to me yesterday, calling MFS a ``strategic asset," but added the company didn't rule out ``anything that builds greater shareholder value for the future."

MFS, which manages $168 billion in mutual funds and institutional accounts, will probably make more than $200 million this year and earn an operating profit of more than 25 cents for every dollar of revenue. In most industries, those kind of numbers confer star status. In the mutual fund business, they classify MFS as below average.

The average mutual fund company earns an operating profit of about 35 percent. In the most recent quarter, MFS reported a margin of 27 percent. The firm has worked hard to lower costs and boost business to lift that figure, but a year's effort has only yielded 1 percentage point of improvement.

``MFS needs to gain scale and that's unlikely to accrue through organic efforts alone," analyst Jason Bilodeau of UBS wrote in a report last month. Versions of that conclusion echoed in other investment research on the MFS question.

Another option that has been discussed in the past, taking MFS public, might raise money for Sun Life, but it wouldn't solve the investment company's basic problem.

MFS has increased the assets it manages to $168 billion, from $150 billion, in the past year. But much of that gain is due to stock market appreciation and its effect on money the company already manages.

MFS has been most successful adding new accounts from big institutional clients. But its mutual fund business, suffering from involvement in the fund scandals of a few years ago and declining popularity of some of its biggest offerings, struggles. So far this year, the amount MFS has returned to customers exceeded new sales by $3.7 billion, according to Financial Research Corp. of Boston.

Analyst Ken Zerbe of Morgan Stanley & Co. thinks MFS is making progress, but it would take years for the company to get profit margins up to industry averages. He believes Sun Life will opt for faster results through some kind of asset management merger in which it retains an ownership of about 30 percent. That would probably mean combining MFS with a firm managing $200 billion to $400 billion, Zerbe wrote in a May report.

Don't count on any big event soon. But one of Boston's biggest mutual fund companies isn't big enough and that will have to change.

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Financial Post, Duncan Mavin, 31 August 2006

Sun Life Financial Inc. is turning in record profits of late and is firing on almost all cylinders, but it's still Canada's "other" global life insurance company, too often in the shadow of giant neighbour Manulife Financial Corp.

Domestically, Sun Life's investment in CI Financial Income Fund has been an undisputed winner (CI's annual earnings have increased about fivefold to more than $100-million since Sun Life's investment in 2002), while its group benefits and group wealth businesses produced year-over-year earnings growth of 20% and 16%, respectively, in the second quarter of 2006.

In China and India, meanwhile, the company continues to expand -- Sun Life now has more than 18,000 advisors in India. In the United States, too, Sun Life is forecasting strong performance, especially as it now has relationships with nine of the top 10 independent life insurance distributors there.

In fact, Sun Life reported earnings of $512-million in the second quarter of 2006, up 8.6% from 2005, while its market capitalization has grown from about $5-billion at demutualization in 2000 to almost $26-billion today.

Nevertheless, the company's stock trades at a discount to both Manulife and Great West Life. Sun Life trades at 13.5 times earnings, while Manulife's stock is priced at 17.2 times earnings and Great West trades at 14.7 times earnings.

One reason is that while most business lines have progressed well in recent years, there is a dark cloud on Sun Life's horizon. The company's U.S. asset manager, MFS Investment Management, has at best stood still, and speculation on Bay Street has it that Sun Life is casting around for a solution.

"Even a cursory review of MFS today makes it difficult not to conclude that this well-respected franchise significantly underperforms its peers," wrote National Bank Financial analyst Rob Wessel in a research note this week. "Although the timing is uncertain, we believe the unlocking of shareholder value through its investment in MFS is one of [Sun Life's] highest priorities."

One problem with MFS is high costs, holding pre-tax margins to about 18% compared with an average of about 34% for other publicly traded U.S. asset managers.

The other main challenge is that MFS's mutual funds don't measure up when compared with those offered by rivals, resulting in persistent net redemptions.

But where others see problems, Mr. Wessel outlines opportunities -- namely, improve profitability, sell a piece of MFS or find another asset manager to partner with it.

Currently, Sunlife is following option number one -- improve profitability. But, as Mr. Wessel said, Sun Life's existing measures to deal with either costs or mutual fund redemptions "have thus far proved somewhat elusive." And, "further improvements in MFS's efficiency could take many quarters if not years," he said.

In contrast, a merger with another asset manager could be quickly accretive, building scale, expanding product mix and leading to cost reductions.

Mr. Wessel said MFS's existing cost base of about US$1.1-billion could be reduced by about 10% following a merger, and he estimates the right deal could add 26 cents per share to Sunlife's annual earnings. (He estimates Sun Life will generate earnings of $3.46 per share in 2006.)

However, Sun Life chief executive Don Stewart and his management team would have to find a suitable and willing merger partner, and that would be a challenge in itself.

Instead, Mr. Wessel's third, and favoured, alternative is to take a portion of MFS public. It is the decision that is "the most within management control."

MFS would be valued upwards of US$4-billion in the public markets, based on the company's current earnings and the price of public asset managers in the United States, Mr. Wessel said. That valuation would create an after-tax gain of about $465-million if just 15% of MFS is sold off, he said.

With MFS publicly traded, the markets would have a clearer valuation of what MFS is worth to Sun Life. Sun Life would also have an extra half-a-billion in excess capital from the sale proceeds, which could be re-invested or returned to shareholders. Under greater investor scrutiny, MFS would be more likely to cut costs and improve performance, added Mr. Wessel.

The result? "Over 10% potential upside to [Sun Life's] share price," he said.

Mr. Wessel rates Sun Life an "outperform" and raised his target price to $52.00 from $49.00.

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For more information, go the the 19 September 2006 entry on this Blog.

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Dividend Tax Credit for 2006 & On

GlobeinvestorGOLD, Gordon Pape, 30 August 2006

It appears that many people aren’t taking advantage of the great investment opportunities created by the overhaul of the dividend tax credit earlier this year. If you’re in that group, it’s time to update your approach and start thinking seriously about switching some of your non-registered money to dividend-paying securities. You’ll be amazed at how much more cash will end up in your pocket after tax, especially if you’re sitting on a lot of bonds and GICs.

I suspect that part of the problem is the confusion that surrounded the sea change in the way dividends are taxed in Canada. The plan was first put forward by then-Finance Minister Ralph Goodale shortly before the fall of the Liberal government and the election call.

Goodale proposed to virtually (but not completely) eliminate double taxation on corporate profits by enhancing the dividend tax credit for individuals. His complex plan involved increasing the “gross-up” of actual dividends paid to 145 per cent (from 125 per cent) and raising the ensuing tax credit to 19 per cent of the grossed-up amount (from 13.33 per cent). The new formula was to apply only to dividends from large corporations; payments from firms taxed at the small business rate would continue to be treated in the old way.

The enhanced dividend credit was actually a fall-back position after the blow up of the government’s plan to impose new taxes on the burgeoning income trust industry. Faced with the prospect of going into an election with much of the 60+ demographic in high dudgeon over the collapse in trust valuations, Goodale retreated to Plan B, saying an enhanced dividend tax credit would “level the playing field” with trusts.

The revised formula went into effect at the federal level on Jan. 1, right in the middle of the election campaign. The problem was that no one knew if it would stick and when the Conservatives came to power the doubts grew. Many provincial governments deferred taking steps to harmonize their dividend tax structure with the Goodale formula while they waited for the first Tory budget.

That finally came in May with the new Finance Minister, James Flaherty, endorsing the Goodale plan. After that, most of the provinces began to fall in line with the biggie, Ontario, recently giving its blessing.

But now that the upgraded tax credit is firmly in place, few people seem to understand just how much money it can save them. Let me give you some examples, courtesy of the excellent tax calculators on the website of Ernst & Young Canada. If you’d like to check your personal situation, go to http://www.ey.com/global/content.nsf/Canada/Tax_-_Calculators_-_Overview

Let’s start with someone in the top bracket. The rates vary dramatically from one province to another, but the highest rate that a high earner will pay on a dollar of dividend income is 32.09 per cent in New Brunswick. By comparison, the same dollar earned as interest will attract a rate of 46.84 per cent in that province.

An Alberta resident in the top bracket will pay only 14.65 per cent on dividends versus 39 per cent on interest income. For high-income Ontario residents, the figures are 25.09 per cent for dividends and 46.41 per cent for interest. One of the fascinating anomalies of the new system is that dividend income is actually taxed at a lower rate than capital gains in several provinces, including Alberta, Saskatchewan, Nova Scotia, and Prince Edward Island.

Here’s something else that’s intriguing. The lower your income, the more effective is the new dividend tax credit. An Alberta resident with $60,000 in taxable income will pay tax at a rate of only 4.5 per cent on dividends. Saskatchewan is close behind at 5.25 per cent. In all, six of the 10 provinces and all of the Territories have single-digit tax rates on dividends at this income level. Quebec, New Brunswick, Newfoundland, and Nova Scotia are the ones that are out of step.

Drop down even further to taxable income of $30,000 and British Columbia, Saskatchewan, Manitoba, Ontario, PEI, and the Territories give you the money free! The effective tax rate in those jurisdictions is zero, and Alberta is close with a rate of 0.1 per cent.

The implications of this are significant. Low- to middle-income people with a little money to invest should put it all into dividend-paying securities. To heck with GICs! It’s time for a new mind-set!

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Scotiabank Q3 2006 Earnings

Kevin Frayer, CP File Photo

BMO Capital Markets, 30 August 2006

Details & Analysis

Scotiabank reported third quarter cash earnings of $934 million, or $0.93 per share, compared to $893 million, or $0.89 per share, last quarter, and $780 million, or $0.77 per share, in the same quarter of last year. This quarter included a $51 million VAT tax recovery that added $0.05 to EPS. As a result, the better comparison is $0.88 per share in this quarter, $0.89 per share last quarter and $0.77 per share in the same quarter of last year. Although results were slightly better that street estimates of $0.86, the source of earnings momentum was somewhat disappointing.

Domestic Banking reported earnings of $323 million, up from $301 million in the last quarter but roughly unchanged from $324 million in the same quarter of last year. It is particularly disappointing to see Domestic Banking (which includes Wealth Management) unable to produce growth year over year. Both revenues (excluding acquisitions) and earnings appear to be unchanged versus the third quarter of 2005. The causes of this relatively poor performance are spread compression (which offset volume growth) and incremental expenses associated with the acquisition of Maple Financial and various other new initiatives.

International Banking reported earnings of $286 million, up from $268 million in the last quarter and $234 million in the same quarter of last year. This quarter's earnings were inflated by a $51 VAT tax recovery. Excluding this item, earnings were down versus the unusually strong second quarter, and essentially flat compared to the third quarter which included large gains on Emerging Market bonds. We continue to believe that Scotia has a solid International Banking platform. Despite this, we have assumed that earnings growth slows dramatically in 2007 as Scotiabank Mexico faces the headwind from the elimination in tax losses. This will be offset by continued growth in the Caribbean and additional contribution from deals in Peru, Costa Rica and El Salvador.

Scotia Capital reported very strong results. Earnings of $279 million were a record and were higher than we had forecast. This reflected loan loss reversals, interest recovery, securities gains and the incremental contribution from the GMAC financing agreement. These are all very valid sources of earnings but there is some question about the sustainability on the first three. As the credit cycle matures and as the level of gross impaired loans declines, loan losses are likely to rise and interest recoveries will become less material. The Corporate segment produced a larger than expected contribution reflecting favourable fair-value marks to market on derivatives as well as funding profits. The latter of these could easily be allocated to the Domestic Banking segment. We believe that this level of contribution is somewhat above a normal run rate.

The bank's credit performance remains stellar. This quarter, with over $100 million drop in gross impaired loans, provisions were well-controlled and there was some interest recapture. Provisions of $74 million were in line with our expectations but will likely be quite a bit higher in 2007 as recoveries decline. We are forecasting provisions of $540 million for fiscal 2007, up from $284 million this year. Scotia continues to have excellent levels of reserves - general allowances are high at $1.3 billion and there is an unrealized security gain of $848 million - principally in emerging market bonds and the residual holding of Shinsei.

Scotiabank continues to have one of the best capital ratios in the industry, but with ongoing growth in risk-weighted assets, Tier 1 declined slightly to 10.0%. RWA growth reflected additional loans in the corporate book and the GMAC securities. The latter is, by all accounts, relatively low risk given their over-secured nature.

Projections & Valuation

We are downgrading Scotiabank to Market Perform from Outperform. Since our upgrade on May 30, 2006, BNS shares have beaten the bank index slightly. At the time of the upgrade we felt that international earnings would continue to offset the relatively weak domestic trends. In addition, with bank stocks having corrected meaningfully, we thought it prudent to recommend four bank equities. The recent quarter suggests, however, that the trends in Domestic Banking continue to be somewhat discouraging and the International Banking business will be facing the challenges of additional tax headwinds in Mexico. Bank stocks have also had an excellent run.

Scotiabank continues to trade at an average P/E multiple and at a slight premium on P/BV. This seems appropriate given the calibre of management, the growth potential of the International business and the strong balance sheet. Despite this, we cannot lose sight of the fact that the bank will be facing increasingly difficult trends into 2007 reflecting higher taxes in International, higher loan losses and a less robust domestic consumer.

At the current time, we recommend TD and CIBC shares. The former has good growth into 2007 on the back of deals completed over the past year, while the latter is relatively inexpensive. We believe that both banks have relatively low exposure to deterioration in the U.S. economy.

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TD Newcrest, 30 August 2006

Event

BNS reported operating EPS of $0.88, ahead of our estimate of $0.84 and consensus of $0.86. We believe the results reflect excellent asset growth, partially offset by higher expenses driven by investments in future growth and as yet assimilated acquisitions.

Impact

Neutral. We are increasing our 2006 EPS estimate marginally to $3.46 (from 3.45), and 2007 estimate to $3.80 from $3.78. Our 12-month target price of $54.00, and our Action List Buy recommendation remain unchanged.

Details

Canadian retail results satisfactory. Cash net income was $323 million, up slightly from $303 million in Q1/06 and essentially flat versus a year ago.

• Asset (i.e. loan) growth of 12.1% year over year is the best of the group thus far. Strength was reported in both residential and commercial lending, led by a substantial increase in residential mortgages (16%) – mainly due to the Maple acquisition.

• Net interest margins, however, fell to 2.67%, down 7 bps sequentially and 21 bps from Q3/05, due entirely to the acquisition of Maple Trust and AcG-13 charges, which were up $13mln in quarter. Management commented that ex-Maple trust margins were flat, and that they were confident that margins would improve given the more disciplined pricing environment. The bank’s significant funding gap requires wholesale funding, which was relatively more expensive in Q3/06, explained management.

• Expenses increased with the efficiency ratio increasing to 62.3% versus 61.7% in Q2/06 and 60.8% a year ago, and reflected investment in numerous initiatives as well as acquisition expenditures (Maple and the Bank of Greece not yet fully integrated).

The international operations continue to grow at a rapid pace, but this growth was not reflected in net income, which was $235 million versus $268 million last quarter and $234 in Q3/05. We highlight that the appreciation of the CAD$ cost the division $31 mln year over year and $9 mln in quarter. Asset growth was strong, up 11% year or year (or 14% organic - excluding the negative impact of foreign currency translation and the Peru acquisition). Growth was driven by a 47% increase in credit card balances and a 27% rise in mortgages.

• Net interest margins rose to 4.19%, up 4 bps sequentially and 21 bps from Q3/05.

• Despite the currency headwinds, revenues rose to $844 million in Q3/06 versus $762 million in Q2/06 and $749 million in the same quarter last year. Stronger revenue generation was due to the combination of strong asset growth, higher margins, and solid other income.

• Expenses increased meaningfully in Q3/06, with the efficiency ratio increasing to 62.6% from 58.1% in Q2/06 and 59.7% in Q3/05.

• We note that management indicated that as of Q1/07, tax loss carry-forwards will be exhausted and the effective tax rate in Mexico will be 15%-20%, which is reflected in our estimates.

Wholesale banking results beat our estimates this quarter, primarily due to controlled expenses and stable revenues in a seasonally slow period. Reported adjusted cash net income was $279 million, up from $277 million in Q2/06 and $202 million in Q3/05.

• Despite weaker trading, revenues of $613 million were up 18.3% year over year, driven primarily by growth in BNS’s loan portfolio, and from loan loss and interest recoveries and securities gains.

• Trading revenues were $187 million in Q3/06 versus $259 million in Q2/06 and $213 million in the same quarter a year ago. Management commented that Q1 & Q4 are normally better quarters, and Q3 was disappointing.

• Credit recoveries were $19 million, versus $54 million in Q2/06 and a charge of $2 million a year ago, with recoveries being realized in the U.S. and Europe

• The efficiency ratio was very low decreasing to 37.8% from 43.6% in Q2/06 and $41.3% in Q3/06.

Tier 1 capital was healthy at 10.0%, but down from 11.1% a year ago. We remind that the bank is growing its risk-weighted assets at the fastest pace of the group, up 16.2% year over year. Management repurchased 1.3 million shares during the quarter. Unrealized security gains remain at a very high $848 million.

Valuation

Trading at 12.8 times 2007 earnings versus a peer group average 12.4 times 2007 earnings, we believe BNS should trade at a greater premium. At current prices, we believe this represents a buying opportunity.

Justification of Target Price

Our $54.00 BNS target price is a product of adding 50% of the $50.38 value derived from our 2007 P/E multiple of 13.5 times to 50% of the $48.43 value derived by our 2007 price-to-book of 2.49 times.

Key Risks to Target Price

We believe that the four key valuation risks include: a) a deterioration in the geopolitical situation in one of the bank’s international markets (most importantly Mexico); b) a tougher credit environment which could lead to credit losses, particularly with the bank’s more aggressive U.S. corporate lending strategy; c) the bank paying a significant premium for an acquisition; and d) the deterioration of the USD.

Investment Conclusion

The market didn’t seem impressed with BNS’s Q3/06 results, we suspect focused on their earnings beating consensus by less than what the Q3/06 peers have thus far reported. We think selling/not buying the bank at these levels is a mistake, as we believe management is priming the bank for sustainable, superior long-term growth, at the expense of short-term earnings out-performance. We do not have the disclosure available, but we believe the bank is spending more money than the others on initiatives. As well, we believe the six acquisitions the bank has completed in the last year have had a dilutive or marginal impact on 2006 earnings, but will add more than $0.08 to next year’s results. The bank’s operating businesses are generating leading ROEs, and with significant excess capital, BNS’s international operations provide multiple opportunities to deploy this balance. The bank is seeing strong growth in its US wholesale operation, a unique growth advantage the other Canadian banks will likely have little leverage to. Acquisitions and internal growth have generated the fastest risk-weighted asset growth of the group, which should produce above-average revenue growth in the future. Perhaps most importantly, we believe BNS enjoys the greatest financial flexibility of the Canadian banks, and shareholders stand to benefit. We reiterate our $54.00 target prices and our Action List Buy recommendation.

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RBC Capital Markets, 30 August 2006

Investment Opinion

• Underlying EPS up 14% YoY. BNS reported cash EPS of $0.93, which normalized to $0.88 (excluding 5¢ for a $51MM tax recovery) for 14% YoY growth. Wholesale drove YoY growth while the domestic division earnings were flat YoY. Scotia earned through a partial normalization in the loan loss this quarter and the tax rate was normal. The heavy expense growth may weigh on investor opinion this quarter, but we think there may be room for cuts in future quarters.

• No Change in Outlook. We are increasing our 2006 cash EPS estimate by 1¢ to $3.47 to reflect the variance to the Q3/06 result. Our 2007 estimate remains unchanged at $3.77 for 8.6% growth and we are introducing a 2008 estimate of $4.10, indicating 8.8% growth. Our price target of $49 remains the same, set at 13x our 2007 estimate of $3.77.

• BNS But Still the Cost Leader. On a constant currency basis and excluding acquisitions, revenue was up 11% and expenses were up 7% YoY. Reported expense growth reflected the acquisitions and strong reinvestment in the business, though we also noted much higher-than-usual incentive compensation relative to associated revenue. Bank-wide, cost/revenue was 57.4% (excluding the tax recovery), still the leader among the peers.

• Wholesale Carried this Result. Scotia Capital reported cash earnings of $279MM, which beat our $260MM estimate for a 2¢ benefit. Domestic and International earnings were both level with year-ago results. In general, strong volume was mitigated by rising costs, which management has a knack for controlling well over the long-term.

• Valuation. Our price target of $49 (unchanged) is set at 13x our 2007 cash EPS estimate of $3.77. Our target P/E is set neutral to our sector target P/E to balance Scotia’s strong long-term growth prospects and disciplined, focused management team, with its above-average credit exposure and earnings reliance on securities gains. Scotia’s international operations are clearly outgrowing North American bank norms, though the overall earnings level is supported by a below-average loan loss accrual and tax rate. Our price target is also indicated at ~2.5x our projected book value of $19.77 (as at Oct 31/07).

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Report on Business Television, 30 August 2006

Click here for the ROBTv video clip, of Luc Vanneste (CFO, Scotiabank) speaking about Scotiabanks's Q3 2006 Earnings.

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The Globe and Mail, Paul Waldie, 30 August 2006

Bank of Nova Scotia is considering a range of potential acquisitions to bolster its already rapidly growing international operations.

"In the last 12 months, we've made six acquisitions, investing more than $1-billion. And there are a number of further acquisition possibilities," Rick Waugh, the bank's president and chief executive officer, told analysts yesterday during a conference call. "We have a strong pipeline and we are seriously looking at opportunities in all of our major markets."

Mr. Waugh's comments came as the bank reported a record third-quarter profit of $928-million or 93 cents a share on a fully diluted basis. That was 20 per cent higher than the same quarter a year earlier and surpassed most analysts' expectations.

The bank's far-flung international operations, which span roughly 45 countries across Latin America and the Caribbean, contributed much of the profit increase. The division reported a record profit of $285-million, up from $235-million a year ago. Revenue climbed 13 per cent to $844-million.

Mexico was the strongest player in the division, contributing $160-million in profit. Revenue at the Mexican unit, Inverlat, increased 10 per cent and the bank plans to open up to 100 new branches by the end of 2007.

Scotiabank has recently acquired banks in Peru, Costa Rica and the Dominican Republic and Inverlat has committed to increasing its market share from 6 per cent to 10 per cent. Over all, the bank expects to generate more than a quarter of its profit outside Canada this year, compared with 19 per cent in 2000.

Mr. Waugh said the bank will make most of its future acquisitions in countries where it already operates. "We're going to stay in the developing world or the emerging world," he said.

He added that the bank will also continue to look for innovative deals such as last year's agreement to purchase $20-billion (U.S.) worth of car loans from General Motors Corp.'s financing arm over the next five years. The bank has acquired about $8-billion (Canadian) worth of loans so far and they are performing well, he added.

On the domestic front, profit at Scotiabank's Canadian operations remained flat at $319-million while revenue increased to $1.41-billion from $1.36-billion.

The bank's brokerage arm, Scotia Capital Inc., reported a $278-million profit, up from $200-million last year. The firm benefited from a strong market for mergers and acquisitions, but its trading revenue fell in the quarter.

Like other Canadian banks, Scotiabank continues to enjoy a favourable credit environment. Its provision for credit losses was $74-million in the quarter, down from $85-million a year ago.

During the conference call, Mr. Waugh justified the bank's 7-per-cent increase in costs by saying it reflects a number of initiatives under way around the world to boost revenue and exposure. As an example, he cited the decision earlier this year to spend $20-million for a 15-year deal to rename Ottawa's Corel Centre "Scotiabank Place." Mr. Waugh said the bank had doubled its awareness in the marketplace since putting its name on the site.

The bank also said it expects to reach the upper end of its objectives for the fiscal year, which ends in October.

Those objectives included posting a return on equity of between 18 and 22 per cent and boosting earnings per share by as much as 10 per cent this year. To date, the bank said its return on equity is 22.5 per cent and its growth in earnings per share is 13 per cent.

The bank's shares closed down $1.30 at $47.63 yesterday on the Toronto Stock Exchange.

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RBC Capital Markets, 29 August 2006

First Impression

• Cash EPS Just Ahead of Expectations. BNS reported cash EPS of $0.93, which normalizes to $0.88 (excluding a 5¢ for a $51MM value added tax recovery in the International division) for 14% YoY growth. This compares to our $0.87 estimate and consensus of $0.86.

• Domestic Retail & Wealth Earnings Flat YoY. The domestic bank reported flat earnings YoY, influenced by the acquisition of Maple and National Bank of Greece. With revenue growth of only 4% YoY, and acquisition-affected expense growth of 6.5%, the domestic bank recorded negative operating leverage of -2.5%. Net interest margins declined another 7bps QoQ and 21bps YoY. Market share in mortgages and term deposits were reported up 114bps YoY and up 68bps YoY, respectively, but this too was boosted by Maple and NBG.

• International Earnings Reported Up 22% YoY. International earnings of $286MM (up 22% YoY) normalized to $235MM (flat YoY) excluding the VAT recovery. This is just shy of our estimate of $240MM. Solid revenue growth of 13% YoY was not enough to outpace normalized expense growth of 18% (for -5% operating leverage). The foreign exchange drag was 7¢ YoY this quarter (versus a 5¢ drag in Q2/06). Scotia Mexico revenue growth was 23% YoY (ex f/x impact) and noninterest expenses increased 16% (ex f/x impact and VAT recovery).

• Scotia Capital Up 40% YoY. The wholesale division reported cash earnings of $279MM, which beat our $260MM estimate (for a 2¢ benefit). Trading revenue at $187MM and securities gains of $105MM totaled to $292MM, about in line with our forecast of $286MM. Strong net interest income growth (up 30% YoY) drove revenue growth of 18% YoY, which more than offset expense growth of 9%. The YoY results benefited from a $19MM loan loss recovery versus a $2MM provision in Q3/05, but was lower than the $54MM recovery in Q2/06.

• Lower than Forecast Loan Losses. Loan loss provisions were slightly lower than expected at $74MM compared to our estimate of $77MM and consensus $83MM, but there was no significant EPS benefit. Impaired loans declined 6% QoQ and the reserve to impaired loan coverage ratio improved to 146% from 136% in Q2/06.

• Dividend Left Unchanged. As anticipated, BNS did not increase its quarterly dividend, which was just hiked last quarter to $0.39/share. The tier 1 capital ratio declined to 10.0% from 10.2% last quarter.

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Bloomberg, Sean B. Pasternak, 29 August 2006

Bank of Nova Scotia, Canada's third- largest bank by assets, said profit climbed for the 13th straight quarter to a record on higher earnings from Latin America.

Net income for the third-quarter ended July 31 rose 19 percent to C$936 million ($842 million), or 93 cents a share, from C$784 million, or 77 cents, a year earlier, the Toronto- based bank said today. Revenue climbed 11 percent to C$2.99 billion.

Profit from international banking rose 22 percent, led by Mexico, Peru and Central America. The bank has spent more than $1 billion since 2000 to buy banks, primarily in Latin America, to offset slower growth in Canada.

``I like their Caribbean and Latin American exposure,'' said David Cockfield, who helps manage $1.1 billion at Leon Frazer & Associates Inc. in Toronto, including Scotiabank shares. ``They're conservative and they know their way around there.''

Bank of Nova Scotia shares fell C$1.30, or 2.7 percent, to C$47.63 at 4:10 p.m. trading on the Toronto Stock Exchange, the biggest decline in three months as Canadian financial stocks fell. They've risen 3.2 percent this year, compared with a 4.8 percent gain for the 39-member S&P/TSX Financials Index.

The bank expects to generate more than a quarter of its net income from outside Canada this year, compared with 19 percent in 2000. There were 22,494 employees in the international business at the end of July, more than in the domestic consumer bank. The international bank's profit of C$285 million topped the investment bank's earnings for the second time in a year.

Earnings were bolstered by the purchase of two banks in Peru for C$390 million in March, making Scotiabank the third- largest bank in that country. Scotiabank also agreed in June to buy Corporacion Interfin SA, the owner of Costa Rica's largest private bank, for about C$330 million.

``Clearly the growth prospects internationally are much greater than they are in Canada,'' said Tom Kersting, an analyst at Edward Jones & Co. in Des Peres, Missouri. ``Scotia's international operations are in countries that are growing quite rapidly.''

Chief Executive Officer Richard Waugh, 58, told investors on a conference call today that the bank is ``seriously'' looking at additional acquisitions in international markets. He didn't elaborate. The bank also plans to open 100 new branches in Mexico next year.

Excluding a 5-cent-a-share recovery for taxes, profit was 88 cents a share, matching the estimate from Robert Wessel, an analyst at National Bank Financial in Toronto. The bank was expected to earn 87 cents a share before one-time items, according to the median estimate of eight analysts polled by Bloomberg News.

Earnings from the Scotia Capital investment bank climbed 39 percent to C$278 million because of higher lending volume and the sale of securities. Record mergers revenue helped offset a decline in trading income, which fell 14 percent to a two-year low of C$187 million. That contrasts with rivals Bank of Montreal and Toronto-Dominion Bank, which had higher trading revenue after stock prices rose and the number of mergers rose to a seven-year high.

Bank of Nova Scotia set aside C$74 million for bad loans, compared with C$85 million a year earlier as a 30-year-low jobless rate cut the number of bankruptcies in Canada. Expenses increased 6 percent to C$1.61 billion because of acquisitions and salaries.

Even with a 19 percent gain, Bank of Nova Scotia's profit growth was the slowest among the four Canadian banks that have reported third-quarter earnings. Consumer banking profit in Canada was unchanged at C$319 million, the third straight quarter in which profit failed to increase. Scotiabank's domestic bank was hurt by higher expenses and increased provisions for credit losses.

Bank of Montreal, the fourth-biggest bank by assets, said on Aug. 22 that profit rose 30 percent to a record C$710 million on higher trading income. Toronto-Dominion, the second-biggest, said Aug. 24 that profit almost doubled to C$796 million on higher trading fees and increased earnings from its U.S. discount brokerage.

Royal Bank, the country's biggest bank, said Aug. 25 that profit climbed 20 percent to a record C$1.18 billion because of its U.S. and international consumer bank.

Canadian Imperial Bank of Commerce and National Bank of Canada, the country's fifth- and sixth-biggest banks, are scheduled to report results Aug. 31.

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Dow Jones Newswire, Monica Gutschi, 29 August 2006

Bank of Nova Scotia's forays into Latin America and Asia have powered the Canadian lender to record third-quarter earnings.

"I'm very impressed," said Theodore Kovaleff, an analyst with New York-based boutique investment bank Skye Capital. "The only thing that I see that really didn't grow as significantly was domestic banking. Everything else seems to be moving along beautifully."

And Tom Kersting at Edward Jones said the "international operations continue to be highlighted, you see that quarter after quarter. They continue to produce for Scotia."

Bank of Nova Scotia reported net income of C$936 million in the third quarter, 19% above C$784 million a year earlier.

On a cash basis, earnings were 93 Canadian cents a share compared to 77 Canadian cents a year earlier, easily beating the Thomson First Call forecast of 86 Canadian cents a share.

Revenue grew 11% in the period, return on equity rose to 22% from 18% the year before, and the bank's industry-leading capital ratio remained strong.

Provision for credit losses were C$74 million this quarter, an improvement from C$85 million a year earlier.

However, expenses rose due to the acquisitions and other growth initiatives.

And even though both the international division and wholesale bank Scotia Capital posted solid earnings growth, the domestic banking operations were flat.

In Toronto Tuesday, Bank of Nova Scotia shares are down C$1.04 to C$47.89 amid a 120-point decline in the key S&P/TSX Composite index. The shares had touched a year-to-date high of C$49.49 on Thursday.

"In our view, the earnings mix was disappointing," said BMO Capital Markets analyst Ian de Verteuil in a midday note. Canadian retail bank earnings were flat, the international division met expectations once a tax-related gain from Mexico is removed, and only Scotia Capital was strong, he noted.

"In our view, the only real good news in the quarter was that management suggested there is a strong pipeline for acquisitions," de Verteuil wrote.

Canadian retail bank earnings were C$319 million in the quarter, unchanged from a year ago, but up slightly from C$296 million in the second quarter. Provisions for credit losses edged up slightly, to C$69 million from C$63 million, while asset growth rose in part due to the acquisition of a mortgage-financing company.

The international operations reported a 13% increase in revenue, with net income rising to C$285 million from C$234 million.

The bank's recent acquisitions, including two banks in Peru, bolstered this quarter's revenue by 5% compared to the same period last year.

Scotia Capital's earnings rose to C$278 million from C$200 million, helped mainly the bank's purchase of asset-backed securities from General Motors Acceptance Corp. Trading revenue fell.

Neither Kersting nor Kovaleff owns Scotia shares nor do their firms have an investment-banking relationship with the company. BMO Capital Markets has an investment-banking relationship but it wasn't immediately clear if de Verteuil owns shares.

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Gloomy Growth Forecast May Spark Flight to Quality

The Globe and Mail, Carolyn Leitch, 29 August 2006

The flock of investors putting money into high-quality assets could turn into a flood as people grow increasingly pessimistic about the global growth picture, predicted Scotia Capital strategist Vincent Delisle.

In Canada, the strategist has "overweight" ratings on the financials, telecoms, industrials and consumer staples groups on the S&P/TSX composite index.

Names in his recommended portfolio include Royal Bank of Canada, Toronto-Dominion Bank, Alimentation Couche-Tard, Rogers Communications Inc., Nexen Inc., Barrick Gold Corp. and TransAlta Corp. Mr. Delisle said the "flight to quality" began in late April as investor psychology shifted from overoptimistic to outright gloomy and stock markets around the globe began to crumble. He says more people adopted the view that rising interest rates in many parts of the world will drag down corporate profit growth.

Suddenly, asset classes that have been shunned since 2004 are back in favour. As a result, bonds have been keeping pace with equities, large capitalization stocks are outperforming small caps, and defensive sectors are leading, he said.

Mr. Delisle noted that flat-to-inverted yield curves in bond markets around the world are signalling slower growth ahead, but corporate bond spreads have yet to move higher. When that occurs, the flight-to-quality trend should intensify, he forecasts.

In stock markets, meanwhile, defensive and interest-sensitive names are appreciating. Health care, utilities, energy, consumer staples, telecommunications and financial services are the winners this quarter on the Standard & Poor's 500-stock index.

Mr. Delisle expects the U.S. economy to lose steam over the next few quarters after two years of raising interest rates by the U.S. Federal Reserve Board, along with today's rising mortgage rates, surging energy prices and deteriorating housing market.

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Deutsche Bank Incurs Growth Pains Chasing Goldman

Bloomberg, Adrian Cox, 28 August 2006

Deutsche Bank AG is finding out just how hard it is to be more like Goldman Sachs Group Inc.

A decade after Germany's largest bank set out to reinvent itself as a Wall Street-styled securities firm, only New York- based Goldman earns more money from trading stocks, bonds, currencies and derivatives. And, there's little prospect that the gap between them will narrow anytime soon because Frankfurt-based Deutsche Bank eludes the risk-taking that characterizes Goldman.

While Goldman's sales and trading revenue almost doubled to $12.9 billion in the first half on big bets in the oil and stock markets, No. 2 Deutsche Bank could only manage a 38 percent increase to $9.7 billion during the same period with a trading strategy that's deliberately risk-averse.

``Deutsche Bank has made a lot of progress, but it will be a big task for them to take on the top tier of Wall Street,'' said Dale Robertson, who helps manage $1 billion in stocks at Edinburgh Partners in the Scottish capital, including shares of Deutsche Bank. ``They still have a ways to go.''

Wall Street's traders have been the engine behind more than three years of rising profits at securities firms, including Goldman, Deutsche Bank, UBS AG, Citigroup Inc. and Morgan Stanley. They typically account for about three quarters of investment-banking revenue, with the rest coming from underwriting securities and advising on mergers.

Market Swings

To make the most of trading opportunities for themselves and clients, firms have increased their so-called value at risk, a measure of how much they could lose in a day if the markets turned against them. While Goldman's value at risk was 40 percent higher in the second quarter than at the end of last year, Deutsche Bank's risk was almost unchanged, company filings show. Value at risk is calculated differently at different banks.

``We have made a strategic decision to pursue a client- driven approach to sales and trading, which has produced consistently strong returns for our shareholders in a wide variety of market conditions,'' said Deutsche Bank spokeswoman Rohini Pragasam. ``We believe we have the appropriate product suite, revenue mix and risk-management capabilities to continue generating superior performance for our clients and shareholders.''

Traders have made some of the quickest profits -- and losses -- in history. In 1992, George Soros's Quantum Fund made more than $1 billion betting that the peg between the British pound and the currencies of Europe would break. Long-Term Capital Management LP, a hedge fund run by former Salomon Brothers Vice Chairman John Meriwether, lost $4 billion in 1998 after a debt default by Russia. Securities firms don't normally disclose specific trades.

Profit Target

To enable Deutsche Bank to maintain its profitability target of at least a 25 percent return on equity before taxes, Chief Executive Officer Josef Ackermann, 58, is relying on Anshu Jain, 43, who oversees sales and trading as co-head of the investment- banking division with Michael Cohrs, 49. The bank can show only a 15 percent gain in its shares since Ackermann took over in May 2002, while profits have risen almost ninefold.

Even though Goldman's swings in trading revenue exceeded those of all its biggest rivals for five of the past six quarters, it has still posted three years of rising trading revenue. Deutsche Bank's quarterly sales and trading revenue, which fell in 2004, seesawed like that of its top four competitors during the past year and a half, rising 88 percent in the first quarter and falling 29 percent in the second.

``The more volatile the earnings, implicitly, the lower quality they are,'' said Keefe, Bruyette & Woods Ltd. analyst Matthew Clark in London.

Trading Loss

Sales and trading, which includes packaging, trading and selling securities such as credit derivatives and providing brokerage services to hedge funds, accounted for about half of Deutsche Bank's total revenue in the first half of this year.

``They're more dependent on their trading business than peers like the Swiss banks or the big French banks, largely because the rest of their business isn't as profitable,'' said CreditSights Inc. analyst Simon Adamson in London.

When Deutsche Bank on Aug. 1 reported a 100-million euro ($128 million) loss from equity trades for its own books in the second quarter, investors who shrug off greater swings from Goldman sold the shares, sending the price down 4.7 percent.

The loss followed a 400 million-euro gain in the first quarter and surprised shareholders who have become accustomed to Ackermann downplaying trading risk. He wrote in an August 2004 letter to the Economist magazine that Deutsche Bank had ``deliberately and dramatically reduced its dependence on risk- taking as a source of operating earnings.''

Merger Ranking

Investors would prefer ``a substantial profit stream from the operating business and not from the trading business,'' said Markus Barth, who helps manage about $8 billion at Hamburg-based Nordinvest GmbH and is a Deutsche Bank shareholder. ``The market doesn't like that kind of uncertainty.''

Deutsche Bank's first-half revenue from equities was $3 billion, far behind the $4.8 billion reported by Goldman, as well as Zurich-based UBS and New York-based Merrill Lynch & Co. and Morgan Stanley. In oil and energy trading where Goldman had estimated revenue of $1.5 billion last year, Deutsche Bank hardly trades a barrel.

In investment banking, Deutsche Bank is a laggard compared with Goldman, which uses its perennial No. 1 position in providing mergers advice and underwriting stock sales to win trading clients. Deutsche Bank is this year's ninth-ranked takeover adviser, and eighth in arranging share sales, data compiled by Bloomberg show. The German company is the third- ranked underwriter of international bond offerings, after placing first last year.

Profit Per Employee

Deutsche Bank has outpaced its European competitors, including UBS, Societe Generale SA and Credit Suisse Group, in sales and trading. The company last year leapfrogged UBS, Europe's largest bank, and New York-based Citigroup, the biggest U.S. bank.

``The European investment banks still don't have the strength in trading that you see at U.S. firms, where risk-taking and capital commitment has been a part of their capital markets business for decades,'' said Bruce Weber, a professor at the London Business School. ``European capital markets have been dominated by bank lending and debt instruments.''

Deutsche Bank's profit per employee in investment banking rose at an annual rate of about 28 percent during the past five years to 313,531 euros in 2005, said Simon Maughan, an analyst at Blue Oak Capital Ltd. in London. The closest competitor was Paris-based Societe Generale, France's No. 3 bank by assets, with 15 percent growth. UBS's profit per employee in investment banking fell 4 percent a year and earnings at Zurich-based Credit Suisse, Switzerland's second-largest bank, declined 20 percent. Goldman doesn't disclose comparable results.

`Generic Drug'

Deutsche Bank is more like its U.S. commercial banking rivals whose risk-aversion deters them from creating new products and investing alongside their clients, said Maughan, who moved to Blue Oak from Allianz AG's Dresdner Kleinwort unit in April.

Goldman's capital-markets revenue rose at an annual rate of 20 percent during the past three years, compared with 8 percent at Deutsche Bank, showing the U.S. firm has been ``more nimble at moving capital to the fastest-growing areas,'' such as derivatives on commodities and loans, he said.

``The big commercial banks are almost like generic drug companies that become the No. 1 player in the market when the product is widely available and balance sheet strength supplants intellectual capital as the driving force,'' Maughan said. ``The total pool of profits is greater but the monopolistic margin was captured a long time ago by the patent holder.''

Proprietary Trading

Jain told investors at a conference in London in May that Deutsche Bank needs to increase its commodities, residential mortgage-backed securities and U.S. cash equities businesses. About 30 percent of the company's sales and trading revenue comes from equities and equity derivatives, compared with almost 40 percent at Goldman. Another 30 percent is derived from the credit markets, and the rest is from interest-rate products and foreign exchange, money markets and commodities.

Less than 20 percent of Deutsche Bank's sales and trading revenue comes from proprietary trading, half the industry average, according to Jain's presentation.

Deutsche Bank's investment-banking unit accounted for 69 percent of the company's 14.8 billion euros of revenue in the first half of this year, up from 63 percent in the first half of 2004 before Jain and Cohrs took over. The rest comes mostly from consumer and small-business banking, private banking and fund management, where growth has been slower.

Eliminating Jobs

As Ackermann cut more than 19,000 jobs and sold at least $18 billion of assets since 2002, London-based Jain has combined fixed-income and equities, pruned the research staff in Europe, and added specialists in equity derivatives, prime brokerage and U.S. mortgages.

He has hired at least 24 executives this year in the U.S. alone, including Goldman's Arun ``Mel'' Gunewardena as head of a fixed-income prime brokerage unit, which caters to hedge funds. Jain's group also has invested in three U.S. and Mexican mortgage companies since March.

Jain joined Deutsche Bank in 1995 along with his mentor Edson Mitchell from Merrill, the third-biggest U.S. securities firm by market value, to build a sales and trading business. Mitchell died in a plane crash in 2000. Jain's background was as a fixed-income derivatives salesman. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

Bankers Trust

Deutsche Bank made its biggest push into Wall Street in 1999 when it bought New York-based Bankers Trust Corp. for about $9.5 billion, at the time the biggest foreign takeover of a U.S. bank. The purchase, which made Deutsche Bank briefly the world's largest financial company, included merger firm Wolfensohn & Co. and Baltimore-based securities firm Alex. Brown & Sons.

As Deutsche Bank's dependence on trading for itself and on behalf of clients has increased, so have concerns about its ability to weather a market slowdown. Rising interest rates and a stock market slide in May and June may be signaling an end to three years of near-perfect trading conditions, when the MSCI World stock index rose 50 percent and the market for credit derivatives grew fivefold.

Deutsche Bank is a leading trader of credit derivatives, a market dominated by contracts insuring debt against default, according to estimates by Fitch Ratings in November.

`Market Downturn'

``They have been gaining market share, but it's not clear how the investment bank has been dealing with the market downturn,'' said Helmut Hipper, who oversees 1.5 billion euros at Union Investment in Frankfurt, including Deutsche Bank shares.

Investors also are skeptical about Ackermann's ability to improve results in consumer banking and fund management. As Deutsche Bank expanded abroad, growth in its home market stalled. The company last year got 29 percent of 25.6 billion euros in total revenue from Germany, down from 69 percent in 1995.

Ackermann sought this year to expand retail banking at home and in emerging markets, agreeing in the past three months to pay 681 million euros for Berliner Bank and 420 million euros for Nuremberg-based Norisbank. Meanwhile, wealth management head Kevin Parker told investors in May that the division ``has seen the bottom,'' and pledged to increase revenue by investing in countries such as India and China.

That prompted Standard & Poor's to say on Aug. 22 that it may raise Deutsche Bank's AA- long-term credit rating if the company improves in areas such as retail banking and wealth management while maintaining earnings at the securities unit. S&P analyst Bernd Ackermann said trading was one of the threats to that outlook.

Relative Value

Deutsche Bank's stock trades at 9.26 times earnings, about the same as Goldman, the second-biggest U.S. securities firm by market value after Morgan Stanley, and 25 percent less than UBS, whose earnings are smoothed by its ownership of the world's largest manager of assets for millionaires.

Shares of Deutsche Bank are up 15 percent in the past five years, compared with Goldman's 90 percent rally, UBS's 72 percent advance, Societe Generale's 68 percent gain and Credit Suisse's 14 percent increase. The German bank is rated ``buy'' or the equivalent by 32 analysts who cover it. Eleven have ``hold'' ratings and five advise investors to sell its shares.

Trading fortunes ultimately follow those willing to gamble the most, Blue Oak's Maughan said. ``Where the risks are lower, the rewards will be commensurately lower.''

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Financial Sector ETFs

GlobeinvestorGOLD, Rob Carrick, 28 August 2006

Bank stocks are looking good these days, and it’s not just because Bank of Montreal has auspiciously begun the latest round of quarterly financial reporting for the sector.

With the U.S. Federal Reserve on hold after a two-year streak of interest rate increases, the stock markets have entered a phase where financial stocks traditionally do well. Certainly, BMO seems to be doing its part to keep this pattern of market behavior alive. The bank has reported a 30-per-cent increase in profits for the third quarter, driven in part by one-time gains but also by strong results from its retail and commercial banking operations.

Will the other banks do as well? Are there banks that are better bets than others for investors? If you’re struggling with these questions, then an easy answer is to buy all the banks at once and hedge your bets.

The way to do this is through an investment in the iShares CDN Financial Sector Index Fund (XFN-TSX), which holds the shares of banks, insurers and mutual fund companies. With about two-thirds of its assets in the Big Six banks, though, this exchanged-traded fund is an ideal way to get bank exposure without twisting yourself in knots over which to buy. The management expense ratio for the iShares CDN Financial Sector Index Fund is reasonable at 0.55 per cent, and the dividend yield is respectable at 2.1 per cent. The fund is up about 6 per cent this year, compared to about 8.2 per cent for the S&P/TSX composite index.

The strong performance of financial stocks following a Fed pause applies to U.S. banks as well as Canadian ones, which means investors may want to consider ETFs that cover the American financial sector as well. Your choices include:

• Select SPDR-Financial (XLF-American Stock Exchange): A low MER of 0.24 per cent, good liquidity and 55-per-cent exposure to the banking sector. Also, a decent dividend yield of 2.2 per cent.

• Vanguard Financials ETF (VFH-Amex): The MER is 0.25 per cent, the bank weighting is about 28 per cent and trading volumes are on the low side.

• iShares Dow Jones U.S. Financial Sector Index Fund (IYF-NYSE): The MER is high at 0.6 per cent, liquidity is modest and the holdings are spread throughout the financial sector.

• StreetTracks KBW Regional Banking ETF (KRE-Amex): The MER is 0.35 per cent for this relatively new ETF, trading volumes are somewhat modest and the focus is on smaller regional banks rather than mega players like Citigroup.

There’s a lot to be said about owning the shares of individual banks, but the simplicity and diversification of financial sector ETFs are an ideal solution for some investors. With the banking sector seemingly heading into a sweet spot, these ETFs make more sense than ever.

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RBC Q3 2006 Earnings

Toronto Star

BMO Capital Markets, 28 August 2006

Details & Analysis

Royal Bank reported third quarter cash earnings of $1.18 billion, or $0.91 per share, compared to $1.13 billion, or $0.86 per share, in the last quarter, and $988 million, or $0.76 per share in the same quarter of last year. The previous quarters include one-time items and all three quarters include the negative impact of discontinued operations. As such, the appropriate comparison is $0.92 per share in this quarter, $0.86 per share in the last quarter, and $0.77 per share in the same quarter of last year. Results were ahead of our expectations of $0.85 due largely to lower loan losses and higher trading revenues.

Overall, Royal has again shown its great diversity. ROE was 23%, EPS grew 19% and credit was excellent. We are modestly raising our forecasts for 2007. The one weakness was the fact that much of the year-over-year earnings growth was driven by much higher trading and lower loan losses.

The bank's credit position remained strong. Gross and net impaired loans were essentially unchanged over the quarter. Loan loss provisions of $99 million were lower than expected and came from both the retail and wholesale operations. In Canadian Personal and Business Banking, after an extended period of higher loan losses, loan impairments in the personal book moderated markedly. This is a very positive development and, if sustainable, suggests a somewhat lower structural level of losses than we have forecast.

From a capital perspective, Royal's Tier 1 increased marginally from 9.5% in the last quarter to 9.6% this quarter. Risk-weighted assets increased by roughly $8 billion, offset by a $300 million preferred share issue in July. Royal was relatively aggressive in repurchasing its stock this quarter - 5.5 million shares under its normal course issuer bid. The bank also increased its quarterly dividend by $0.04 to $0.40, more than we had expected. Royal Bank, along with National Bank, has been most prepared to return excess capital to shareholders.

Projections & Valuation

We are increasing our Cash EPS estimates by $0.10 in each of 2006 and 2007 - to $3.55 and $3.75 respectively. The higher earnings this year principally reflect the earnings surprise this quarter, while the increase for 2007 is based on our assumption of more moderate loan losses in Royal's domestic banking business.

This was clearly a very solid quarter for Royal. Domestic retail earnings were up 9% over the year - 15% if we exclude the one-time items. This is another solid result from Canada's biggest retail bank, well ahead of the BMO where the comparable growth was 8% and the TD where growth was 22%.

The only issue this quarter was that much of the growth in earnings came from lower loan losses and better trading. In addition, tax rates were modestly lower.

We maintain our Market Perform rating and $52 target price. This quarter again shows the strength of Royal's franchises. Domestic retail was strong, the U.S. and International business continues to improve from a low base and the Capital Markets business was again robust. The Bank continues to manage capital aggressively, but prudently. At current levels, we prefer investment in TD or CIBC. The former is beginning to benefit from extensive restructuring over the past few years, while the latter is quite cheap.

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Scotia Capital, 28 August 2006

Extremely Strong Third Quarter Earnings – 20% YOY Growth

• Royal Bank (RY) reported extremely strong earnings of $0.91 per share, up 20% YOY from $0.76 per share a year earlier, better than expected. Earnings were driven by a 4 basis point (bp) improvement in retail net interest margin and strong trading revenue.

• All business segments experienced solid growth, with U.S. & International P&B earnings up 32%, RBC Capital Markets up 31% and Canadian P&B earnings up 9%.

• Cash ROE is expected to be an industry high at 23.3% versus 20.5% a year earlier. Return on risk-weighted assets was 2.18% versus 2.06% a year earlier.

• The bank increased its common dividend 11% to $1.60 per share, with a payout ratio of 44% based on 2006E EPS.

Solid Retail & Wealth Management Earnings

• Canadian Personal and Business (P&B) earnings grew 9% YOY to $743 million supported by Canadian retail NIM which improved 4 basis points (bp) QOQ and 4 bp YOY to 3.26%, and despite a 22% decline in Global Insurance earnings.

• Underlying earnings for Canadian P&B would have increased 21% YOY excluding Global insurance earnings and an accounting adjustment from a year earlier.

• Operating leverage in Canadian P&B was negative 2% mainly due to the Global insurance business. Excluding Global insurance, operating leverage at Canadian P&B would be 3% with revenue growing 9% YOY and expenses growing 6% YOY.

• Wealth Management revenue increased 21% YOY to $667 million with mutual fund revenue up 34% to $328 million, assisted by the Dexia transaction. Mutual fund assets (as reported by IFIC) increased 20% YOY to $64.3 billion.

• Personal Banking and Card & Payment revenues were up 6% YOY on solid volume growth, with residential mortgages up 14%, personal loan balances up 12% and credit card balances (including securitization) up 13%.

• Business and Commercial Banking revenue increased a modest 2% YOY to $541 million.

• Insurance revenue was $821 million, down 8% YOY from $888 million a year earlier due to the impact of the strong Canadian dollar on U.S. operations and lower annuity sales. Insurance policyholder benefits, claims and acquisitions expense also declined 8% YOY.

• Securitization revenue was $61 million, unchanged from the previous quarter and down 6% from $65 million a year earlier.

Canadian Retail NIM Improves 4 bp

• Canadian retail net interest margin (NIM) improved 4 basis points (bp) QOQ and YOY to 3.26% reflecting higher deposit and mortgage spreads.

U.S. & International P&B Earnings Increase 32% YOY

• U.S. & International P&B segment recorded strong growth at 32% to $121 million.

• Operating leverage was 1% with revenue flat YOY (although up 11% in U.S. dollars) and expenses down 1% (and up 10% in U.S. dollars). Wealth Management revenues were up 2% (or 13% in U.S. dollars) while Banking revenue declined 2% (although was up 8% in U.S. dollars).

• Loan loss provisions in this segment declined to $5 million from $18 million a year earlier, reflecting improved credit quality in the loan portfolio at RBC Centura.

RBC Capital Markets Earnings Exceptional

• RBC Capital Markets earnings were up 31% to $335 million reflecting higher trading revenue, and strong M&A activity.

• Operating leverage was 3% with revenues (teb) (excluding impact of VIEs) increasing 13% and expenses increasing 10% from a year earlier, mainly due to higher variable compensation.

Strong Trading Revenue

• Trading revenue remained strong at $537 million, only slightly below Q2 level of $586 million and compared to $376 million a year earlier. This quarter reflected extremely strong performance in equities offsetting some slightly weaker fixed income revenue versus the previous quarter.

• Equity trading revenue increased 27% QOQ to $171 million. Fixed income and foreign exchange revenues were weaker, declining 20% and 14% versus the previous quarter.

Capital Markets Revenue

• Capital Markets revenue was solid at $544 million, versus $606 million in the previous quarter and $525 million a year earlier with securities brokerage commission revenue up 6% to $291 million.

Total Bank Operating Leverage

• The Bank's total operating leverage was 1% with revenue growth of 6% and expense growth of 5%. Operating leverage was low mainly due to the weak results from Global Insurance. Excluding Global Insurance, operating leverage would be 4% with revenue growth at 9% and expense growth at 5%.

Security Gains Negligible

• Security gains were $11 million or $0.01 per share versus $22 million or $0.01 per share in the previous quarter and $33 million or $0.01 per share a year earlier.

• Unrealized security deficit improved in the third quarter to negative $49 million versus a deficit of $166 million in the previous quarter.

Loan Loss Provisions - Low at 18 bp

• Specific loan loss provisions (LLPs) remained low at $99 million or 0.18% of loans compared with $124 million or 0.25% of loans in the previous quarter and $128 million or 0.26% of loans a year earlier.

• We are reducing out 2006 LLP estimate to $425 million or 0.20% of loans from $450 million or 0.21% of loans. Our 2007 LLP estimate remains unchanged at $550 million or 0.26% of loans.

• Gross impaired loans (GILs) were $791 million compared to $793 million in the previous quarter and $866 million a year earlier. Net impaired loans (NILS) were negative $624 million versus negative $642 million in Q2/06 and negative $703 million a year earlier.

Tier 1 Ratio

• Tier 1 capital ratio was stable at 9.6% compared to 9.5% in the previous quarter.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.3%.

Share Buybacks

• During the quarter RY repurchased 5.5 million shares for $253 million or $46 per share. RY launched a new repurchase program on June 26, 2006 to repurchase up to 7 million or 0.5% of common shares outstanding, with 4.8 million shares already purchased.

RBC Centura to Acquire Flag Financial Corporation

• On August 9, RY announced that wholly owned subsidiary RBC Centura will acquire Flag Financial Corporation (Nasdaq: FLAG) and its bank subsidiary, Flag Bank for US$456 million, or US$25.50 per share. FLAG has 17 branches and 370 employees, serving Atlanta, central and western Georgia. RBC Centura already has 30 banking centres in Georgia, primarily in the Atlanta area.

• This acquisition is expected to be neutral to RY's EPS in Year 1. The transaction will be financed with cash, and is expected to close by the end of 2006, subject to regulatory and shareholder approval.

Earnings Estimates Increased

• We are increasing our 2006 and 2007 earnings estimates to $3.60 per share and $4.00 per share from $3.45 per share and $3.85 per share, respectively, reflecting strong earnings momentum in all business segments, strong trading revenue, and net interest margin improvement.

• Our 12-month share price target is unchanged at $58, representing 16.1x our 2006 earnings estimate and 14.5x our 2007 earnings estimate.

Reiterate 1-Sector Outperform

• We reiterate our 1-Sector Outperform rating on the shares of Royal Bank based on a high relative ROE, and strength in its retail, wealth management, and capital market platforms. RY is expected to produce the strongest core earnings this quarter and we believe its P/E multiple is on track to expand to a 10%-15% premium to the bank group.

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Financial Post, Duncan Mavin, 26 August 2006

Royal Bank of Canada will not be rushed into buying up more banks in the United States to add to its RBC Centura franchise, chief executive Gord Nixon said yesterday after announcing record third-quarter profits at Canada's largest bank.

RBC reported earnings jumped 20% to $1.2-billion compared with $1-billion for the same period last year, while revenue grew 6% to $5.2-billion.

Cash earnings per share were 91 cents, compared with an average estimate of about 85 cents among Bay Street analysts.

Mr. Nixon said the bank's strong performance was a reflection of the successful execution of growth initiatives in North America.

Net income at RBC's U.S. operations increased 39% to $168-million compared with a year ago, and now represents more than 14% of total earnings. Also, during the quarter RBC announced the US$456-million acquisition of Atlanta-based Flag Financial Corp. However, Canada's largest bank is taking a cautious approach to further growth in the United States.

"I think we want to continue to grow patiently as opposed to grow aggressively," said Mr. Nixon, who explained that RBC's U.S. strategy involves opportunistic acquisitions and limited new branch openings.

RBC Centura has opened a fairly conservative 32 new branches in the past three years and is planning 12 or 16 more in the next 12 months.

The approach contrasts with that of rival Toronto-Dominion Bank.

Many U.S. banking industry observers have predicted a wave of consolidation in the sector as a difficult interest rate environment and intense competition takes its toll on smaller, regional banks in particular. TD executives have said the bank intends to take advantage of the tough conditions by targeting one or two regional banks each year to add to its Banknorth franchise in the north east U.S.

But Mr. Nixon warned that "the key issue" is how to achieve market share growth in the U.S. without impairing shareholder value, and he is prepared to bide his time for the right deal.

"There will continue to be opportunities in the United States for a long time," said Mr. Nixon. "The challenge will be opportunities that are reasonably priced and strategically attractive. They are few and far between."

Meanwhile, RBC's record third quarter was broadly in line with heightened expectations, coming after TD and Bank of Montreal had already reported strong results earlier in the week.

"At this point, TD's results stand as the strongest we have seen so far this quarter," said UBS Investment Research analyst Jason Bilodeau in a note.

RBC's earnings from core domestic retail banking grew an impressive 9% compared with last year but that fell short of the 14% growth reported by TD, he noted.

RBC also followed in the footsteps of TD and BMO by hiking its dividend, by 4 cents, or 11%, to 40 cents a common share.

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The Globe and Mail, Sinclair Stewart, 26 August 2006

The trading team at Royal Bank of Canada produced huge numbers for the second consecutive quarter, surprising analysts and helping to power the bank to a 20-per-cent increase in profit.

RBC, the country's largest company by market capitalization, is viewed as the bellwether for the Canadian banks, and its results suggest the sector is well positioned to continue its impressive performance.

The bank reported third-quarter profit yesterday of $1.16-billion, or 90 cents a fully diluted share, up from $968-million or 74 cents a year ago.

Credit provided a big lift to RBC's bottom line, with loan-loss provisions accumulating at a far slower clip than Bay Street had been expecting. Provisions for soured loans were just $99-million, down from $128-million a year ago.

Domestic retail banking was also strong, much as it was for rival Toronto-Dominion Bank, thanks to a combination of improving profit margins and a heady appetite for consumer and business borrowing.

This was somewhat expected, however, given TD's results on Thursday. What was more of a surprise was the continued strength in RBC's trading platform, which is generating more than half a billion dollars' worth of revenue every three months.

In the third quarter, total trading revenue reached $537-million, an increase of 43 per cent from the same period in 2005. The results dipped from a record $586-million that RBC's trading operations produced during the second quarter, but not nearly as much as some analysts had forecast.

"Trading was extremely high," said one analyst who tracks the company. "$586-million is a monstrous number, $537-million is just a really, really huge number."

On a conference call with analysts yesterday, RBC said the trading unit benefited from increased market volatility during the quarter, as well as "business expansion."

The bank has taken pains to dismiss suggestions it could be assuming more market risk with its trading, and said that despite the stellar results, it is no more reliant on this business than it has been historically. Trading accounted for a little more than 10 per cent of the bank's total revenue in the first nine months of the year, the same percentage as three years ago.

RBC chief executive officer Gordon Nixon told analysts he was pleased with the performance of the U.S. retail bank, RBC Centura, which has rebounded following a period of poor performance, caused in part by a troubled mortgage unit. Its profit increased 39 per cent during the quarter to $111-million. "We think Centura has turned around," he said.

The improvement reignited RBC's U.S. expansion earlier this month when it acquired Flag Financial Corp. for $510-million. Mr. Nixon said the bank will continue to look for acquisitions, but acknowledged that reasonably priced, strategically situated targets are "few and far between."

On a cash basis, which analysts use to forecast profitability, RBC made 91 cents a share -- about 7 cents better than consensus estimates. The Canadian personal and business division made $742-million, up 9 per cent, while the investment bank made $329-million, up 29 per cent.

Even so, RBC shares sank yesterday amid a general selloff among the banks, as investors took money off the table following a two-month rally in the sector. RBC also raised its quarterly dividend yesterday by 4 cents a share to 40 cents.

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RBC Capital Markets, 25 August 2006

• RY Beats Consensus Again. RY posted $0.92 cash EPS (excludes -1¢ from discontinued ops) for ~21% growth YoY, and well ahead of the $0.85 consensus. While the positive EPS variance was driven by stronger trading revenue and the low loan loss, it was acceleration in underlying domestic retail business that caught our attention upon deeper analysis. We estimate 9% reported YoY domestic retail profit growth was 16%, excluding a Q3/05 accounting gain, and was 22% excluding the decline in insurance contribution. This was an excellent result, matching TD.

• EPS and Price Target Adjustments. For the 6¢ Q3/06 variance, we are raising our EPS 2006 cash EPS estimate to $3.54 from $3.46 – our Q4/06 estimate is also up 1¢ to 87¢. Our 2007 estimate remains $3.94, and we are introducing a 2008 $4.41, indicated up 11-12%. Our price target remains $55.00 (target P/E remains 14x, at a 1 point premium to our sector target P/E of 13x). Reiterating Outperform rating.

• Credit Impressed Again. RY’s loan loss provision at $99MM this quarter compared to our estimate of $140MM and consensus of $150MM (nearly 3¢ EPS benefit versus consensus). Impaired loans were stable and the reserve-to-impaired loan coverage ratio was steady at 179%.

• Domestic Retail Bank Up 16% YoY, 22% Excluding Insurance. This was a solid result despite the specific market-sensitive weakness in retail insurance. Core retail product sales momentum remained very strong. Lower retail credit losses, down $28MM, tipped RBC divisional earnings growth positively. Expense growth at 6% YoY appeared to be high, but excluding the insurance operation, the retail bank actually generated 3 points of positive underlying operating leverage.

• Valuation for RY. Our $55 price target is set at 14x our 2007 cash EPS estimate of $3.94. Our premium target P/E is based on high-quality EPS revisions potential, what we believe to be best-in-class ROE and excellent credit performance. Our price target is indicated at ~3.0x our projected book value of $18.63 (as at Oct 31/07). RY continues to face some execution risk in its US operation as it undertakes ambitious cost savings and operating leverage programs. An over-sized Enron provision could pose a short-term risk to price performance, though we expect this risk is fairly well contained with the Q4/05 litigation reserve of US$500 million (pre-tax).

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Report on Business Television, 25 August 2006

Click here for the ROBTv video clip, of Janice Fukakusa (CFO, RBC) speaking about RBC's Q3 2006 Earnings.

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Bloomberg, Sean B. Pasternak, 25 August 2006

Royal Bank of Canada, the country's biggest bank, said profit rose for the seventh straight quarter, led by its U.S. and international consumer bank.

Net income for the period ended July 31 rose 20 percent to a record C$1.18 billion ($1.07 billion), or 90 cents a share, from C$979 million, or 74 cents, a year earlier, the Toronto- based bank said today. Revenue rose 5.6 percent to C$5.21 billion.

Chief Executive Officer Gordon Nixon turned around the money-losing U.S. business by selling a mortgage unit and cutting about 500 jobs. Royal Bank is the third Canadian lender this week to beat analysts' estimates because of a surge in trading income and higher profit from consumer lending and capital markets.

"It looks to have been a smart move to get rid of the U.S. mortgage business," said Gavin Graham, director of investments at Guardian Group of Funds in Toronto, which manages about $5.3 billion including Royal Bank shares. ``The retail business is booming.''

Profit from U.S. and international consumer banking, which includes Raleigh, North Carolina-based RBC Centura, rose 39 percent to C$111 million. RBC Centura cut costs and targeted business clients in North Carolina, Florida and Georgia after a slowdown in the U.S. led to Royal Bank's first annual profit decline in four years in 2004.

"We've overhauled our business strategy," RBC Centura Chief Executive Office Scott Custer said in an Aug. 9 interview. ``We think we're on the right track, but in many ways, we've still got a long way to go.''

This month, the bank announced its first U.S. consumer bank acquisition in almost three years, agreeing to buy Atlanta-based Flag Financial Corp. for about $456 million. Royal Bank could make future purchases once Flag has been integrated, Chief Financial Officer Janice Fukakusa said.

"Our immediate focus is developing a banking platform that we can leverage," Fukakusa said today in a telephone interview.

Royal Bank shares fell along with other Canadian banks after rising 10 of the past 14 sessions. The stock fell 90 cents, or 1.8 percent, to C$49.80 in 4:10 p.m. trading on the Toronto Stock Exchange. They've risen 9.7 percent this year, double the gain for the 39-member S&P/TSX Financials Index. Bank of Nova Scotia and Bank of Montreal also declined.

Excluding one-time items, Royal Bank earned 91 cents a share, topping the 84-cent median estimate in a Bloomberg News survey of seven analysts. Robert Wessel, an analyst at National Bank Financial, also expected 84 cents a share on that basis. Trading fees were 8 cents to 10 cents a share higher than expected by Jason Bilodeau, an analyst at UBS Canada.

Canada's economy is benefiting from record prices for commodities such as oil and nickel, helping cut the jobless rate to a 30-year low. Transactions on the Toronto Stock Exchange rose 42 percent this year as the value of mergers in Canada climbed to a seven-year high. That contributed to a 29 percent increase in investment banking profit for Royal Bank, to C$329 million. Equity trading revenue rose 76 percent to C$171 million.

RBC Capital Markets leads all lenders in advising on Canadian mergers this year, according to data compiled by Bloomberg. The bank is working with Inco Ltd., the world's second-biggest nickel miner and the target of three takeover bids. The firm also ranks first for managing new stock sales this year.

Consumer banking profit in Canada rose 9.3 percent to C$742 million, driven by higher revenue from mutual funds, credit cards and mortgages. Insurance revenue declined 7.5 percent to C$821 million.

The bank boosted its quarterly dividend 11 percent to 40 cents a share, the fourth increase in two years.

Canadian banks are also taking advantage of a decline in bad loans. Royal Bank set aside C$99 million for soured loans, a 23 percent decrease from the year earlier.

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Dow Jones Newswire, Monica Gutschi, 25 August 2006

Royal Bank of Canada appears to have done everything right in the third quarter - easily roaring past analyst estimates.

But it made the mistake of issuing its financial report a day after rival Toronto-Dominion Bank delighted investors with record-breaking numbers. So Royal suffers in the comparison.

While most of the lift in Toronto-Dominion's numbers came from its cornerstone domestic-banking operations, Royal Bank was helped along by low loan-loss provisions, a lower tax rate and strong (but unsustainable) trading revenue.

Royal Bank net income rose to C$1.18 billion or 90 Canadian cents a share from C$979 million or 74 Canadian cents a year earlier. On a cash basis, third-quarter earnings were 91 Canadian cents a share, well above the Thomson First Call mean estimate of 84 Canadian cents a share.

Return on equity soared to 23.1% and revenue grew 6%. Provisions for credit losses dropped to C$99 million from C$128 million a year earlier. All of the bank's business units performed well, especially its U.S.-based retail bank as the makeover of the past few years bore fruit.

As expected, Royal Bank also raised its dividend.

Nevertheless, "we don't think these results are as good as TD's results," Ian de Verteuil, analyst at BMO Capital Markets said in a note. And UBS' Jason Bilodeau suggested that, while the headline earnings number was good, it "may fall short against heightened expectations in wake of TD's numbers."

In Toronto Friday, Royal Bank is down 90 Canadian cents to C$49.80 on nearly 2 million shares. After rallying in the period since central banks in Canada and the U.S. stood pat on interest rates, the shares nudged close to record highs this week.

Shares in other Canadian banks are also lower Friday, with the exception of Toronto-Dominion.

Net income at Royal Bank's Canadian retail unit rose 9% to C$742 million, representing 58% of total profits. Net interest margins widened, and the bank saw strong volume growth in a number of businesses, including residential mortgages, credit cards and business deposits. However, insurance revenue sagged.

Net income at the U.S. and International banking division rose 39% to C$111 million. Better credit performance played a strong role, further confirming the turnaround at RBC Centura, the company's U.S.-based retail bank.

Earlier this month, Centura announced that it had purchased Flag Financial of Georgia for US$456 million, the first U.S. buy since 2003.

Chief Executive Gord Nixon said the purchase "was very opportunistic as opposed to driven by the desire that we have to grow." He noted there would continue to be acquisition opportunities in the U.S. although the bank would only consider targets that met strategic and financial parameters.

Net income at the Capital Markets division rose 29% to C$329 million, driven by strong trading revenue.

"It's all pretty good if you look at it in isolation," said Bruce Campbell, of Campbell-Lee Investment Management, who holds Royal Bank shares. However, "it's not quite as good as TD's."

Part of the problem, Campbell said, is that the bank is "a little more at risk as far as loan losses go" if the North American economy weakens next year.

De Verteuil at BMO agreed: "RY's loan losses in a downturn will need to rise much more meaningfully than TD's loan losses," he wrote. Additionally, he noted that earnings at Toronto-Dominion's domestic retail bank rose 22%, compared with 15% at Royal Bank.

And Campbell also said the stock's recent rally has a role in the market reaction Friday. "The upside on it is less," he said. "I prefer TD at the relative prices."

Andre Hardy of Merrill Lynch noted that both banks have "better momentum" than their peers to grow Canadian-based revenue. However, he also said in a note that Royal Bank's "relative risk profile has risen," as its leading loan growth has come primarily from unsecured loans. Tellingly, personal core deposits rose only 1% in the quarter.

BMO Capital Markets, UBS and Merrill Lynch all have investment-banking relationships with Royal Bank and own its securities. It wasn't immediately clear if the analysts own shares.

Royal Bank is the third Canadian lender to report quarterly results. Bank of Montreal, the fourth-biggest bank by assets, said on Aug. 22 that profit rose 30 percent to a record C$710 million. Toronto-Dominion, the second-biggest, said yesterday that profit almost doubled to C$796 million on higher trading fees and increased earnings from its U.S. discount brokerage.

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Life Insurance Companies vs. Banks

Financial Post, John Turley-Ewart, 26 August 2006

Canada's insurance industry is in moral decline.

Financially it is sound. Policies are being honoured as usual, dividends are being paid, and insurance stocks are having a good run. But the business ethics on offer from some of the industry's guiding lights give pause. The battle by insurance companies to keep other financial institutions from retailing insurance through their branches has revealed the sector's unseemly side.

Take the most recent example. The Ontario government will not allow credit unions, which fall under provincial legislation, to own insurance brokerages and retail insurance through their branches, a practice already permitted in Quebec.

The reason borders on the bizarre: The Ontario government found that "there was no consensus on this issue between the credit-union sector and the insurance industry." This effectively gives insurance companies a veto over credit unions retailing insurance, a decision grounded in banana-republic values rather than liberal-democratic ones.

Insurance companies and brokers see it differently, of course. The continuing dominance brokers have over retailing is good for customers, according to Randy Carroll, the chief operating officer for the Insurance Brokers Association of Ontario. "Trying to mix credit with insurance doesn't make any sense," he said last week. "As a consumer, the last thing I want to do is try to negotiate my mortgage and feel obliged that I have to place my house insurance with that same company."

In May, Paul Desmarais Jr., co-CEO of Power Corp. of Canada, which owns Great West Life and, through it, Canada Life and London Life, complained that if banks use their data banks to market life and health insurance through their branches it would be "coercive."

Just a week before that, Dominic D'Alessandro, chief executive of Manulife Financial Corp., stated in these pages: "I don't know why the prohibition on selling insurance products within bank branches has survived. Is it because there are concerns that the banks would exploit their unique relationship with borrowers and engage in tied selling?"

This constant mantra should not be dismissed lightly. Banks and credit unions do not engage today in the tied selling of credit and investment products that they retail in branches. Why would they suddenly turn to tied selling if allowed to sell insurance in branches?

The logical extension of the insurance sector's campaign is that your local mild-mannered bank and credit union managers are untrustworthy rogues. Where is the evidence for any such allegations?

In Ontario, tied selling has been illegal under current provincial legislation for 10 years. Art Chamberlain, a spokesman for Credit Union Central of Canada, says that to the best of his knowledge there has not been one conviction under this legislation.

Tied selling also violates the federal Bank Act. Since 2002, section 459.1 (1) outlawing tied selling has been on the books. Compliance with the law is enforced by both federal regulators and the Financial Consumer Agency of Canada, which since 2002 has found but one case of tied selling -- just one. This amounts to a damning indictment not of banks but of insurance industry leaders who, in their quest to protect their turf, have lost their moral compass, stoking damaging doubts about the integrity of bankers and credit unions.

Tied selling rules are too vague, some in the insurance industry argue. Advocis, which represents 12,000 insurance brokers and financial advisors, tried to make this case in its June response to Finance Canada's 2006 Review of Financial Sector Legislation. It wants Ottawa "to more clearly define what constitutes undue pressure or coercion. [And] ... to develop regulations which would clarify for consumers the types of behaviours which are not permitted."

It is a preposterous argument. What part of "coerce" does Advocis not comprehend? The definition of the word is unequivocal: "To compel by force, law, authority or fear."

What insurance-sector leaders are doing is not just unethical from a business standpoint but misleading. Banks are regulated federally and insurance companies are subject to both federal and provincial regulation, which puts insurance companies at a disadvantage. That is a valid concern. The answer is one national regulation system, but the insurance sector thinks it will lose that argument and has resorted to demagoguery dressed up as concern for consumers' interests, regardless of the impact it has on the good name of Canadian banks and credit unions.

There is no known evidence to suggest local credit unions and bank branch managers are criminally inclined. If the insurance industry has information to the contrary, it's time to put up. To do otherwise gives consumers cause to ask one question: If Canadian brokers and insurance companies will bend the truth to keep rivals at bay, what will they do to sell an insurance policy?

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