Higher Threshold for Foreign Insurers in China

China Daily

Beijing, Feb. 28 -- Foreign insurers are going to face a much higher threshold to enter the Chinese market due to the industry watchdog revising the management rule on foreign insurers' representative offices in Beijing.

As a major change, the new draft, which is open to the public opinion before March 9, required foreign insurance institutions to have at least 20 years of continuous experience in running an insurance business when applying for a licence to set up a representative office in China.

For those running non-insurance businesses, they should have a business history of more than 20 years, said the China Insurance Regulatory Commission (CIRC) in a statement.

"Compared with the original rule which has no requirement for foreign insurers' years of experience, the newly added threshold shows the regulatory authority's commitment to prevent potential risks and strengthen management of foreign insurance institutions," said Wang Guojun, an insurance professor at the University of International Business and Economics.

According to the original rule, foreign insurance institutions could apply for the licence to set up a representative office once they saw a favourable business performance and had no blunders on record three years prior to the application.

The CIRC also will require stricter management by chief representatives by raising criteria of scholarship, capacity and experience.

"I don't think there will be any influence on our representative office," said Kumjoo Huh, chief representative of Kyobo Life Insurance Co (Beijing representative office).

The South Korea-based life insurer entered the Chinese market in 2004 and is actively seeking local partners to start a joint venture.

Akihiro Matsumoto, senior resident representative of Sumitomo Life Insurance Company (Beijing representative office), also shared the same view.

"The revised article has no influence on us," he said.

The Japan-based insurer, which set up its Beijing representative office in 1991, took a 29 per cent stake in PICC Life Insurance Company last December.

"The revised rule will be a big challenge for those small and medium-sized foreign insurers that are eager to cash in on the huge Chinese insurance market," Matsumoto added.

China's insurance industry has maintained an average of 30 per cent growth in the past decade, and the market potential is still growing.

A Sigma report from Swiss Reinsurance suggests China's premiums are likely to top 453.1 billion yuan (US$55.9 billion) in 2006. Boston Consulting Group (BCG) believes that this figure will reach 830 billion yuan (US$102 billion) in 2008.

After completely opening its doors to foreign insurers in late-2004, China has seen many multinationals expanding throughout the country in the past year and grabbing a larger share of the market.

Joint venture insurers such as Skandia-BSAM Life, Generali China Life, and Manulife-Sinochem nearly doubled their presence in China in 2005.

After conquering large cities such as Beijing, Shanghai and Guangzhou, these operators began expanding into mid-sized centres such as Qingdao, Hangzhou, Chongqing and Chengdu.

CIRC's figure suggested that the 40 foreign insurers reaped 34.1 billion yuan (US$4.2 billion) in premiums last year, which represented 6.9 per cent of the market.

Three more foreign insurers were allowed to enter the market last year, while a total of 25 operational entities by foreign insurers were set up.

"The growth of foreign insurers reflects the strong desire to tap into this huge market. It also says a lot about Chinese consumers' confidence in foreign companies," said an analyst with China Securities.

A report from the Development Research Centre of the State Council says domestic customers place high expectations on foreign insurers.

It shows that 74.1 per cent of Chinese consumers surveyed think foreign insurers offer exceptional service, 82 per cent trust the employees of multinationals, and 77.9 per cent prefer foreign insurance products.

Facts and figures

* The new draft requires foreign insurance institutions to have at least 20 years of continuous experinece in running an insurance business when applying for a license to set up a representative office in China.

*Statistics from the industry watchdog showed there were 40 foreign companies and 44 domestic firms operating in the Chinese insurance market by December 2005. Approximately 124 foreign insurers from 18 countries have established representative offices in China.

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S&P Revises Outlook for RBC & TD

Investment Executive, James Langton, 28 February 2006

Standard & Poor’s Ratings Services has revised its outlook on TD Bank to positive from stable, and from negative to stable of Royal Bank.

The rating agency said now that TD Bank has successfully repositioned its platform to reflect its desire to build a retail powerhouse and streamlined and exited underperforming businesses consistent with its risk appetite, it is poised for more stable and stronger profitability in the future.

“The successful expansion into the U.S. retail and commercial banking industry through TD Banknorth Inc. and the opportunistic discount brokerage position, coupled with domestic operations that will continue to provide a substantial base of stable earnings, could give TD Bank the edge over some of its large Canadian peers in the foreseeable future,” S&P added.

"The outlook revision acknowledges the strength of TD Bank’s formidable domestic retail franchise and the significant restructuring of the bank and its lowered risk profile in the past few years," said S&P credit analyst Lidia Parfeniuk.

S&P said that TD Bank is exceptionally well positioned in the domestic retail banking market. This situation is further enhanced by promising prospects for TD Ameritrade (which resulted from the merger of TD Waterhouse USA with Ameritrade), as partnering up with a strong player will eliminate some of the fierce competition in the U.S. discount brokerage arena and improve profitability and market share.

“The success of the U.S. expansion through TD Banknorth hinges on the success of this incremental growth strategy that would allow TD Bank to achieve a stronger foothold in the larger, more diverse U.S. Market,” it said. “The challenges associated with this strategy remain, including managing a large minority shareholder position in Banknorth and, in particular, the difficulty of generating a decent return on invested capital; however, early indicators are positive and will depend on TD Banknorth’s strong local management to manage the risks of integrating the large acquisition made recently.”

S&P said it believes that the magnitude of the eventual Enron Corp. settlement (particularly the Newby class action suit) and the possibility of additional reserves would not be material enough to significantly affect the bank’s strong capital position. If the bank maintains capital discipline with regard to acquisitions and demonstrates the smooth integration of the recent acquisitions, the ratings could be raised, it concluded.

At the same time, the rating agency also revised its outlook on Royal Bank. "The outlook revision acknowledges the improved operating results of the retail segment in the U.S. and Royal Bank’s commitment to its U.S. operations," said Parfeniuk.

S&P said that Royal Bank has been moving in the right direction to boost the performance of its U.S. retail operations with encouraging results. The bank has also demonstrated its continued commitment to the U.S. through its support of RBC Centura Bank, despite the problems the business unit faced in 2004. As a result, Standard & Poor’s has taken more comfort with Royal Bank’s direction in the U.S. and sees good progress with the objectives set out. Standard & Poor’s expects the operating results of RBC Centura to continue on a positive trajectory.

In addition, Standard & Poor’s is now more comfortable that any additional legal reserves, if necessary, will not be material enough to significantly affect the bank’s strong capital position.

The stable outlook is predicated on the continued improvement of the U.S. operations and strength of the solid domestic retail franchise, it said. However, it noted that should the final Enron legal cost significantly exceed its expectations, the outlook on Royal Bank and its subsidiaries could be revised to negative, as capital would decline to levels below that of its Canadian peers and financial flexibility would be diminished with respect to future strategic initiatives.

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TD Taps Canada's Mosaic for Growth

The Globe and Mail, Sinclair Stewart, 28 February 2006

When Toronto-Dominion Bank scooped up Canadian auto finance company VFC Inc. recently, it raised more than a few eyebrows among investors. Why was TD, with its newfound aversion to risky lending, suddenly courting car buyers with weak credit profiles?

TD provided a number of answers, ranging from the potential size of the market to the strength and experience of VFC's management team.

But there was another, equally compelling reason for the purchase that didn't receive much attention: This was a way for TD to grab a larger share of the immigrant market, one of the most lucrative sources of domestic growth available to Canada's big banks.

No one needs to explain this to TD. The bank has quietly forged a commanding share of the business among the country's ethnic groups, according to a study to be released today by Toronto-based Solutions Research Group Consultants Inc.

The firm conducted telephone interviews in nine languages with 3,000 Canadians last summer, and found that TD's retail bank ranked No. 1 for primary relationships among all six of the country's major ethnic populations: Chinese, South Asian, Italian, Black, West Asian/Arab, and Hispanic.

Among people with South Asian backgrounds, TD Canada Trust held 43 per cent of the market -- more than Canadian Imperial Bank of Commerce, Royal Bank of Canada and Bank of Nova Scotia combined. TD was also No. 1 among Chinese Canadians, with a 29-per-cent share.

TD is also a clear favourite among immigrants who have been in the country less than 10 years.

"TD has done a little bit more, a little bit more aggressively, particularly with the South Asian community," said Kaan Yigit, who directed the diversity study for SRG. "If you have a leadership position with the fastest-growing segments, you're going to get disproportionate rewards if you can maintain these relationships."

These rewards, especially for banks scrounging for growth on their home turf, could be huge. Immigration accounts for nearly 70 per cent of Canada's population expansion; one in five Canadians is expected to belong to a visible minority by 2017. New Canadians are also much younger, and many tend to be highly educated.

TD has seen the demographics, and plans to almost triple its ethnic marketing budget this year, said chief marketing officer, Dom Mercuri. The bank has always placed a heavy emphasis on the Chinese market, but has become much more active with the South Asian community, recently sponsoring television coverage of India-Pakistan cricket matches.

"It is the future: You just have to go to the Statscan Web site," said Mr. Mercuri, who chairs a diversity committee within the bank. "It is a huge opportunity. But it's one of those opportunities that if you don't capture the growth segment now, organizations will see their customer base erode."

The challenge is that these immigrants often arrive with no brand preference, no banking relationships, and no credit profile -- one of the reasons that companies such as VFC, which services people with little or no credit profile, can help TD make another point of contact with new Canadians.

"As a category, banks have caught onto this faster than anyone else," said David Innis, whose Toronto advertising agency, Fat Free Inc., specializes in the South Asian market. "Within the banking spectrum, TD certainly looks to be the most active. If I had to draw a distinction between it and the other banks, it's that TD has both feet in the water, whereas the other banks tend to be just dipping their toes."

Part of TD's success with minorities, however, may have little to do with its ethnic targeting efforts. Indeed, some simply attribute the bank's growing share of the ethnic market to its marketing-driven culture, a residue of its merger with Canada Trust in 1999.

While other banks may have historically focused more on customer retention, the smaller Canada Trust was forced to hunt aggressively for new customers.

It pioneered longer banking hours (a popular draw for immigrants, Mr. Mercuri said), used Johnny Cash as a spokesman for its eponymous automated bank machines, and gave away cars. The tradition has continued at TD, which recently has given out iPods.

In other words, TD has become good at getting new customers; it just so happens that an increasing number of these customers are new to Canada. "I'd say that what we had at Canada Trust, and to some extent at TD, we were always the little guys," Mr. Mercuri said. "We always had to be aggressive and drive for growth, and I'd say that's continued. Some of the others may not have focused as much that way."

• New Canada rates the old banks •

What is the name of your primary financial institution or bank?

Rank	Chinese	South Asian	West Asian /Arab	Black	Hispanic	Italian
1	TD	TD	TD	TD	TD	TD
2	CIBC	CIBC	RBC	CIBC	RBC	CIBC
3	RBC	RBC	CIBC	RBC	CIBC	RBC
4	HSBC	Scotiabank	BMO	Scotiabank	Dejardins	BMO
5	BMO	BMO	National Bank	BMO	Scotiabank	Scotiabank

Source: Solutions Research Group

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Cdn Banks vs. Verdun Showdown

The Globe and Mail, Sinclair Stewart, 28 February 2006

For years, Robert Verdun has been one of Corporate Canada's biggest gadflies, a controversial shareholder activist known for his withering assessments of the country's Big Banks.

This week, however, as the banks begin hosting their annual meetings, the tables could be turned, and it could soon be Mr. Verdun who finds himself on the wrong side of an attack.

A lawyer for Robert Astley, the former Clarica Life insurance Co. boss who now sits on Bank of Montreal's board, sent a legal warning to Mr. Verdun last month. The message was blunt: If Mr. Verdun continued to publicly question Mr. Astley's ethics, and his fitness as a director, he would be slapped with a lawsuit.

Mr. Verdun, reached at his home in Elmira, Ont., said he is undaunted by the threat of legal action; so much so, in fact, that he filed a complaint with the Ontario Securities Commission yesterday, demanding an investigation into what he called a "misleading" disclosure by BMO that "casts doubt on the honesty, ethics, and integrity of the entire board."

The complaint is sure to add fuel to the already combustible relationship between Mr. Verdun and the bank's directors, particularly Mr. Astley, in the lead-up to the bank's annual meeting Thursday in Calgary.

Don Jack, Mr. Astley's lawyer, could not be reached for yesterday, but sources said he plans to attend the meeting personally to monitor Mr. Verdun's behaviour.

Banks are naturally loath to get embroiled in a David and Goliath legal showdown with a small investor, because of the obvious public relations nightmare that could ensue.

Yet, given the escalating nature of the feud between Mr. Verdun and Mr. Astley, this case could well prove an exception.

"It firms my resolve to keep fighting this one," Mr. Verdun said of the legal letter. "I'm not the least bit concerned."

The conflict between the two sides erupted last year in Toronto, when Mr. Verdun spent nearly a half-hour at a microphone chastising BMO directors at the company's chaotic annual meeting.

He saved his most acid criticism for Mr. Astley, who he claimed should "never be a director of any public company" because of Clarica's involvement in a troubled financing with the City of Waterloo.

The city struck a deal with MFP Financial Services Ltd. to build a sports arena, and MFP sold the debt to Clarica, then headed by Mr. Astley. When the cost turned out to be nearly double the original estimates, the city sued both companies; the matter eventually was settled.

Mr. Verdun went on the offensive again last month, issuing a shareholder proposal to each of the major banks that anyone tainted by "judicial findings of unethical behaviour" should not be allowed to serve as a director.

He acknowledged that Mr. Astley was never found guilty of any unethical conduct, and was not singled out during the inquiry. However, he pointed out that a judge chastised Clarica for abdicating its due diligence, and said decisions on the financing were made at the highest levels.

BMO offered a vigorous defence of Mr. Astley in its proxy circular, condemning Mr. Verdun's "personal attack" and noting that the former insurance executive was never implicated in the scandal. In fact, he was thanked by the mayor of Waterloo for bringing some of the problems to light.

Mr. Verdun, however, after being hit with the legal warning, took the matter to the regulators. In his letter to OSC chairman David Wilson, he argued that BMO's defence of Mr. Astley in its proxy circular was "unethical" and "dishonest."

A BMO spokesman said the bank stands behind the disclosure in its proxy circular as fair and accurate.

"The board has the highest regard for Bob Astley," Paul Deegan said. "Beyond that, in terms of the judicial inquiry, no one at Clarica was found to have done anything wrong at all."

Mr. Deegan said this year's meeting in Calgary is unlikely to be a repeat of 2005, when Mr. Verdun exceeded his personal allotment of time, and repeatedly quarrelled with BMO chairman David Galloway, who in several instances seemed unable to maintain control of the gathering.

"I don't think the chair is going to allow one of our directors to be assailed, especially when the statements are inappropriate personal attacks," he said.

"You want to give shareholders latitude at meetings, but when it comes down to it, the meeting will have to be run in there interests of all shareholders."

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Citigroup / Chuck Prince

Critics are sniping and the stock is lagging, but Citigroup's Chuck Prince keeps charging ahead, blowing up business practices put in place by his famed mentor, Sandy Weill.

Fortune, Marcia Vickers, 27 February 2006

(FORTUNE Magazine) - The company is likened by some to the Roman Empire, by others to that misunderstood giant of sci-fi films, Godzilla. Getting to see its leader, though, feels more like Mission: Impossible.

The sounds of traffic on Manhattan's Park Avenue disappear as you enter the headquarters of the largest, most formidable financial institution the world has ever known. More than a dozen security guards man the lobby, and once your identity has been ascertained and confirmed--and it matches a guest-admission list on the computer system--you are escorted by a single envoy into a special elevator. The machine whisks you up just one floor, the guard still by your side. A new gatekeeper takes over, and you are led through a maze of soft rugs and wood-paneled walls.

And then, suddenly, you're there, sitting across from Charles O. Prince III, the 56-year-old chief executive officer of Citigroup. His 6-foot-4 linebacker-esque frame is economically packed into a club chair in his palatial yet understated office. His desk, at the other end of the room, is pristine. His computer glows, but too far away to reveal any secrets. He has a reputation for being folksy at some times and bristly at others, and is generally averse to introspection. His words on this midwinter morning have a scripted air. Yet every now and then, confidences emerge.

"I'll try things to see if they work," he says of his initiatives at Citi, as if he's experimenting with a recipe instead of a 300,000-person company with operations in 100 countries, $100 billion in shareholder equity, and more than $1 trillion in custodial accounts. Citigroup's former general counsel--a lawyer with only limited operational experience--Prince describes a predilection for micromanaging that doesn't quite fit his current job description. He talks about reading biographies (on Ronald Reagan and F.D.R.) to glean leadership lessons: "You pick up things you can apply," he says. He is essentially admitting that he is not the consummate CEO, at least not yet, and in some ways the sentiment is endearing, even charming. "I'm a doer," says Prince, who is known as "Chuck." But it is also a bit disconcerting, this undertone of inexperience, given that each of his company's four divisions is itself the size of a FORTUNE 1,000 enterprise. (Citigroup was No. 8 on last year's list.) Perhaps his self-deprecation is calculated, that he is just being coy.

Or perhaps not. Right next to Prince's office is the lair of Robert Rubin, 67, the former Treasury Secretary and Wall Street luminary who is a Citigroup director and chairman of the executive committee. Rubin has worked with--and counseled--some of the greatest business leaders of the modern era. So his assessment of Prince, while gently put, is biting in its implication: "He has the potential to be a great CEO," Rubin says during a separate interview. Rubin talks about how he encouraged Prince to hire as chief administrative officer Lewis Kaden, 63, a lawyer from Davis Polk and a longtime consigliere to business titans, to add more depth to the Citi management team. Kaden, who started last fall, has his office on the other side of Prince's, giving the CEO another gray eminence near at hand to turn to. "It was a good plan to get Lew in," Rubin says. "It's working well."

Across Manhattan, in a different corporate world headquarters, another Prince advisor echoes this on-his-way-but-not-there-yet theme. "He probably didn't have enough line experience [when he became CEO]," says Citigroup board member Richard Parsons, the chairman and chief executive of Time Warner (which owns this magazine), from his 11th-floor perch in the Time Warner Center on Columbus Circle. "He's turning out to be a better leader than we hoped. Still, you can't anticipate the experience of being CEO."

It seems almost unanimous--among employees, former employees, investors, analysts--that 2½ years into his job, Chuck Prince is still feeling his way. That might be unremarkable except for one thing: While learning on the job, Prince has taken it upon himself to stage one of the most difficult turnabouts ever attempted on Wall Street. Citigroup was built, metaphorically brick by brick, by the colorful and loquacious Sandy Weill, Prince's mentor and predecessor. It was Weill who masterminded the unlikely string of acquisitions that created the Citi behemoth, who lobbied regulators and politicians to lift laws that would have prevented it, who wowed investors into cheering its stock and motivated managers and rank-and-file workers with his distinctive, charismatic operational style. Prince, as a longtime Weill acolyte, benefited from all of that. Yet now he has committed himself and Citi to completely tearing up Weill's management system and philosophy. Organizational structure has been revamped, priorities--in particular, the imperative to meet each quarter's earnings estimates and worry about the long term later--have been rearranged, and heads have rolled.

Why? In part, Prince has been prompted by a string of Citi scandals to put ethics on an equal footing with profitability. (He personally sermonized to 45,000 employees in a series of town hall meetings around the world.) But he's also responding to a fiscal reality: The growth-by-acquisition route that Weill plied so superbly has ceased to be effective--and with Citi so enormous, as Prince has quipped, "the only way we could do a transformational acquisition would be to buy Canada." Instead, Prince sees Citi's future as dependent on organic growth, which in turn will require a more efficient, centralized, and systematized corporate culture than the one Weill bequeathed to him. If that means breaking a few eggs, chef Chuck seems ready and eager to get cracking. ("I'm impatient," he confesses. "I want things done yesterday.")

Prince, who has little of Weill's populist appeal and none of his hard-earned Wall Street cred, is engendering enormous skepticism both inside the company and out. In the past year a slew of high-ranking, experienced managers at the firm have exited. A swelling chorus is questioning whether the bank even needs this complete reengineering. Prudential Securities analyst Mike Mayo put out a positive note about Citi's prospects on Feb. 16 but cited "ongoing concerns about its management." Says Merrill Lynch analyst Guy Moszkowski: "Sandy [Weill] was a rock star. Investors were in awe of him because he made a lot of people rich." In contrast, when Prince's name comes up, critics are likely to utter the word "lawyer" in a pejorative tone. (That is no news to Prince, who jokes that they usually say he's "just a lawyer.") As one industry insider puts it: "It's like they took the lawyer for an NFL team and made him the quarterback overnight."

The pressure to perform--and soon--is almost palpable. During his tenure, Prince has overseen a 40% hike in the dividend and in 2005 alone plowed almost $13 billion into share buybacks. Yet Citi's stock has languished, returning just 10.8%, including dividends, since Prince took the helm, vs. 34% for the S&P 500 and 33% for the S&P 500 financials. When Citi announced its fourth-quarter earnings on Jan. 20, Wall Street was disappointed--for the third consecutive quarter--and the stock dropped almost 5%. Industry publication American Banker chided Prince and CFO Sallie Krawcheck for repeatedly blaming a "challenging" external environment during their quarterly conference call, counting up 11 uses of the word during the 80-minute presentation.

Shareholders aren't calling for Prince's head. He is, after all, dealing with less than hospitable economic conditions, including a flattening yield curve and a shriveling mortgage market. Citi's board remains supportive: When Weill steps down as chairman this spring, Prince is the odds-on favorite to add that title. But there's no question that Wall Street is getting antsy. Says Citi's biggest investor, Prince Alwaleed bin Talal bin Abdul Aziz al Saud, who owns close to $11 billion of stock: "It's all wonderful and lovely that Chuck Prince has cleaned up Citigroup. But we now need him to execute growth and boost the stock price."

It's Dec. 16, and more than 100 analysts and reporters have gathered for Investor Day in the 12th-floor auditorium at Citi's Park Avenue headquarters. The slickly staged presentation begins with a booming, big-screen-video melange of Citi's television ads from all over the world. The commercials, in different languages, highlight the company's deep global reach and induce a few chuckles as well as muted oohs and aahs from the crowd. Then the lights come up, and Prince takes the stage, exuding confidence and energy: "I know where we are taking this company! I know how we are going to get there! My job today is to make sure that you know it as well!" He throws an air punch--pow!--in Howard Dean-esque fashion.

It's an unexpected, and somewhat forced, display of theater from a man whom Bob Rubin describes as "the thinking person's CEO, vs. a flamboyant, charismatic CEO." But if Wall Street's lukewarm reception over the past few years has taught Prince anything, it's that he's got to get a little more of Sandy Weill's flash into his public persona. "He should be out there selling the Citi story!" exclaims Alwaleed. "If he's publicity-shy, then it's my job as a shareholder to have him change that habit."

Weill certainly didn't need to be coached. An inspiring leader to many, he built Citi from the bit parts of a low-rent consumer-finance outfit called Commercial Credit. Among those bit pieces was a young lawyer named Prince, who latched on to Weill and played a helping role as he acquired a string of companies: Primerica, Shearson, Travelers, Salomon Brothers, and finally Citicorp. Prince was the jack-of-all-trades who planned Weill's annual birthday bashes (and often emceed them), wrote many of Weill's speeches (as well as a skit in which Weill appeared onstage dressed as Moses, ready to deliver his employees to the promised land), and signed off on most documents before Weill got to see them. He was so devoted to Weill that Prince's own mother said to the Los Angeles Times shortly after he was named CEO, "I always ask [Chuck]: 'What are you doing next time for Sandy?' "

Prince became Weill's fixer, working on everything from the Argentine peso crisis to Citi's Enron and WorldCom exposure. In 2001 he ascended to the title of chief operating officer, and the next year was moved over to run Citi's investment banking unit. He negotiated directly with New York State attorney general Eliot Spitzer over alleged conflicts of interest. (Prince, ironically, is referred to as "C.O.P.," his initials, by some Citigroupers.) When Weill named a successor as CEO in the summer of 2003, amid fallout over his own questionable behavior, Prince was the stunning choice.

Citi's stock fell nearly 3% on the news, an inauspicious start. Weill stood by his protege, proclaiming when Prince officially took the reins in October 2003 that he had "no doubts he was the right man for the job." Prince certainly seemed unlikely to undermine Weill's legacy. "Sandy assumed," says a former executive, echoing the sentiments of many Citi stalwarts, "that as CEO, Chuck would more or less go along with Weill's decisions." (Weill remained chairman.)

But during his first few months Prince started "to poke under couches to see what was there," according to a Citi board member who asked not to be identified. Prince, this person says, was astonished by what he found. In some divisions, tools like accounting software were antiquated or nonexistent. Conduct codes, if they existed, were often loosely worded. Most Citi managers were so focused on quarterly earnings and revenue targets that divisions competed with one another, often in a bloodthirsty manner. "They would eat each other for lunch if they could," says a former Citi division head. Prince became increasingly troubled that there was no unified culture at the bank, no shared history. "It was kind of like Yugoslavia," says board member Parsons.

To Prince, the lack of internal controls and systems was unacceptable. That became all too clear when Citi's private banking operation in Japan was charged by regulators with taking part in money laundering and selling risky products to customers, among other things. The private bank was forced to shutter operations there in the fall of 2004. Other troubles followed: in Europe, a bond-trading investigation surrounding a scheme dubbed "Dr. Evil"; a class-action suit in the U.S. filed by shareholders of Global Crossing; accusations in Italy of helping Parmalat create a complex financial structure called buconero--"black hole" in English --that allegedly allowed the dairy company to hide debt. (Citi denies the Parmalat charges and, despite settling, the Global Crossing suit allegations.) Prince started bulking up compliance, reportedly doubling the staff.

Several months into his tenure as CEO, Prince took an important symbolic step: He moved his office from next door to Weill's on Citigroup's third floor down to the second floor. "He wanted to physically separate himself," says a former executive. Prince also began talking up the idea of a "new Citi," repeating mantras like "My job is not to run a museum" and calling Citi a "battleship" that needed "to be turned around." Parsons says it was a terrifically tough period for Weill. "We would be in board meetings, and Chuck, especially in the beginning, came on a bit strong. He'd say those things, and Sandy would just stare at the ground." Prince had always followed Weill's counsel in the past, says Parsons, but now the tables had turned: Whenever Weill tried to give advice, Prince would "maybe take three out of the five suggestions."

At the same time, Prince sought out Weill's former co-CEO, John Reed--whom Weill had famously pushed out in February 2000--for advice. To the shock of some Citi execs, Prince took to quoting Reed-isms publicly, at one point telling the Harvard Business School newspaper, "John Reed used to say that the most important part of a racecar is the brakes, and that you can't drive fast unless you have the ability to stop."

Prince and Weill communicated mostly through staffers. "Sandy was grumpy for a while. Let's face it, he wasn't The Man anymore," says Parsons. (Weill was not made available for interviews.) Prince and Weill have since reconciled, according to Parsons, with Joan Weill, Sandy's wife, bringing the two together. Prince says he's remained close with Weill, continuing "to have standing lunches on Mondays."

Meeting him now, it's hard to believe that Prince was once known as "the resident funny guy at Citi," according to a former executive, who also recalls Prince's keeping a bowl of candy in his office to lure visitors. A child of sunny California--growing up just a few miles from Disneyland--Prince played the trumpet as a teenager and had dreams of becoming a professional musician. He also had a studious side. Prince (whose mother was a homemaker, and father, a construction worker who later became a union boss) eventually piled up academic accolades: bachelor's and law degrees from the University of Southern California, and two master's degrees from Georgetown.

As the CEO, say several former Citi execs, Prince underwent a personality change. "He became much more serious," as one puts it, "almost imperial." Always prone to the I'm-a-workaholic-and-proud-of-it badge, Prince became even more so and pushed those around him to follow suit. "Chuck is a stickler when it comes to deadlines," says CFO Krawcheck. "He gives you a task to do, sometimes a monumental one, and asks for it about two days earlier than you'd expect."

Prince also became a hostile target for Weill fans who disagreed that Citi's operations needed radical fixing. "Nobody thinks of Prince as a visionary or a great leader," says one such critic, still a top Citi manager. Early on, Prince made bold statements that struck some of the naysayers (none of whom was willing to speak for attribution) as naively overreaching. A former senior executive says that at one meeting, Prince announced a goal for Citi of $50 billion a year in profit within five years. "We were aghast," says this person, who notes that earnings at that point were running at about $18 billion. "This was just laughable." (Prince says it was merely an exercise to get people to think on a multi-year basis.)

To clean house after the regulatory scandals, in the fall of 2004, Prince fired some heavy-hitting Weill loyalists: Thomas Jones, who ran asset management; Deryck Maughan, the former Salomon CEO who headed international operations; and Peter Scaturro, CEO of the private banking group. At one point Weill had considered both Jones and Maughan for the CEO job. Other former Citi execs say the fired men were not just scapegoats for the Japan problems; "Chuck wanted people he was threatened by out of Citi, and he's achieved that," as one puts it. Responds Prince: "A good manager isn't threatened."

In the past year Prince's managerial style and decisions have prompted the voluntary exit of more senior execs with several years of operational experience at Citi. Most notable were Marge Magner, who had been with Weill from Commercial Credit days and ran consumer banking, and Robert Willumstad, Citi's president and chief operating officer. When Prince was installed as CEO, Willumstad was reportedly viewed by Weill and the board as an essential part of the deal, to provide operational experience--he was paid a salary and bonus identical to Prince's. (Since walking away, Willumstad has not taken another job but has been recruited to join the board of insurer AIG.)

The turnover is not viewed everywhere as a problem. "The Sandy crew underperformed," says Richard Bove, an analyst at Punk Ziegel. "Chuck absolutely needed his own new team." Prince has brought fresh blood into the top echelon of Citi, turning to the 41-year-old Krawcheck as a key player, tapping former CFO Todd Thomson, 45, to run Smith Barney, and splitting consumer banking between Ajay Banga, 46, and Steve Freiberg, 48. Some question whether this team has the experience to manage such a huge and complicated global enterprise. Even board member Parsons stresses, "The most important thing for Chuck is to get his team functioning at the highest level. He needs to get them to be super-effective, and fast." Prince says he has a great team "with new ideas, new thinking."

Not one to tread softly, Prince has radically changed the way decisions at Citi are made. Earlier this year he bulked up the management committee to nearly 100 members to give greater exposure to more executives. At the same time, he's created a smaller 14-member business-heads committee. There's also a 34-member operating committee. Some bridle at a system that requires more meetings. "That's what he thinks of as streamlining," says a former top executive. "Things get kicked around so much in these committees that many decisions are being made more slowly than ever." One former exec calls it the "catch-and-release decision-making process: I thought we made that decision already, but here it is again, swimming around, like a fish." (Says Prince: "This is such a huge company, you have to have a certain amount of bureaucracy.")

To combat complaints--and gauge their universality--Prince has launched a morale indicator called the Voice of the Employee and an initiative called the Wax Removal Program to fight excessive bureaucracy, including a website where staffers can vent about unnecessary rules. One top Citi manager says he went "to complain on Chuck's Wax Removal site" and found himself exasperated by the bureaucracy of the site itself: "There were so many questions, I just gave up." But Prince is unrepentant and adamant that Citi needs to develop a more cohesive corporate culture; he's even taken to handing out books about Citi's history (example: The Banker's Life, by former Citibank chairman George S. Moore) to his top managers. "We can't grow as fast as we want to grow," Prince declared at an investor conference last summer, "if we don't have a culture, if we don't have the controls, and if we don't have a set of internal values that serve as a foundation for guiding our business practices."

Ultimately, of course, Prince knows that his success lies in the numbers, not the number of new programs. Earnings in 2005 clocked in at almost $25 billion, a record for the company, though that was boosted by one-time events, such as $4.2 billion in gains from the sale of assets. (Prince got Citi out of the asset-management business last year, trading it to Legg Mason in exchange for that firm's 1,200-strong brokerage network; he also got out of the insurance business, selling off Travelers Life & Annuity.) Some of Citi's operations--most notably underwriting and M&A--are booming. But the institution that invented the ATM and the certificate of deposit also finds its U.S. consumer banking division lagging far behind Bank of America and Wells Fargo in number of domestic branches, with about 900, vs. 6,000 and 3,200, respectively. Prince plans to add as many as 100 U.S. branches this year, and is looking to make what he calls "string of pearls" purchases--businesses that mesh with its existing infrastructure. Most of Citi's future growth, he says, will probably come from overseas, where, with the exception of Mexico, it has single-digit market share yet widespread brand awareness and an existing toehold. Citi, he notes, is the only U.S. bank that already has a global presence it can build on. In January a Citi-led consortium purchased an 85% stake in China's Guangdong Development Bank Co., making it the first foreign firm with controlling interest in a Chinese lender.

His growth plans won't blossom overnight, and he acknowledges that, lamenting, "Investors want to know what you'll do in the next 90 days to make the stock go up." He's got to keep those shareholders at bay so that his longer-term efforts have a chance to hit the bottom line. Analyst John McDonald of Banc of America Securities gives Prince "points for making decisions that depress current results for the benefit of long-term growth potential." But McDonald also downgraded the stock on Jan. 4, from buy to neutral, primarily citing Citi's organic growth challenges.

Prince and his people assert that much of his cultural and managerial framework is now in place. Others say it's a monumental work in progress. Observes Harvard Business School associate professor Rakesh Khurana: "The culture can't change overnight. Citi is deeply rooted in past decisions and strongly held belief systems."

Prince may not be the natural leader his predecessor was, but given Citi's challenges--and the imperative for stricter controls because of a string of scandals--the board sees him as the right chief right now. Parsons compares Prince's CEO-dom to the rule of Augustus Caesar. "After Julius Caesar," Parsons notes, "he was the one who had to come in to put in the infrastructure so the place would be around for the next hundred years." Julius Caesar, you may recall, was assassinated by conspirators led by Brutus. Augustus Caesar, in contrast, lived to the ripe old age of 76. Prince's plan is surely to follow in those footsteps.

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US Financial Stocks Lead S&P Herd

Sector's Dominance Bodes Better than Energy-Industry Strength, but Rising Interest Rates Pose Risk

The Wall Street Journal, E. S. Browning, 27 February 2006

With oil prices back above $62 a barrel, oil stocks are in vogue. Exxon Mobil once more has surpassed General Electric as the biggest stock, with a market value of more than $375 billion, compared with GE's $350 billion. Microsoft and Procter & Gamble trail well behind. So do Citigroup and Bank of America.

But as a group, financial stocks -- not energy stocks -- dominate the Standard & Poor's 500-stock index. Banks, stock brokers, insurance companies and the like make up 21% of the index's market value. Technology is next, followed by drug and other health-related stocks, according to data compiled by Birinyi Associates in Westport, Conn. Energy stocks, for all their gains, come in sixth, with 9%.

And that is good news for the stock market, because financial stocks have longer coattails.

When oil stocks are dominant, as they were in the 1970s, it is because oil prices are so high that other parts of the economy suffer. When financials are strong, it is because inflation and interest rates are low. That is great news for banks and insurance companies because it holds down their cost of obtaining funds. And low interest rates hold down costs and boost profits at most other companies, too. That is why investors love to see financials lead the market.

"Financials are a good bellwether for the rest of the market," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

The question is whether financials are going to stay strong and keep leading stocks higher. On that subject, Mr. Ablin and some others have worries.

Every decade, it seems, a different group of stocks takes command. The 1970s were a miserable period for most stocks, with oil prices soaring, some Arab oil exporters temporarily cutting off supplies, and lines to get gasoline snaking around city blocks. Oil stocks dominated the market. Back then, energy companies represented more than 20% of the S&P 500.

In the 1980s, as big consumer companies like Coca-Cola expanded world-wide, consumer stocks led. In the 1990s, it was technology stocks.

Now, although oil stocks are moving up again -- in the 1990s, they were just 5% of the S&P -- oil companies are nowhere near as important to the economy as they used to be. Service companies, particularly financial services, play a much bigger role. Which stock group dominates in the future will tell a lot about the market's direction.

"To get the broad market to go to new highs, you are absolutely going to need to see leadership come from the financial sector and see those stocks do well, so that their gains translate into the broader market," says Stephen Sachs, director of trading at mutual-fund group Rydex Investments in Rockville, Md.

If the world economy overheats, or if oil supplies are disrupted, oil stocks could benefit, and the rest of the market would suffer.

Last week, as oil futures pushed to $62.91, their highest level in more than two weeks, investors seemed uncertain which way stocks were headed. The Dow Jones Industrial Average finished at 11061.85 -- just short of a 4½-year high, but down 0.5% on the week, including a decline of 7.37 points on Friday. The average still is up 3.2% since the year began.

Hoping rates will stay low by historical standards, investors worry about how high the Federal Reserve will push them. The yield of the 10-year Treasury note remains less than 4.6%, for example, even though consumer prices rose 4% over the past 12 months. That means money remains very inexpensive.

The question is whether inflation fears will prompt the Fed to keep raising rates and choke off all this easy money, or whether it will be able to stop while rates remain relatively low, permitting the economy to remain robust. That is where the worries come in.

Some investors fear the Fed won't stop raising rates until some kind of financial blowup occurs, as was the case in 1998 when Russia defaulted on its debt and investment fund Long-Term Capital Management collapsed, almost taking the bond market down with it.

In a report to clients last week, New York research and brokerage firm International Strategy & Investment warned that people shouldn't buy financial stocks until they see clear signs the Fed is finished raising rates.

"Previous cycles have shown us that the sector does not begin to consistently outperform until after the Fed is done and is closer to easing rates," ISI investment strategist Jason Trennert wrote in the report.

A big problem for financial companies is that short-term rates have risen faster than long-term rates, which is squeezing financial firms, notes Mr. Ablin of Harris Private Bank. Financial firms tend to borrow at short-term rates and lend at long-term rates. When the two move close to each other, financial firms' profit margins get squeezed. As long as the Fed keeps raising short-term rates, the problem is likely to persist.

Mr. Ablin says investors are blasé about that. Low interest rates make it inexpensive to borrow and invest, which makes people too tolerant of risky investments, he says, and which could threaten profits at financial companies.

"Right now there is too much complacency" about risk, he says. Junk bonds are selling for yields that are only about 2.25 percentage points higher than those of virtually risk-free 10-year Treasury bonds, compared with a 4.5-point differential in more normal times. That could be a sign of trouble to come, Mr. Ablin says.

He forecasts stock-market gains in the low single digits this year, which would mean that many of the gains already have been registered. He fears that technology stocks and small stocks may show a decline for the year, as the economy slows.

Adds Mr. Sachs of Rydex, "Given the interest-rate environment we are in now, the question is whether financial stocks can continue" to do well.

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TD Bank Q1 2006 Earnings

• Analysts at Blackmont Capital have raised their target price for TD from $65 to $72.

• Analysts at UBS downgrade TD from "buy" to "neutral," while raising their estimates for the company. The 12-month target price has been raised from $72 to $74. In a research note published this morning, the analysts mention that following its significant appreciation, TD's share price reflects the company’s healthy growth prospects. The EPS estimates for FY06 and FY07 have been raised from $4.65 to $4.75 and from $5.30 to $5.35, respectively.

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TD Bank profit gets high marks, but analysts wary

Reuters, Cameron French, 24 February 2006

Toronto (Reuters) - Analysts gave a broad thumbs-up on Friday to Toronto-Dominion Bank's first-quarter financial performance, but one brokerage downgraded the bank, while others advised caution as the stock's high valuation and questions about U.S. operations could keep a lid on gains.

Net income at the bank, Canada's second largest by assets, nearly quadrupled in the quarter as TD booked a C$1.67 billion ($1.45 billion) gain on the sale of its Waterhouse USA online broker to Ameritrade Holdings Ltd. in exchange for a one-third stake in the combined company.

Core profits also climbed, and at a faster pace than expected, while the bank continued its pattern of raising its shareholder dividend every second quarter.

"Gold medal out of (first-quarter) starting gate," said a research note by RBC Capital Markets analyst Jamie Keating, who raised his 2006 earnings per share estimate to C$4.70 from C$4.68.

The bank's performance was driven by steady top-line growth in TD's domestic branch banking business, and also by robust wealth management and brokerage income as strong financial markets increased mutual fund sales and trading volumes.

Keating noted the trading revenue was unsustainably strong, however, echoing a warning from TD chief executive Ed Clark the previous day.

UBS Investment Research went a bit further with its concerns, downgrading the stock to "neutral" from "buy," despite noting TD has one of the better growth outlooks of Canada's banks.

Analyst Jason Bilodeau noted the stock has already benefited from heady expectations, and that its valuation has grown in recent years to now sit even with, or just above, its Canadian peers.

"A premium valuation is deserved in our view, but from here, amid a generally fully valued sector, we expect additional expansion will be harder to come by," he said.

He said while the bank's positives -- which include the strong domestic retail bank and U.S. growth prospects -- are reflected in the shares, potential problems may not be.

These include concerns about profits and acquisition risk at TD's newly-acquired U.S. Banknorth retail unit, as well as the potential for a large settlement in a lawsuit by shareholders of energy trader Enron, which collapsed amid an accounting scandal in 2001.

While analysts were unsure of the prospects for future TD stock gains, investors seemed pleased with the bank's results, driving the stock higher after the earnings release and also again on Friday morning.

Merrill Lynch analyst Andre-Phillippe Hardy left his TD rating at "neutral," having recently downgraded the stock.

He noted concerns in the immediate future include Enron, the potential for disappointing Banknorth earnings, and the fact that cost benefits from the Ameritrade deal will likely take 18 months to materialize.

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BMO Nesbitt Burns, 24 February 2006

Q1/06 Results – Nothing too Fancy, Just Solid Fundamentals

For the first quarter ending January 31, 2006, TD Bank reported net income of $2.3 billion, or $3.20 per share compared to $630 million, or $0.95 per share, in the same quarter of last year. More importantly, excluding unusual items, the bank reported Cash EPS of $1.15 compared to $1.04 a year ago—ahead of our forecast of $1.11. The variation from our forecast came from very strong trading at TD Securities.

All in, we would view this as a solid quarter. Retail earnings were in line. Wealth Management had an excellent quarter and Wholesale banking performed well ahead of our expectations. The corporate segment, however, produced more of a drag than we had forecast. All in, we expect Wholesale performance to moderate in the future, but believe that this will be more than offset by better expense performance across the bank.

The Canadian Personal and Commercial Banking segment reported solid results, with net income of $476 compared to $443 in the previous quarter and $424 in the same quarter of last year. Strong loan growth, particularly in real estate secured lending, and consistent credit quality (provisions for credit losses were broadly unchanged over the period) were the main contributors. Spreads also widened from the fourth quarter, likely helped by the increase in the Prime rate and less aggressive pricing by competitors. Non-interest expenses were above our expectations, and we believe that there is room for further improvement in expense ratios. On the market share front, TD performed more credibly this quarter, with no discernable change in consumer deposits and loans, but some improvement on the business front. Overall, we believe that 12% bottom-line growth appears to be sustainable for all of 2006.

Wealth Management reported net income of $138 million, compared to $136 million in the last quarter and $98 in the same quarter of last year. These results were due to strong fee growth and trading volumes, partially offset by the fact that TD Waterhouse USA (TDWUS) was only included for part of the quarter. Specifically, TDWUS only contributed $33 million this quarter, compared to an unusually strong $51 million in the fourth quarter of 2005. Next quarter, TDWUS will be deconsolidated and AMTD will begin to contribute, albeit only partially. Outside of TDWUS, results were excellent.

Wholesale banking performed unusually well this quarter. Contribution of $199 million (which excluded $35 million of further restructuring charges) was the highest in three years reflecting excellent trading results. Trading revenues were $375 million compared to our forecast of $275 million. We expect the performance of this division to moderate in coming quarters.

As always, there was a lot of noise in TD’s overall reported results. This time the clutter was exacerbated by a changed approach to defining “items of note” and a restatement of the corporate segment. As we look at it, the “operating loss” of $43 million was somewhat worse than we had thought, and this offset some of the strength in Wholesale and Wealth.

Credit quality, for the most part, remained strong in the first quarter. Gross impaired loan formations tracked up to $263 million from $214 million in October. Net impaired loans were $210 million (before $1.2 billion of general allowance), up only slightly from the previous quarter but lower than the year-ago quarter. As in the last quarter, none of these loans relate to the corporate loan segments. Loan losses of $114 million (which included a $17 million PCL in Wholesale that relates to Merchant Banking) were slightly higher than our forecast of $100 million. All in, there were no surprises on the credit front.

Tier 1 and tangible common equity ratios increased to 11.9% and 8.8%, respectively, largely due to the gains arising from the Ameritrade and Banknorth deal. Currently, TD Bank has one of the best balance sheets in the Canadian banking system. It is interesting to see where the bank deploys its excess capital in the longer term. In the short term, it increased its dividend from $0.42 to $0.44 (mainly due to the better earnings base). TD also announced that it had acquired 500,000 shares of BNK and that it intends to purchase 15 million shares of AMTD by August 22nd. The AMTD purchase will use up about US$325 million of excess capital. We expect to see TD become more aggressive on the purchase of BNK shares in the coming quarters.

Projections

We are leaving our Cash EPS forecasts largely unchanged. For 2006, exclusive of unusual items, TD should earn $4.70. We forecast $5.25 for 2007. This was a strong quarter, but much of the upside has arisen from the Wholesale business which tends to be volatile. We are not increasing our assumptions of the medium term earning potential for TD Securities. The Domestic P&C business had excellent revenue performance this quarter, but expense control was less than apparent. We would expect that the bank has some “levers” should loan growth moderate in the second half of 2006.

We still like TD Bank shares at current prices. Clearly, the core businesses are in great shape. In addition, the bank is positioning itself well for the long term. The deal with Ameritrade should be very accretive in the second half of 2006 and into 2007, and the acquisition of VFC looks reasonable. The one blemish is TD Banknorth. Earnings growth in U.S. banking is somewhat muted by the flat yield curve, and the ongoing competitive pressures on deposit pricing. Having said this, this quarter BNK contributed $65 million of the overall bank’s $835 million of after-tax profits—less than 8%. With its strong balance sheet, TD is adequately positioned to deal with the U.S. situation, whatever the short-term conditions. At discounted P/E and P/BVs, TD shares remain attractive.

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RBC Capital Markets, 24 February 2006

Gold Medal Out of Q1 Starting Gate – Raising 2006 Estimate

• TD Scores a ‘Perfect’ Q1. Adjusted EPS of $1.15 was solidly above $1.09 consensus expectation. These results included unusually high trading and securities gains at ~5¢ - the underlying EPS of $1.10 was of excellent quality. We are edging our ’06 EPS estimate up 2¢ from $4.68 to $4.70 and maintaining our above consensus $5.30 cash EPS estimate for 2007. TD also hiked the quarterly dividend 2¢ to 44¢/share.

• Strong Trading Revenue. The caveat was unsustainably strong trading revenue at $375MM and high underlying securities gains at ~$75MM (reported was $23MM, though net of a $52MM Banknorth charge, the underlying gains triggered totaled $78MM). A $17MM merchant bank write-down partly mitigated these items, so we judge sustainable EPS at ~$1.10.

• Strong Divisional Profit Growth. At $476MM, P&C net income was up 12% YoY (25% divisional ROE) driven by volume growth. Wealth profit leapt 41% YoY on 12% revenue growth from mutual funds sales and assert management returns. Wholesale profit grew 41% YoY on 16% revenue growth, largely on higher trading revenue. In U.S. retail banking, TD Banknorth’s profit was flat as expected.

• Credit Excellent. The loan loss provision (LLP) at $114MM included a $17MM merchant banking write-down and compared to our $107MM estimate ($110MM consensus). Net of the write-down, the $94MM underlying LLP was level with Q4/05 at $94MM and was up from Q1/05 at $80MM. Impaired loans were stable and reserve coverage is league leading at 372%, double the sector norm.

• Capital & Reserves Remain Very Strong. TD’s 11.9% Tier 1 capital ratio was higher than the 11.5% we had modeled. Unrealized securities gains grew to $806MM (85¢/share).

• Valuation. Our price target of $72 (unchanged) is set at 13.5x our 2007 cash EPS estimate of $5.30. Our premium target P/E reflects TD’s leading domestic franchise, a management that we rate as peerless and the unique structure for growth in the U.S. with Banknorth and TD Ameritrade. Our target P/E is set at a 3% premium to the group, above the five-year average discount of 1%; however, TD has traded at an average 6% forward P/E premium to its Canadian bank peers since 1998 and we would view positive execution experience on BNK as an avenue to revaluation. Our price target is indicated at ~2.8x our projected book value of $25.54 (as at Oct 31/06).

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Scotia Capital, 24 February 2006

Strong First Quarter Earnings and 5% Dividend Increase

• TD bank reported strong first quarter earnings of $1.15 per share, an increase of 11% from a year earlier, ahead of expectations. Earnings were driven by a significant increase in wealth management earnings, extremely high trading revenue with retail bank earnings supported by a 5 bps increase in the net interest margin and solid insurance revenue.

• Return on equity for the quarter was 19.9% versus 21.3% a year earlier. Return on risk weighted assets was 2.48% versus 2.67% a year earlier.

Ameritrade Transaction Boosts Book Value and Capital Ratios

• Reported net income was $3.20 per share including a number of items of note (highlighted in Exhibit 2) but particularly a $2.32 per share dilution gain on the Ameritrade transaction.

• The Ameritrade transaction assisted the book value growth of nearly $3 per share in the quarter to $25.25 per share. The Ameritrade transaction also helped boost the bank's capital ratios.

• Tier 1 capital improved to 11.9%, which is expected to be the highest of the bank group, from 10.1% in the previous quarter. Common equity as % of RWA is 13.6% and tangible common equity to RWA is 8.8%.

Consistent & Frequent Dividend Increases

• The bank announced a 5% increase in its common dividend to $1.76 per share with a payout ratio of 38%. The low payout ratio and strong earnings growth outlook bodes well for continued high dividend growth. The bank has now increased its dividend every second quarter since the third quarter of 2003.

Wealth Management - Earnings Driver

• In terms of earnings growth, Wealth Management earnings increased 41% to $138 million driven by 12% revenue growth and 3% expense growth reflecting the significant operating leverage inherent in this business/operating platform.

• Wholesale Banking had an exceptional quarter with a 41% increase in earnings to $199 million driven by very high trading revenue. We would expect lower earnings from this business over the next several quarters.

• Canadian P&C Banking increased 12% YOY to $476 million driven by 8% volume growth with net interest margin increasing 5 bps in the quarter. The bank's US P&C Banking business was the one weak spot with earnings declining 6% to $65 million from the previous quarter. Earnings in this business are expected to show only modest growth over the next few years given the difficult operating environment including the flat yield curve. This business only represented 8% of total bank earnings.

Favourable Business Mix

• TD continues to have a very favorable business mix in the higher P/E multiple businesses with retail and wealth management representing 81% of total bank earnings.

Earnings Estimates and Share Price Target Unchanged

• Our 2006 and 2007 earnings estimates remain unchanged at $4.60 per share and $5.10 per share, respectively. Our 12 month share price target is also unchanged at $75 per share representing 16.3x our 2006 earnings estimate.

Maintain 1 Sector Outperform - P/E Expansion - 10% Premium to Group

• Maintain 1-Sector Outperform rating on shares of TD based on dominant retail and wealth management platforms, high earnings growth vehicle through TD Ameritrade, higher than bank group profitability and capital, and the absence of any meaningful P/E multiple premium. We expect TD's P/E multiple to expand to a 10% premium relative to the bank group on higher earnings growth providing significant outperformance over the next several years.

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The Globe and Mail, Sinclair Stewart, 24 February 2006

TD's U.S. growing pains

Toronto-Dominion Bank reported what its chief executive officer described as a “remarkable” first quarter yesterday, churning out $2.3-billion in profit, recording double-digit growth in its juggernaut Canadian retail operations, and turning in stellar trading results that underpinned a resurgent performance by its investment bank.

Yet despite breezing by consensus analyst estimates, and generating significant improvement across most of its business lines, TD's growing pains in the United States have suddenly made Ed Clark look a little less bulletproof.

TD Banknorth, the linchpin of the bank's U.S. retail operations, contributed just $46-million in the quarter, down from $69-million in the final quarter of last year, as regional banks south of the border continue to be hobbled by a nasty interest-rate environment.

This has taken a bit of the shine out of TD's much-lauded expansion strategy, and some are now questioning whether Mr. Clark spent too much in his eagerness to tap the U.S. market: not just on Banknorth, which was acquired for $5-billion, but for the $1.9-billion (U.S.) takeout of New Jersey-based Hudson United Bancorp.

“I think that even if we think these are great assets . . . you've got a long way to go before they are economically profitable for shareholders,” said Darko Mihelic, an analyst with Blackmont Capital.

“In other words, Ed Clark overpaid.”

The flattening yield curve has hurt regional U.S. banks, which depend heavily on the spread between short-term and long-term interest rates for their profit margins.

Yet as targets, their asking prices have remained stubbornly high, raising a dilemma for the banks: If this is what U.S. growth looks like, how wise is it to leave the relatively high returns of Canada in the first place?

“There's no question that U.S. regional banking looks less like the mecca it did two years ago,” acknowledged another analyst who tracks TD.

“The issue is, should you be doing any more, or should you just keep your powder dry?”

Mr. Clark said the company's U.S. purchases have created the opportunity to build a powerful name for itself in that market, but added he's in no hurry to do another acquisition right now.

“Clearly, operating a bank in the United States is tough today,” he told analysts during a conference call yesterday. “[Banknorth CEO] Bill Ryan's team is looking at everything they can do to respond to this challenging environment.”

Another concern is whether Banknorth bit off more than it could chew with the sizable purchase of Hudson United last summer, given that bank's well-documented regulatory problems and concerns about the quality of its earnings.

“Banknorth is buying something a little bigger than they have normally bought — and they're doing it with a fixer-upper,” said National Bank Financial Inc.'s Robert Wessel. “If there's one thing I focus on [with the U.S. expansion] it's that.”

Mr. Clark may finally be showing a few chinks in his Kevlar, but it would be misguided to think investors are fretting.

TD's share price reacted favourably yesterday to the bank's quarterly profit, which more than tripled to $2.3-billion (Canadian), or $3.20 a share, thanks to a massive $1.7-billion gain from the merger of TD Waterhouse with rival discount broker Ameritrade Holding Corp. last year.

On an adjusted basis, which strips out this gain along with a number of other one-time items, profit was $830-million, or $1.15 a share: about a nickel better than analysts' average estimates.

The bank also rewarded shareholders by raising its quarterly dividend by 2 cents a share to 44 cents, and they responded by driving up the bank's stock 40 cents to $64.85 on the Toronto Stock Exchange.

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BMO NB's Note on TD Bank Q1 2006 Earnings

BMO Nesbitt Burns, 23 February 2006

For the first quarter, TD Bank reported Cash EPS of $1.15 compared to our estimate of $1.11. Variations were across the businesses with surprisingly strong results from wholesale and excellent wealth management performance, offset by somewhat elevated corporate expenses. Simply put, this result is better than the street’s forecast of $1.09, but much of the variation is due to wholesale (due to excellent trading). Overall, this may disappoint some investors, as the market generally values retail higher than wholesale. The dividend was increased from $0.42 to $0.44 (we had expected $0.45) and the bank’s capital position is even better than expected (Tier 1 of 11.8%). Although some will quibble on the strong wholesale, we like these results. Wholesale results will moderate, but the beginning of leverage in retail is there. Wealth management was very strong, and the retail bank seemed to accrue expenses at a higher than normal rate. We believe the outlook for all of 2006 is very good.

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Former TD Bank Vice Chair, New CEO of Mellon Financial

Barron's, Fei Mei Chan, 23 February 2006

Share of Mellon Financial have been looking ripe of late. And insiders, including the new chief executive, are banking that little will spoil its condition.

Only 17 cents a share off its 52-week high, Mellon stock has gained 29% over the last 12 months, due largely to the success of its asset management and processing businesses. It is currently trading at 36.86.

A week after his first day as Mellon's newly appointed chairman and chief executive officer, Robert P. Kelly bought 70,000 shares in the open market worth $2.5 million, according to filings with the Securities and Exchange Commission.

"You would expect a CEO coming in to buy, but this is a $2.5 million buy for a guy whose base salary is under a million per year," says Ben Silverman, a research director at InsiderScore.com.

A filing with the SEC also reveals that Kelly already held 30,000 shares of Mellon as of Feb. 13, his first day as chief executive of Mellon. Ken Herz, director of corporate communications at Mellon Financial, says Kelly made the open-market purchase following Mellon's announcement on Jan. 31 that he would become CEO.

In his new job, Kelly is obligated to hold shares equal to 25 times his base salary in company stock within five years of his employment. At Kelly's current base salary of $975,000, this ultimately translates to $24.4 million worth in holdings (this would include any vested stock grants he received as part of his compensation package, which total 328,000 shares).

Jonathan Moreland, director of research at InsiderInsights.com, notes that Kelly was a smart trader at Wachovia, where he was chief financial officer.

SEC filings reveal that two board members also exercised options in February and kept their shares.

Director Robert Mehrabian exercised 8,100 and 8,912 shares on Feb. 3 at $13.56 and $19.31, respectively. Seward Prosser Mellon, a direct descendant of founder Thomas Mellon, and a board member since 1972, exercised 8,100 shares at $13.56. Their shares were scheduled to expire between April 2006 and 2007.

"This is quite a reversal of sentiment from [the directors]," says Moreland.

Mehrabian, who has sat on Mellon's board since 1994, was a smart seller in 2000, according to Moreland. And Seward Mellon was a seller in 2005 at lower prices.

Like many other companies, Mellon has been experiencing the wrath of institutional investors seeking to break up the company in the hopes of unlocking value (see Barron's, "Squeezing Mellon," Nov. 28, 2005 and "A Mellon-choly Outcome," Feb. 6, 2006).

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Cdn Banks & Sub-prime Lending

National Post, Keith Kalawsky, 23 February 2006

The Canadian banks dominate financial services in Canada, with the exception of two areas: life insurance and sub-prime lending.

The banks aren't allowed to sell insurance through their branches, but they are now moving into sub-prime, as shown by Toronto-Dominion Bank buying automotive lender VFC Inc. and Bank of Nova Scotia acquiring Maple Trust, a mortgage company.

There are three sub-prime lenders that potential takeover targets for the banks keen on exploiting what could be the final frontier of financial services: Home Capital Group Inc, Xceed Mortgage Inc., and Equitable Group Inc. Since the acquisitions by TD and Scotiabank, the share prices of all three have taken off.

Since Feb. 16, the date of TD's deal announcement, Xceed is up $1.41 or 17% to $9.90. Equitable has risen $2.74 or 11% to $26.99. Home Capital, the least likely target because of its high valuation, according to analyst Darko Mihelic at Blackmont Capital Inc., has increased $1 to $41.50.

Based solely on the hefty price TD paid for VFC, Equitable could go for $41.46 a share, Xceed could fetch $15.94 and Home Capital could get $37.43, the analyst noted in a research note last week. Mr. Mihelic's price targets on Equitable, Xceed and Home Capital are $30, $11 and $9, respectively. His targets are adjusted downward by a risk discount.

"We believe the Canadian banks are likely to enter the non-prime mortgage market via acquisitions given their excess capital, limited growth opportunities and the attractiveness of the non-prime mortgage market," Mr. Mihelic wrote. "In our view, this trend has played out in the U.S. and U.K. market and it is a logical extension of the banks' business in Canada."

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Judge Gives Initial Approval on Enron Settlements

AP, Kristen Hays, 22 February 2006

HOUSTON (AP) -- Down the hall from the fraud and conspiracy trial of Enron Corp. founder Kenneth Lay and former Chief Executive Jeffrey Skilling, a federal judge gave initial approval Wednesday for three more banks to pay $5.8 billion to settle civil claims that they helped the company manipulate earnings.

U.S. District Judge Melinda Harmon is expected to give final approval to the deals with the Canadian Imperial Bank of Commerce, JP Morgan Chase & Co. and Citigroup Inc. later, said William Lerach, who represents the University of California, the lead plaintiff in the conglomerate of shareholder lawsuits in Enron's hometown of Houston.

The litigation's settlement tally has so far reached $7.2 billion against Wall Street firms accused of helping the energy trader hide losses in a massive accounting fraud before it filed for bankruptcy protection in December 2001.

As Harmon addressed the settlements, her colleague U.S. District Judge Sim Lake presided over the fourth week in the criminal trial of Lay and Skilling down the hall on the ninth floor of Houston's federal courthouse.

Lay and Skilling also are named as defendants in the shareholder lawsuit, which is slated to go to trial in November. Lerach and other plaintiffs' lawyers visited the criminal trial after the settlement hearing wrapped up.

The three banks last year announced settlements with the largest amounts yet: CIBC, $2.4 billion; JP Morgan, $2.2 billion; and Citigroup, $2 billion. Lerach said Wednesday that combined $5.8 billion has risen to $6.7 billion with interest.

Before those agreements, some $500 million of settlements had been reached with Lehman Brothers Holdings Inc., Bank of America Corp., Andersen Worldwide, and 18 former outside Enron directors -- including 10 who put up $13 million from their own pockets after they had sold inflated stock.

Other banking and brokerage heavyweights that have not struck settlements and remain defendants in the action include Merrill Lynch & Co., Barclays PLC, Toronto-Dominion Bank, Royal Bank of Canada, Deutsche Bank AG and the Royal Bank of Scotland Group PLC.

About 50,000 Enron stock and bond holders led by the university's board of regents filed claims in the action. Approximate damages reach $47 billion, but Lerach has said the actual awards will be pennies on the dollar.

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BMO, Scotiabank Expected to Lead in Q1 Profit Growth

Canadian Press, Tara Perkins, 22 February 2006

Toronto (CP) - The Bank of Montreal and Scotiabank are expected to take the gold and silver for first-quarter earnings growth in Canada's banking industry.

The Big Six banks will take turns releasing financial results for the November-to-January period over the next two weeks, with TD Bank first out the gate on Thursday. Analysts are forecasting a strong showing for the quarter and are cautioning investors not to be spooked by higher provisions for loan losses.

The consensus estimate of analysts surveyed by Thomson Financial expects the Bank of Montreal to report a 10 per cent rise in first-quarter profit, followed by the Bank of Nova Scotia at seven per cent, Royal at six per cent, TD at five per cent and CIBC at two per cent.

National Bank trails with an expected earnings drop of two per cent.

Canada's banking industry took a slight tumble in 2005, when half of the Big Six took charges for their liabilities in lawsuits related to the Enron scandal in the United States.

But it also proved that it can land on its feet, picked up in part by good mortgage lending and wealth-management sales. The outlook is good for those sectors again.

"It should be a good quarter for wealth management and trading activity at the Canadian banks," said Sumit Malhotra, an analyst with Genuity.

Factors that are expected to boost capital market-related revenue and wealth-management income include volatile foreign exchange and commodity markets, high stock-trading volumes, continued mutual-fund market share gains, tightening activity by central banks and the federal government's decision to leave income trusts untaxed.

"The economy has remained pretty solid, the consumer has remained solid, so you would expect retail banking to post good results in general," said Tom Kersting, a financial services analyst with brokerage Edward Jones.

"Overall, we would expect a clean bill of health for the quarterly earnings checkup."

Malhotra said 2006 is expected to bring a return to stable net interest margins - the difference between what the banks receive on loans and what they pay on deposits - a trend that showed signs of beginning in the second half of 2005.

Scotiabank is expected to lead the way on that front, Malhotra said.

The most important valuation issue facing bank-stock investors, though, is rising loan losses, said National Bank Financial analyst Robert Wessel.

Excellent earnings growth of the past two years was driven primarily by falling loan losses, Wessel said in a note to clients.

He expects provisions for loan losses to begin to rise in the second half of 2006, and notes "there are already signs that the credit cycle is beginning to turn."

Many investors will be watching the provisions closely.

"Because credit has been so good for so long, it's almost as if investors are just waiting for the other shoe to drop," said Malhotra. "They are very sensitive to even the perception that the environment for lenders is weakening."

Credit losses will be higher in the first quarter, on a year-over-year basis, Malhotra said. But "it's not so much that we think there are bad trends in credit, as much as there is just less in the way of reversals and recoveries," he said.

"Those huge pools of gross impaired loans that were around after the writedowns of 2002 are getting smaller, so there's less recoveries for the banks to get from bad loans."

Kersting agrees that larger provisions for loan losses in the first quarter will not be a signal of bad credit quality.

"It's really a return to a more normalized level," he said.

Malhotra expects Royal, BMO and TD to announce an increase in their quarterly dividends, along with their earnings.

Looking further into the next two years, Wessel expects the "excellent" dividend growth of the past two years to slow, as earnings headwinds arise.

At the same time, he expects the banks to deploy more capital as their common equity continues to grow.

"The acquisition cycle has begun," he said.

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RBC CM's Preview of TD Bank Q1 2006 Earnings

RBC Capital Markets, 22 February 2006

TD leads off the banks’ Q1/06 reporting schedule on February 23. Our normalized cash EPS estimate of $1.08 is $0.01 below the Thomson First Call mean estimate, although with gains TD should report well over $3.00.

Investment Opinion

• Cash EPS Expected Up 5% YoY. Our cash EPS estimate of $1.08 indicates a 5% lift YoY (up 2% QoQ), which excludes over $2.00 for the TD Waterhouse dilution gain on its vend-in to Ameritrade this quarter. Further excluding our estimates for higher loan losses (back toward normal levels) and for lower securities gains, we expect ~10% underlying earnings growth.

• Full Year Consensus EPS Estimate for TD Seems Too Low. For both 2006 and 2007, we still think the Street consensus earnings outlook is too low. Our 2006 cash EPS of $4.68 reflects roughly 11% core growth plus $0.10 accretion for Ameritrade and Hudson United. Our 2007 $5.30 cash estimate includes another $0.26 accretion (mostly from the Ameritrade deal), yet if included in consensus implies only 4.5% organic growth.

• League-leading Credit Reserves. Last quarter, TD’s impaired loans dropped again to $774 million or 0.39% of total loans – TD’s reserve coverage bloated to a league-leading 370%. Of all Canadian banks, given excess capital, coverage and business mix, in our view TD looks best set to weather any unforeseen credit issues. Our Q1/06 loan loss provision estimate of $107MM is 14% higher than Q4/05 and up 33% versus year ago levels, representing a very acceptable 0.27% of loans and acceptances.

• Looking for a Dividend Increase. TD is on schedule to raise its dividend this quarter (usually every 2nd quarter) since the last hike was in August 2005. We are forecasting a 3¢ lift to $0.45 per share. TD’s Tier 1 capital ratio should jump to 11.7% as a result of the TD Waterhouse gains, up from 10.1% in Q405 and down from the pre-Banknorth level of 13.0% a year ago.

• Valuation. Our price target of $72 (unchanged) is set at 13.5x our 2007 cash EPS estimate of $5.30. Our premium target P/E reflects TD’s leading domestic franchise, a management that we rate as peerless and the unique structure for growth in the U.S. with Banknorth and Waterhouse. Our target P/E is set at a 3% premium to the group, above the five-year average discount of 1%; however, TD has traded at an average 6% forward P/E premium to its Canadian bank peers since 1998 and we would view positive execution experience on BNK as an avenue to revaluation. Our price target is indicated at ~2.8x our projected book value of $25.54 (as at Oct 31/06).

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RBC CM's Preview of Cdn Bank Q1 2006 Earnings

RBC Capital Markets, 20 February 2006

Cash EPS Growth Estimated Up 7% YoY. We are estimating 7% YoY cash EPS growth for Q1/06. Our estimated growth is indicated highest at RY (driven by continued broad-based revenue growth and operating leverage), followed by BNS (International divisional growth, now less adversely impacted by currency) and BMO (on revenue growth and operating leverage gains). Our TD estimate excludes over $2 in gains, preannounced for the TD Waterhouse USA vend-in and a dilution loss on Banknorth’s Hudson United acquisition.

Accelerating Revenue Growth. For Q1/06, we are estimating 10% YoY revenue growth, still up 8% excluding the impact of TD’s Banknorth acquisition. Measured either way revenue growth is well through the 0-5% range of 2005. We look for a sequential up-tick in retail spread and growing corporate/commercial loan volumes to contribute to already solid wealth and wholesale activity. After years of dull revenue growth, a positive trend could drive strong operating margin gains and EPS surprises, particularly at high-momentum banks RY, NA, TD, and now also at BNS.

Credit Solid. Despite large percentage increases, the dollar impact of normalizing credit losses should have only muted EPS impact from the current low level. Our normalized loan loss provision estimates for the group are indicated up 23% QoQ and 37% YoY, purely on a return to more normal, run-rate levels rather than as a result of impaired loan developments that we expect to remain very low. We are looking for an increase in LLP/L&A to 0.30% versus 0.25% in Q4/05 – in our view, 0.30-0.35% should now be the cycle-neutral average. This level of credit provision remains very manageable with only moderate EPS impact at the current low levels. In our view, heightened sensitivity to wider corporate bond spreads, auto industry issues and/or currency woes for small domestic manufacturers will not be showing up in impaired loan development.

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BMO NB's Postscript on Life Ins Q4 2005

BMO Nesbitt Burns, 20 February 2006

• Overall, Q4/05 results were in line with expectations driven by strong gains in equity markets, good credit and expense gains from acquisitions. The clear standout in the quarter was Manulife, which reported robust earnings and sales results.

• The Canadian life insurers remain prolific generators of excess capital. We estimate that the lifecos had approximately $5.5 billion in excess capital at the end of 2005. This could increase 48% to $8.2 billion by the end of 2006.

• Despite the growth in excess capital, ROEs are expected to continue to rise. Total payout ratios, which included dividends and share re-purchases, was 52% in the industry and is comparable to the banks.

• While long term earnings growth favours the insurers over the banks, the banks currently have higher yields and ROEs as a group and trade at comparable P/E valuations. Moreover, the banks are experiencing very high levels of asset growth in their retail banking franchises.

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Price Targets for Life Insurance Companies

Great-West Lifeco
• BMO Nesbitt Burns maintains a "market perform", target price raised to $32.00
• Credit Suisse downgrades to "underperform", target price is $31.00
• GMP Securities maintains a "buy", target price cut to $33.50
• RBC Capital Markets maintains a "sector perform", target price cut to $32.00
• TD Newcrest maintains a "hold", 12-month target price is $30.00

Industrial Alliance Insurance & Financial Services
• BMO Nesbitt Burns maintains "outperform", 12-month target price is $34.00
• Credit Suisse maintains "outperform", 12-month target price is $35.00
• GMP Securities maintains "hold", 12-month target price is $32.50
• RBC Capital Markets maintains "outperform", 12-month target price is $36.00
• Scotia Capital Markets maintains "sector perform", 12-month target price is $33.00
• TD Newcrest maintains "hold", 12-month target price is $32.00
• UBS 12-month target price is $34.00

Manulife Financial Corporation
• BMO Nesbitt Burns maintains a "outperform", target price raised to $80.00
• Credit Suisse maintains a "outperform", target price raised to $78.00
• Desjardins Securities maintains "top pick," target price raised to $84.00
• GMP Securities maintains a "buy", target price raised to $77.00
• Genuity 12-month target price is $79.00
• RBC Capital Markets maintains a "top pick", target price is $86.00
• Scotia Capital Markets maintains a "sector outperform", 1-year target price is $76.00
• TD Newcrest maintains a "buy", 12-month target price raised to $80.00
• UBS 12-month target price is $79.00

Sun Life Financial Inc.
• BMO Nesbitt Burns maintains a "outperform", target price raised to $54.00
• Credit Suisse maintains "neutral", 12-month target price is $51.00
• Desjardins Securities maintains "top pick," target price is $53.00
• GMP Securities maintains a "buy", target price is $54.50
• RBC Capital Markets maintains a "sector perform", target price is $52.00
• Scotia Capital Markets maintains a "sector perform", 1-year target price raised to $52.00
• TD Newcrest maintains a "buy", 12-month target price is raised to $53.00
• UBS 12-month target price is $56.00

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ML Downgrades TD Bank to Neutral

The Globe and Mail, Roma Luciw, 17 February 2006

Merrill Lynch Canada Inc. downgraded Toronto-Dominion Bank Friday, extending its increasingly bearish view to all but one of the biggest Bay Street banks.

Analyst André-Philippe Hardy said he expects the TD's per-share profit growth to slow to 10 per cent in 2006 from 12 per cent in 2005. Continued growth in retail volumes will be partially offset by higher provisions for credit losses, lower securities gains and the stronger Canadian dollar.

He also noted that TD stock has risen 4.2 per cent in the last month and 27.9 per cent in the last 12 months to a share price that already reflects its proper value. “We believe that stock performance in 2006 will be muted, as the stock now trades at 14.1 times 2006 estimated earnings per share, which is in line with the multiple of its Canadian peers, and ahead of many of its global peers...,” Mr. Hardy said.

National Bank of Canada is now the sole Merrill Lynch buy-rated stock among the big six Canadian banks.

“Our current, more muted, view of the sector is a reflection of its relative valuation versus historical averages...” Mr. Hardy said.

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RBC Centura Results Remain Stable

BMO Nesbitt Burns, 17 February 2006

Centura (Royal Bank’s U.S. regional banking operation) this morning posted its results to the FDIC website for the quarter ending December 2005. These results are included in the current fiscal first quarter for RY.

Broadly speaking, the results are slightly better than we expected, with the entire variation being lower than forecast loan losses. Specifically, the business made US$29mm in the quarter versus a run rate of about $21 mm in the first three quarters of the year. These results are not entirely transferable to RY as there are other non-deposit taking entities where there is no visibility. This is a small business (total RY earnings this quarter will be over $1 billion), but since the U.S. has been in problem in the past, investors do focus on the operating trends at Centura. Together with the strong domestic P&C and Wealth operations, we believe this result supports our view that Canadian banks will have a strong quarter in the upcoming weeks.

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Scotia Capital's Preview of Cdn Bank Q1 2006 Earnings

Earnings Growth 4.3% YOY - Led by TD and RY

• Our first quarter earnings estimates are highlighted in Exhibit 1. First quarter bank earnings are expected to be up 4.3% year over year and 1.3% sequentially. TD and RY are expected to lead in earnings growth at 8% and 7%, respectively, with CM and NA actually forecast for a 3% decline in earnings.

• First quarter bank earnings are expected to be supported by continued firming of retail net interest margins (Exhibit 8). The 50 bps increase in the primate rate in late 2004, in our view, contributed to the stabilization of the retail net interest margin in 2005 after a four year decline. The more recent 100 bps increase in the prime rate as highlighted in Exhibit 7 bodes well for margin improvement in 2006 although the lag could be two or three quarters.

• Wealth management earnings are also expected to be strong although only three banks are now disclosing these earnings on a separate basis. The fact that RY, TD, and BMO have seen an increase in their mutual fund assets in the 20% range is a good proxy for significant operating leverage.

ROE Expected at 20.1%

• Profitability is expected to continue to run at historical highs on very large capital positions. Return on equity is expected to remain extremely high at 20.1%. Consensus earnings estimates and share price targets are highlighted in Exhibit 4.

BMO, RY and TD Dividend Increase Candidates - BNS Expected to Increase Payout Range

• We expect BMO, RY, and TD to announce dividend increases in the 6%-7% range. We also expect BNS to increase its target payout ratio to 40%-50%. A 2-for-1 stock split for RY remains in the cards although the bank might want to see its share price go through a $100 per share first.

• Bank of Montreal is expected to report $1.18 per share, a modest 4% YOY increase. We expect the bank will be challenged to repeat the level of trading revenue it recorded in the previous quarter especially given the major shift in the natural gas market. Security gains have a low level of sustainability ($0.04 per share in Q4/05) given minimal unrealized security surplus. Harris earnings growth is expected to remain sluggish. A dividend increase is expected of 6.1% to $2.08 per share.

• Bank of Nova Scotia is expected to report $0.80 per share, a 4% increase YOY. A strong Canadian dollar continues to mute the bank's earnings growth from Mexico and the Caribbean. A large unrealized security surplus provides for sustainable security gains. Dividend payout ratio increase expected.

• Canadian Imperial Bank is expected to report $1.42 per share, a 3% decline from a year earlier. The bank's earnings will be challenged as the bank needs a repeat high level of securitization revenue ($0.08 per share - Q4/05) as well as repeat or replace security gains ($0.12 per share - Q4/05 excluding Global Payments/Shoppers). Security gains are much more difficult given the very low level of unrealized security surplus (Exhibit 17). The bank needs to rely on acceleration in costs saves and to benefit from its interest rate positioning for higher short term rates. The interest rate positioning needs to offset its high dependency on wholesale deposits to fund its retail loan book. Also, the bank needs its unsecured personal loan portfolio to stabilize from a credit perspective and avoid the negative impact on this portfolio of a 25% increase in short term rates. The impact of rising rates on this portfolio is likely to be felt over the next year.

• National Bank is expected to report earnings of $1.18 per share, a 3% decline from a year earlier. The bank needs to continue to generate strong trading and capital market revenue with its retail bank performance expected to remain strong. Unrealized security surplus remains healthy.

• Royal Bank is expected to report $1.62 per share, a 7% YOY increase. Retail and wealth management earnings are expected to remain solid, supported by strong insurance earnings. As a proxy, ING Canada reported fourth quarter calendar operating earnings growth in the 15% - 20% range. RY is expected to increase its dividend 6.2% to $2.72 per share and the possibility of a stock split remains.

• Toronto Dominion Bank is expected to report $1.12 per share representing the highest YOY growth rate of 8%. Like at Royal, retail and wealth management earnings at TD are expected to remain solid, supported by strong insurance earnings with the recent results from ING Canada a positive indicator. This is an important quarter for TD as it consolidates and closes the Ameritrade and Hudson United transactions. TD book value is expected to be given a $2 per share boost from the Ameritrade transaction. In addition we are hopeful that this is the last quarter of the TDSI restructuring of its global structured products division and the last of the interest rate immunization at Banknorth. Thus we expect the second quarter of 2006 will be a relatively clean, straight forward quarter for the bank and will not distract to investor focus from the operating performance of the bank's core businesses. TD is expected to increase its dividend 7.1% to $1.80 per share.

Strong Fundamentals - Remain Overweight

• We believe bank fundamentals remain the strongest in history with low balance sheet risk, high capital levels, strong asset quality, record profitability, and historically low earnings volatility.

• Bank stock valuations remain attractive although not as compelling as they have been. Banks are trading at a low (based on fundamentals) 13.9 times our 2006 earnings estimates with bank dividend yields relative to bonds (Exhibit 9), equity markets, income trusts (Exhibit 10) and pipes and utilities (Exhibit 11) all in the Buy range although not at the previous extreme discounts.

• Solid earnings growth outlook and double digit dividend growth expected for the next three to five years bodes well for continued appreciation in bank share prices.

• We reiterate our Overweight Banks recommendation based on compelling valuation, strong fundamentals, and low relative low risk.

• Maintain 1-Sector Outperform ratings on RY, TD and LB, and 2-Sector Perform ratings on BMO, CWB, and NA, with a 3-Sector Underperform rating on CM. We are restricted on BNS.

• We expect TD and RY to move to 10% P/E premiums to the bank group with CM and BMO declining to 10% discounts based on relative fundamentals.

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Cdn Banks Target Sub-prime Lenders

BMO Nesbitt Burns, 17 February 2006

• TD Bank announced yesterday that it has entered into an agreement to acquire VFC, a financial institution in the sub-prime, used auto lending market. The transaction value is $326 million—just under four times tangible book value.

• For this deal to be successful, the people and the processes put in place to originate loans at VFC are crucial. We believe that both are sound. The senior executives have extensive experience and the three senior executive will take stock for 100% of their shareholdings in VFC. In addition, we believe that the process of risk-based pricing by VFC, though untested by a recession in Canada, is robust.

• We are not blind to the risks associated with buying VFC—loan losses can be volatile (to state the obvious), the potential for reputation harm is tangible (lending at over 20% typically doesn’t win anyone friends) and originations and margins can fluctuate.

• We believe that buying a “stand-alone” player in one segment of the market, which seems to have capable management and a good track record, is a reasonable way to capitalize on the opportunity. In this report, we consider the economics and provide a detailed background on VFC, the sub-prime auto business and its operating model. Overall, we consider this a reasonable deal and retain our Outperform rating on TD Bank shares.

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The Globe and Mail, Sinclair Stewart, 17 February 2006

Brimming with cash, but bereft of places to spend it, acquisition-hungry Canadian banks are descending on one of the last apparent markets for growth in domestic retail lending: the higher risk, or "sub-prime," consumer.

Toronto-Dominion Bank entered the fray yesterday, agreeing to pay $326-million for VFC Inc., a Canadian company that provides car financing for buyers with weaker credit profiles.

The larger Canadian banks have steered clear of these consumers, in part because the potential financial reward was not deemed worth their while, and in part because they fretted about reputation damage if they began charging as much as 30 per cent interest on a loan.

But that attitude is changing, spurred by the approximately $10-billion in excess capital the banks are lugging around and the lack of expansion opportunities.

The sub-prime borrowers, or "near-prime" consumers, have suddenly become a sought-after market, and banks are swimming downstream to help them buy cars and homes.

On Tuesday, Bank of Nova Scotia announced a $233-million acquisition of Maple Trust, a mortgage lender that provides financing through an army of brokers.

"It's the last frontier, so to speak, of retail lending in Canada," said Darko Mihelic, a bank analyst with Blackmont Capital in Toronto. "I think banks are going to steamroll this [market] in the next five years. It's only a matter of time before they become the source for all of this stuff."

The sub-prime category, particularly in car lending, didn't really exist five years ago. Today, however, it is estimated to be a $4-billion market, only 25 per cent of which is currently served by existing players such as VFC, Home Capital, and Wells Fargo.

The mortgage market for these consumers, meanwhile, is pegged at about $20-billion. Although Scotiabank has said it plans to target the near-prime borrowers, many analysts believe this will be only a stepping stone to the fatter profit margins of sub-prime lending.

"We believe there is good growth there," said Alberta Cefis, executive vice-president of domestic personal lending and insurance at Scotiabank, which will become the country's number three mortgage provider. "It's an untapped market."

South of the border, and in the U.K., non-prime lending accounts for about 30 per cent of the entire retail lending market. In Canada, by contrast, it remains in the low single-digits, but is growing much faster than conventional lending.

Tim Hockey, who heads up personal banking at TD Canada Trust, said profit margins remain strong in this category because the large banks have traditionally ignored it. He said his bank is also considering a move into this area of the mortgage business.

"That is clearly another strategic push that is under consideration," he said in an interview, pointing out that the management at VFC should help TD learn more about servicing these customers in other areas. "This is a consumer segment we have not touched."

There are still questions, though, particularly around the credit environment: the banks are moving into this sector while rates are historically low and credit quality is atypically high. Executives at VFC acknowledged yesterday their relatively young company has never experienced a sustained downturn, which could lead to fewer purchases and more frequent defaults.

While default rates are much higher for non-prime borrowers, so are the interest payments (they range from 13 per cent to nearly 30 per cent) which has allowed VFC to mitigate its exposure.

And these borrowers are not all high-risk: many are immigrants, who arrive in Canada with no credit histories, no banking relationships, and no hope of qualifying for a conventional mortgage or car loan at a branch.

"We want to make sure we're the bank of choice for new Canadians," acknowledged Mr. Hockey. "I'd say [the industry] is not very good at recognizing their needs."

VFC's performance over the past five years illustrates the appeal of non-prime lending for banks: profit has grown steadily from $2.7-million in 2001 to $11.2-million last year, while its portfolio of receivables has jumped from $72-million to $380-million.

The real opportunity is in the area of funding: TD has a much cheaper cost of capital than a small player like VFC, which should help it boost its margins immediately. It's an attractive model for other banks inclined to slide into the sub-prime sector, and analysts like Mr. Mihelic believes others will soon follow.

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The Globe and Mail, Andrew Willis, 17 February 2006

With the sale yesterday of car lender VFC, Sprott Securities completed one of tidiest pieces of cradle-to-grave advisory assignments you'll ever see on the Street.

Back in 2003, Sprott demonstrated its small-cap, special situations focus by taking VFC public at $6.50 a share. (The other lead brokerage house on that offering was TD Securities.)

VFC extends credit to those 18-year-olds who flip burgers, just have to drive a '79 Camaro, and can't get a bank to advance them a cent. Done with skills that include the occasional repossession of used muscle cars, making the loans that banks won't touch is a great business. VFC built a $380-million loan portfolio with 25,000 clients -- or an average loan of $15,200 per customer.

Yesterday, Toronto-Dominion Bank swooped in with a friendly deal to buy VFC for $326-million or $19.50 a share. That's three times the IPO price in less than three years. The adviser that helped VFC end its days as an independent company was Sprott Securities, which has been building its merger and acquisition expertise. On the other side of the table, TD Securities was there to advise TD Bank on the purchase.

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Canadian Press, Gary Norris, 16 February 2006

TD Bank Financial Group is jumping into the business of making high-interest loans to used-car buyers with dodgy credit ratings by taking over VFC Inc. for $326 million.

TD and VFC announced Thursday that TD is offering $19.50 per share for VFC, whose stock had closed Wednesday at $14.15.

"This acquisition is a logical extension of our existing business as a leader in dealer-based automobile financing and an opportunity for us to increase our range of product offerings in response to what dealers and their customers have said they want," stated Tim Hockey, head of TD's personal banking group.

So-called non-prime consumer lending is "an underserved market segment with significant growth opportunity," Hockey said, telling an investor conference call that the high-risk loan segment "will grow faster than the traditional consumer lending market will, and we want to be at the table."

Charles Stewart, president and CEO of Toronto-headquartered VFC, cited "potential synergies of the two organizations, particularly with regard to referrals and distribution," and observed that the TD bid "represents an attractive value proposition for our shareholders."

VFC shares jumped $5.15 or 36 per cent to $19.30. The company, founded in 1994, went public in October 2003 at $6.50 per share - exactly one-third of TD's offer price.

VFC, with offices in Toronto, Montreal and Nanaimo, B.C., has 220 employees and $380 million in receivables from more than 25,000 customers lined up through relationships with 2,000 car dealers.

Auto loans are 95 per cent of its portfolio and Stewart said 95 per cent of these loans are for used vehicles, typically two to four years old, with about half of the transactions originating from new-car franchised dealers and half from independents.

VFC will continue under its own brand and management and Stewart said he and other top executives are committed to stay with the company for at least three years.

VFC stockholders have the option of taking $19.50 per share in cash or $19.45 per share in TD common stock plus a nickel per share in cash.

The offer is endorsed by the VFC board, and management and other shareholders owning 29 per cent of the company have entered into lockup agreements to tender their stock.

Among those shareholders is Manulife Financial Corp..

The arrangement includes a $9.25-million break fee if VFC reverses its acceptance.

VFC connects to dealers via the Internet and Stewart said it turns around loan decisions within 10 minutes using a combination of computerized screening and human decision-making.

Last month it struck a deal with Chrysler Financial under which customers who don't qualify for loans from the automaker are automatically forwarded to VFC.

TD's Hockey said VFC will look at all car-loan applications that TD's standard lending operation turns down, and "a broader non-prime lending strategy . . . is something we'll keep open."

VFC earned $3.5 million on revenue of $20.4 million in its latest reported quarter, up from $2.2 million on $15.2 million a year earlier.

Colleen Johnston, TD's chief financial officer, said VFC's business is forecast to grow at 20 per cent or more annually "before the benefit of referrals from TD." The bank expects the transaction to start adding to its earnings next year.

Dominion Bond Rating Service observed that keeping VFC as a separate brand will "clearly delineate between the higher-risk lending operations and TD's own lower-risk prime auto lending business."

VFC's business - lending to people who have undergone financial problems, have brief credit histories, or are self-employed - provides high interest margins but also high loan losses, DBRS analysts Robert Long and Brenda Lum noted.

"While the portfolio is higher-risk in nature, associated credit risks are manageable," they added, estimating that VFC's portfolio amounts to only 0.2 per cent of TD's total consumer loans.

VFC's Stewart told analysts - who congratulated him on a great deal for his shareholders - that the company has "always been constrained by the cost of capital," which will be reduced as a unit of TD, likely by two or three percentage points, analysts estimated.

But Stewart said VFC's pricing and risk strategies will not change.

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