31 May 2006

UBS Report Suggests Slide in CIBC Market Share

Canadian Press, Tara Perkins, 31 May 2006

CIBC's Canadian banking operations might be losing market share, a key item for investors to watch when the bank reports its earnings tomorrow, an analyst said.

The rest of the big banks have already reported second-quarter results, and each one has shown market-share gains, UBS analyst Jason Bilodeau said in a note to clients. "We are concerned that the donor may be (CIBC)," Bilodeau wrote.

"I'm raising it as a potential issue," he said in an interview.

If CIBC's market share is dwindling, it's possible the bank is intentionally handing business to its rivals, notes Genuity Capital Markets analyst Mario Mendonca.

CIBC has been stung many times in the past year. Its biggest wound came from the $2.63 billion after-tax charge it took last August in relation to lawsuits stemming from its dealings with the now-defunct Enron Corp.

That forced the bank to report a $32 million loss for 2005, its first loss in more than a decade and a half. CIBC chopped its workforce, shedding 15 per cent of its executives and 900 others.

The bank's capital ratio took a hit. And CIBC has high provisions for credit losses from consumers and businesses, Mendonca said.

So, the bank has been trying to shed some of its riskier business, including credit cards and unsecured personal loans. Royal Bank of Canada and TD Bank Financial Group are swiping credit card business, an area CIBC is known to dominate, Mendonca said.

In the first quarter, CIBC had 18.3 per cent market share in credit cards outstanding, down from 18.9 per cent a year earlier. It held 28.6 per cent of credit card purchase volumes, down from 29.1 per cent a year earlier.

It's also known that "CIBC has been in net redemptions on the mutual fund side," Mendonca said. "The street's not going to be floored by seeing CIBC's market share going down."

However, the street will react if CIBC loses ground in residential mortgages, secured personal lending or consumer deposits, Mendonca said.

It had 14.7 per cent of the residential mortgage market and 19.3 per cent of consumer deposits in the first quarter.

After CIBC's Enron announcement last summer, its stock plunged as low as $68.56, but shares hit $81.23 in March — their highest to that point — after CIBC reported first-quarter earnings.

The profits, lower than the same period a year earlier, still beat expectations. The market was buoyed by CIBC's assurances the Enron issues were over.

30 May 2006

Scotiabank Q2 2006 Earnings

The Globe and Mail, Sinclair Stewart, 30 May 2006

Bank of Nova Scotia has always been fond of flaunting its reputation as the country's most global bank, and yesterday it offered some compelling numbers by way of justification: It now employs more people in its international operations than it does in its entire Canadian retail and brokerage division.

Recent acquisitions in Peru and El Salvador, coupled with continued expansion in the Caribbean and Mexico, boosted Scotiabank's international work force by 20 per cent during the second quarter to 22,249 positions.

That compares with 21,045 staff in domestic banking and wealth management.

More importantly for investors, however, is that Scotiabank's foreign push is beginning to demonstrate some significant financial results.

The international unit posted record results yesterday, accounting for nearly one-third of the bank's bottom line and driving an 8-per-cent gain in overall profit.

Scotiabank's profit climbed to $887-million or 89 cents a fully diluted share from $822-million or 81 cents in the same three months of 2005. The bank also increased its quarterly dividend by 3 cents a share to 39 cents.

"We had a very strong quarter," Scotiabank chief executive officer Rick Waugh told analysts during a conference call. Mr. Waugh was on the phone from Costa Rica, where he and other members of the board are spending three days touring the bank's Central American holdings. They were hosting the President of Costa Rica last evening, and are meeting with the President of El Salvador today.

Mr. Waugh said the bank has a strong pipeline of potential acquisition opportunities in the Americas, although he said he feels no urgency to buy his way into the U.S. market.

Instead, the bank will look to bolster its presence in some of its existing markets, in part by opening new branches. The bank intends to add more than 50 domestic branches by the end of 2007, 100 in Mexico, and an additional 50 in countries where it has smaller presences.

The international division made $268-million in the quarter, up 44 per cent from a year ago. Scotiabank's Mexican unit, Inverlat, along with its long-standing Caribbean locations, accounted for the bulk of the earnings, but the bank also received a lift from recent purchases.

Rob Pitfield, who heads the unit, credited new contributions from Peru, El Salvador, and Chile for helping to drive the improvement. However, he said sales practices put in place some time ago are now beginning to pay off across the network, and assured analysts the results this quarter are not a fluke.

Scotiabank's performance beat analysts' profit expectations by about 6 cents a share, yet there were some lingering questions about the quality of its results. For one thing, the bank enjoyed an unusually low tax rate of about 18 per cent. It also benefited from very low loan-loss provisions in its international division and at Scotia Capital Inc., the investment banking arm. In fact, Scotia Capital booked loan-loss recoveries of $54-million.

When these items were stripped out, analysts said the bank essentially met expectations. The bank's shares gained 1.8 per cent or 75 cents before closing at $43.65 on the Toronto Stock Exchange: a gain that may reflect more on the stock's recent sluggishness than it does on the financial results. Scotiabank shares have lost more than 5 per cent since the beginning of the year.

"The stock is so inexpensive that even okay numbers are good enough right now," explained Mario Mendonca, an analyst with Genuity Capital markets in Toronto.

Scotiabank's provisions for soured loans were just $35-million this quarter: Unchanged from a year ago, but down considerably from the $75-million recorded in the first quarter of this year.

Scotia Capital had a solid quarter, with profit rising 15 per cent to $276-million. Trading results were better than last year, although they couldn't keep pace with the torrid numbers posted in the first quarter of 2006.

The retail bank's profit was up 6 per cent to $296-million, although it fell more than 11 per cent from the first quarter.

The bank has been aggressively pursuing new customers on the retail side, and said it now has the third-largest share of mortgages and deposits in the country.

Bloomberg, 29 May 2006

Bank of Nova Scotia, Canada's third- largest bank, said profit climbed for the 12th straight quarter to a record, led by its bank units in Latin America. The stock had its biggest one-day jump since September after profit topped estimates.

Second-quarter net income rose 8.2 percent to C$894 million ($808 million), or 89 cents a share, from C$826 million, or 81 cents, a year earlier, the Toronto-based bank said today. Revenue for the period ended April 30 climbed 5.3 percent to C$2.83 billion.

Earnings from international banking climbed 44 percent to an all-time high of C$270 million, on higher profit from the Caribbean, Mexico and Peru. Scotiabank has spent more than $1 billion since 2000 to expand abroad to counter slowing growth at home, after the federal government banned mergers among Canadian banks.

International banking is ``a really bright spot for Scotia, and something that differentiates it from their Canadian peers,'' said Tom Kersting, an analyst at Edward Jones in Des Peres, Missouri, who rates the bank ``hold.''

Scotiabank completed a C$390 million purchase of two banks in Peru in March to create the third-biggest bank in that country. The company also owns Grupo Scotiabank, the sixth- largest bank in Mexico.

Shares of Scotiabank rose 88 cents, or 2.1 percent, to C$43.78 at 3 p.m. in trading on the Toronto Stock Exchange. The stock is down 5.1 percent this year, the worst performer among the country's six biggest banks.

Investment Banking

Profit from investment banking rose 15 percent to C$277 million, as the bank joined Bank of Montreal and Royal Bank of Canada in reporting a surge in trading revenue this quarter. Trading volume on the Toronto Stock Exchange has risen by more than a third in the first four months of the year after commodity stocks soared.

Domestic consumer banking profit rose 6.4 percent to C$298 million, boosted by higher deposits, as well as mortgage and credit card fees.

The bank was expected to earn 82 cents a share, according to the median estimate of seven analysts polled by Bloomberg.

Scotiabank boosted its dividend 8.3 percent to 39 cents a share, the fourth increase in eight quarters. The bank set aside C$35 million for bad loans, unchanged from the previous year. That's less than the C$85 million estimate from CIBC World Markets analyst Darko Mihelic.

Other Banks

Scotiabank is the fifth of Canada's eight publicly-traded banks to report second-quarter results. Bank of Montreal said earnings climbed 7.3 percent to C$644 million, or C$1.24 a share. National Bank of Canada said profit climbed 5.9 percent to C$214 million, or C$1.26 a share, while Toronto-Dominion Bank said earnings rose 23 percent to C$738 million, or C$1.01 a share.

Royal Bank of Canada, the country's No. 1 bank, said on May 26 that earnings climbed 23 percent to C$1.12 billion, or 85 cents a share, as trading revenue climbed to a record. Royal Bank, National Bank and Bank of Montreal also topped analysts' profit estimates, and Toronto-Dominion missed.

Canadian Imperial Bank of Commerce, Laurentian Bank of Canada and Canadian Western Bank are scheduled to release results this week, with CIBC reporting June 1.

TD Securities' Goal of Top Tier Market Share

The Globe and Mail, Andrew Willis, 30 May 2006

Two years back, Toronto-Dominion Bank CEO Ed Clark set a goal for his investment banking team. He wanted the squad to hold the same top-tier market share that TD's retail bank enjoys.

Well, five months of results don't mean mission accomplished, but TD Securities is on a run. The equity underwriting team is in No. 3 position, behind CIBC World Markets and RBC Dominion Securities, while the institutional desk continues to rank as the top block trader.

The arrival of new talent confirms that TD Securities has the wind behind it. Eric Morisset joined the dealer this week as Montreal-based head of its Quebec operations. He fills a slot that came open when Michael Fortier jumped into the federal cabinet (without ever having to win an election). Mr. Morisset was at CIBC World Markets for the past 12 years, most recently as managing director in the Montreal office. And institutional equity arm TD Newcrest just picked off one of the Street's better hedge fund sales specialists, as Mike Arbus joined from RBC.

27 May 2006

Hunkin's Enron Retreat was Right Move for CIBC

The Globe and Mail, Eric Reguly, 27 May 2006

John Hunkin invited me to lunch about two years ago and we met in the sleek dining room atop the CIBC tower in Toronto. He was peeved because I had written a column called "Hit the road, Hunkin" and wanted to set me straight. The piece politely suggested he defenestrate himself because of the bank's run-ins with New York State Attorney-General Eliot Spitzer, in the mutual funds trading scandal, and the U.S. Department of Justice, in the Enron case.

Mr. Hunkin was gracious and funny nonetheless. Before we sat down, he gave me a quick tour of the executive offices. "Is that where Spitzer sits when he's here?" I asked, pointing to an empty desk. "No," he said, "we built him an office down the hall."

Inevitably, the conversation turned to Enron. Only a few months before, CIBC had reached a settlement with Justice in the Enron affair, which came to a sensational conclusion this week with convictions of Kenneth Lay and Jeffrey Skilling, the chairman and CEO team who oversaw the biggest fraud in U.S. corporate history.

In the autumn of 2003, the rumours said CIBC was in serious trouble with Justice, that it faced possible criminal indictments for its sordid dance with Enron. The rumours of possible indictments were forcibly denied by the bank, though Mr. Hunkin was obviously nervous. He went on a damage-control campaign and met with media executives. The message: Call off the dogs, don't print rumours, thousands of employees' jobs are at risk if the bank takes an unjust beating in the press.

CIBC settled with Justice that December while still denying that threats of criminal indictments forced it to run up the white flag. But the wording of the settlement made it clear CIBC had come close to the precipice. Justice said CIBC "has accepted responsibility for the criminal conduct of its employees in connection with a series of structured finance transactions with Enron." It added: "As long as CIBC abides by the terms of the agreement, the Justice Department has agreed to not prosecute the bank."

CIBC was required to pay $80-million (U.S.) to the Securities and Exchange Commission, exit the structured finance business in the United States and appoint an independent monitor to oversee the bank's compliance systems.

I asked Mr. Hunkin why the bank had settled. Intimidation was more or less the answer. He said arriving at Justice's offices was scary, because the walls are lined with pictures of Justice "kills," (like Ivan Boesky and Michael Milken, though he didn't identify the photos and said he hadn't been there himself). In the end, CIBC had no desire to become a piece of art.

Good call on his part. No financial institution had survived a criminal indictment. The memory of Arthur Andersen was painfully fresh. In 2002, Andersen, Enron's auditor, was convicted of obstruction of justice for shredding Enron documents. Three years later, the U.S. Supreme Court overturned Andersen's conviction. But it was too late. The Big Five accounting firm had been reduced to rubble.

If indicted, CIBC too would have faced eradication. In the months before the settlement, rival Canadian banks began to fear for their own health -- if Justice were to nuke CIBC, the fallout would hurt everyone. The federal Office of the Superintendent of Financial Institutions arrived to help broker a deal with Justice. The Federal Reserve Bank of New York probably got involved too, though its role has never been confirmed. The two regulators may have convinced Justice that taking out a big Canadian bank, one with a significant Wall Street presence, would cause more problems than it solved.

At the time, the settlement costs seemed relatively minor, the equivalent of a speeding ticket. But Justice left behind a time bomb. The settlement prevented CIBC from disputing its unsavoury conduct in the Enron affair, meaning it could not defend itself against shareholder lawsuits. The bomb went off last August, when CIBC settled a class-action lawsuit for $2.4-billion, a price greater than the ones paid by Citigroup and J.P. Morgan for their Enron sins.

Still, CIBC had done the right thing -- for the bank, its employees the shareholders -- by settling.

The Enron fiasco had a pleasant ending. It seemed to have convinced Mr. Hunkin that the United States was a dead end for the bank. Wall Street's Oppenheimer, bought by CIBC in 1997, was largely sold in 2002. Amicus, the electronic bank, failed and was put to rest. The dream that CIBC could make a splash in the U.S. market vanished.

Canada became the new focus. CIBC bought Merrill Lynch's Canadian retail arm and rode the income trust bucking bronco. Profits roared back. The shares have more than doubled to $80 (Canadian). Over four years, CIBC's shareholder returns have been better than Royal Bank's.

Mr. Hunkin was replaced as CEO last year by Gerry McCaughey. He took his fortune and disappeared from view. Mr. Hunkin will never go down as a bank hero. He will go down as someone who did his best to correct a horrendous series of mistakes made under his watch.

26 May 2006

RBC Q2 2006 Earnings

The Globe and Mail, Sinclair Stewart, 27 May 2006

Royal Bank of Canada is on pace to shatter the industry's record for annual profit, due in no small part to a reinvigorated capital markets division that produced what one analyst called "outrageous" trading revenue this quarter.

RBC, the country's largest company, reported second-quarter profit yesterday of $1.1-billion or 85 cents a share, a 24-per-cent improvement from the $895-million or 69 cents it delivered to investors in the same period last year.

For the first six months of fiscal 2006, the bank has made nearly $2.3-billion in profit, positioning it to exceed its previous annual high-water mark of $3.3-billion in 2005.

All of RBC's major business units increased their profitability from last year, but the standout was RBC Dominion Securities Inc., the investment banking and brokerage division.

The capital markets business made $433-million this quarter, up 47 per cent from last year, amid a near perfect confluence of factors: Mergers and acquisitions activity was up, equity markets were solid and trading was stellar. The bank's trading operations contributed $586-million in revenue this quarter, more than 40 per cent above their output a year ago. "This past quarter was just one of those quarters where everything seemed to move in the right direction," RBC chief executive officer Gordon Nixon said of the trading business in a conference call with analysts to discuss the bank's results.

"They're hitting a lot of good things right now," said one analyst who covers the bank. "If you look at the trading revenue this quarter, it was outrageous."

RBC has been expanding its trading operations in the past couple of years, both geographically and in terms of the types of products it buys and sells. Yet the success of the bank's capital markets businesses this quarter, and in particular its trading, has elicited some questions about how much added risk RBC is assuming.

Toronto-Dominion Bank and Canadian Imperial Bank of Commerce, both of which were scorched by corporate lending disasters a few years ago, have been weaning themselves off of the riskier, more volatile revenue stream from investment banking and focusing more heavily on retail banking. TD has become retail-centric under the leadership of Ed Clark, while CIBC has stripped capital away from its investment bank after some high-profile scandals.

RBC, however, is the only one of the major Canadian banks that has not meaningfully reduced the amount of capital it allocates to its investment bank, even though it has cut back on large corporate loans, according to a recent research report by National Bank Financial Inc. analyst Robert Wessel.

Mr. Wessel suggested this is one reason for RBC's "massive growth" in profitability over the past two years relative to its peers. He also noted that the bank appears to have raised its market risk, based on the growth in risk-weighted assets for the investment bank. Banks are required to have specific amounts of capital set aside for their assets; the amounts vary according to how risky each asset is deemed to be.

But RBC was not merely relying on its investment bank this quarter. Profit at the Canadian retail division, which includes personal banking and wealth management, was up 16 per cent. Strong mutual fund sales helped, as did the bank's ability to avoid a costly price war on loans and mortgages that has dented margins for some of its peers.

On a cash basis, which excludes some items, RBC made 86 cents a share in profit, about 4 cents better than analysts had been expecting. Its shares closed up 21 cents yesterday, at $46.66 on the Toronto Stock Exchange.
Bloomberg, 26 May 2006

Royal Bank of Canada said second- quarter profit rose 23 percent as trading revenue jumped to a record and soaring commodity prices led to more merger assignments.

The country's biggest bank said today that net income for the period ended April 30 climbed to C$1.12 billion ($1.01 billion), or 85 cents a share, from C$907 million, or 69 cents a year earlier.

Trading volume on the Toronto Stock Exchange rose by a third this year and new stock sales surged by half, increasing underwriting and trading fees for Royal Bank and Bank of Montreal. Canadian mergers almost doubled to $73.6 billion this year as record commodity prices led to takeover bids by Royal Bank clients such as nickel miner Inco Ltd.

"There's been healthy activity in the capital markets," said Gordon Higgins, who helps manage $4.9 billion including Royal Bank shares at Sentry Select Capital in Toronto. "Year over year it's steady, which is what you want to see."

Excluding one-time items such as hurricane-related insurance losses, profit for the Toronto-based bank was 86 cents a share, beating the 82-cent-a-share median estimate of seven analysts polled by Bloomberg News.

Profit from investment banking climbed 47 percent to C$433 million, the highest in at least eight quarters, led by trading revenue and brokerage fees. Canada's economy is growing at its fastest pace in six years as prices for copper, nickel and oil rise to records. Canada is the biggest supplier of crude to the U.S., and is the world's No. 2 producer of zinc and nickel.

Mergers Ranking

RBC Capital Markets ranks first for merger advice in Canada this year, working with companies such as Inco in its C$18.6 billion bid for mining rival Falconbridge Ltd. RBC Capital also ranks second for new stock sales in Canada, helping manage the initial public offering for Tim Hortons Inc., the country's biggest coffee and doughnut chain.

Revenue rose 9.3 percent to C$5.12 billion. Trading revenue from stocks and bonds almost doubled to C$724 million. Volume on the Toronto Stock Exchange has risen by more than a third this year, after the benchmark stock index rose 7 percent in the first quarter.

Non-interest expenses climbed 10 percent to C$2.93 billion in the quarter, mostly from an increase in compensation for investment bankers and traders.

Mutual Funds

Consumer banking profit jumped 16 percent to C$608 million as loans and deposits rose. Revenue from mutual funds rose by a third to C$316 million. The bank has increased its share of the C$570 billion mutual fund market by selling funds from its network of 1,105 branches and offering lower fees than independent fund companies. Royal Bank had the highest net sales in the industry for the past 10 quarters.

"Royal is a standout in that regard," Jason Bilodeau, an analyst at UBS Canada in Toronto, said before results were released. "They seem to have momentum on their side, and no reason to believe that that's going to slow down in the immediate term."

RBC Centura

Earnings from Royal Bank's U.S. and international consumer banking, which includes Rocky Mount, North Carolina-based RBC Centura, rose 29 percent to C$106 million. The bank cited higher U.S. brokerage fees and investment banking revenue. Chief Executive Officer Gordon Nixon, 49, trimmed costs after a 2004 slowdown in the U.S. led to the first annual profit decline in five years.

The bank said today it will buy back as many as 7 million shares by its fiscal year-end in October. Royal Bank has repurchased 8.8 million shares under a buyback program that ends next month.

Canadian bank profits have been tempered by a surging Canadian dollar, which has risen to a 28-year high of about 90 U.S. cents. That reduced the value of U.S. earnings when converted to Canadian dollars. Royal Bank said the stronger dollar cut profit by C$35 million.

The banks are also suffering from higher borrowing costs after the Bank of Canada raised rates seven times to stem inflation. Higher rates erode lending margins by forcing the banks to pay more for deposits, and lead to more loan defaults. Royal Bank set aside C$124 million for bad loans, up 6.9 percent from the year-ago period. The net interest margin as a percentage of assets fell to 1.34 percent, from 1.57 percent.


Results included a C$23 million gain for converting seats on the New York Stock Exchange to NYSE Group Inc. stock; C$61 million in hurricane-related costs for its insurance business and a C$47 million loss related to its credit card loyalty program.

Strong capital markets also helped boost profit for Bank of Montreal, which reported May 24 that profit rose 7.3 percent to C$644 million, or C$1.24 a share.

Toronto-Dominion Bank, Canada's second-biggest bank, reported yesterday that profit rose 23 percent to C$738 million, or C$1.01 a share, led by mutual fund sales and its U.S. operations. National Bank of Canada, the No. 6 bank, said that earnings climbed 5.9 percent to C$214 million, or C$1.26 a share.

National Bank, Bank of Montreal and Royal Bank topped analysts' estimates this quarter, while Toronto-Dominion fell short.

Bank of Nova Scotia and Canadian Imperial Bank of Commerce, respectively the country's third- and fifth-biggest banks, are scheduled to report earnings on May 29 and June 1.

Citigroup Entering TD Banknorth's Markets

AP, 26 May 2006

Citigroup Inc. is entering the highly competitive Boston and Philadelphia retail-banking markets, with plans to open several branches in each city this year and then expand in the future.

The forays into Boston and Philadelphia are part of an ambitious retail growth plan that Citigroup Chief Executive Charles Prince unveiled late last year.

The New York bank, the world's largest, expects to open up to 100 new bank branches in the United States this year.

The goal is to beef up Citigroup's lackluster retail presence in its current footprint and also to jump into new regions where it can offer banking services to its existing credit-card, student-loan and automobile-finance customers.

Citigroup's expansion plans have gotten off to a sluggish start. The company opened just 11 new branches in the first quarter and sold 21 branches in upstate New York to M&T Bank Corp. The slow pace has fueled speculation that Citigroup will turn to a retail acquisition.

Citigroup spokesman Robert Julavits said Friday that the company will open a "handful" of branches each in Boston and Philadelphia. The Boston Globe reported Friday that Citigroup has selected sites for four branches in downtown Boston, which Julavits confirmed. He wouldn't provide details about Citigroup's longer-term aspirations in either city, beyond saying that "the plan is to expand our presence."

New Jersey is another focal point for Citigroup. Despite being within sight of Citigroup's Manhattan headquarters, New Jersey is home to just four of the company's bank branches, Prince said in December. The company plans to open 15 to 20 new branches there this year, Julavits said.

Citigroup's selection of Boston and Philadelphia as the two new markets to enter this year isn't a big surprise, given their proximity to Citigroup's core New York market and their high-profile banking markets. Prince has noted that Citigroup has many consumer-finance customers in the two cities.

But starting from scratch in either market won't be easy, since a cluster of big banks already have amassed imposing positions.

The Boston metropolitan area is dominated by two players: Bank of America Corp., which had 218 branches and more than 22 percent of the deposits as of June 30, 2005, and Citizens Bank, a Royal Bank of Scotland Group PLC unit with 198 branches and a roughly 16 percent market share, according to the Federal Deposit Insurance Corp. Two other banks -- Sovereign Bancorp Inc. and TD Banknorth Inc. -- also boast more than 100 branches each in the metro area and have been expanding rapidly.

Philadelphia is similarly concentrated. Four banks -- Wachovia Corp., Citizens, Sovereign and PNC Financial Services Group Inc. -- controlled about 71 percent of the deposits in the city as of last June, according to the FDIC. Wachovia is at the top of the heap, with a roughly 32 percent share of the market.

National Bank Q2 2006 Earnings

TD Newcrest, 26 May 2006


National Bank of Canada reported a solid quarter, with core diluted EPS of $1.23 (excluding a gain on sale relating to shareholder management activities), in line with our estimate and above consensus of $1.19. EPS was down from $1.26 last quarter, but up from $1.08 in Q2/05. Wealth management operations drove the quarterly results, particularly mutual funds and segregated management. Management also increased the dividend to $0.50 (from $0.48).


Neutral. We are maintaining our 2006 and 2007 EPS estimates, our $71.00 target price and Action List BUY recommendation on the stock.


Wealth management results were strong. Net income of $42 million (or $37 million excluding the gain on sale of shareholder management activities), was comparable with $38 million in Q1/06 and up from $30 million in Q2/05.

Year over year revenue growth was driven by momentum in brokerage, mutual funds, and segregated & private investment management divisions. Expenses were controlled at $165 million, up from $155 million last quarter and $160 million a year ago. We also highlight total bank assets under administration rose 13% to $189 billion, and assets under management increased 16% to $40 billion year over year.

Retail results were solid, with net income of $111 million, down slightly from $114 million last quarter (principally due to fewer days in the quarter), and up from $105 million a year ago. Earnings were driven by volume growth year over year, with revenues up in retail banking, insurance and credit cards. Net interest margins were 2.86%, down 3 bps sequentially (less than the decline reported by some of the banks competitors to date) and 11 bps from Q2/05 (which we also note is partially attributable to higher volumes of lower margin partnership loans, which have high collateral values). Asset growth was strong, with average loans and BA’s of $46 billion, up 2% sequentially and 9% year over year, and management commented that approximately 70% of this increase YTD was from loan growth through partnership agreements.

Financial Market earnings declined as expected, with net income of $59 million, down from an exceptionally high $82 million in Q1/06 and flat with $61 million a year ago. Sequentially, much of the decline can be attributed to lower trading revenues of $83 million (down from $90 million in Q1/06), and lower investment gains which were $31 million versus $42 million last quarter (more consistent with average gains of approximately $35 million). Expense control was good, with expenses declining to $142 million, from $151 million in Q1/06 and $150 million a year ago, although the reduction was not enough to offset the decline in revenues. We do highlight the significant increase in average loans and BA’s to $14 billion, up 10% sequentially and 56% year over year, with approximately $1 billion attributable to increased corporate lending and the remainder trading activities.

Credit remained strong, with PCL’s of $22 million, up slightly from $17 million last quarter and $18 million a year ago. Gross impaired loans remained low, declining to $242 million from $260 million at January 31, 2006, and formations were only $3 million, down from $15 million in Q1/06 and flat with $1 million a year ago.

Tier 1 capital declined to 9.1% (at the lower end of the bank group) from 9.5% at January 31, 2005, and the bank repurchased 2.7 million shares during the quarter. An innovative capital issuance is expected to prop the ratio up 47 bps next quarter.


NA is currently trading at 10.9 times estimated 2007 earnings, versus the rest of the peer group, which is trading at 12.0 times 2007 earnings. We are forecasting EPS growth of 11% and 12% in 2006 and 2007 respectively, and given NA’s relatively relative earnings prospects, we believe that it should at least trade at par with the group.

Justification of Target Price

Our $71.00 NA target price is a product of adding 50% of the $71.11 value derived from our 2007 P/E valuation of 13.4 times to 50% of the $71.28 value derived from our 2007 price-to-book valuation of 2.6 times.

Key Risks to Target Price

We believe that the four key valuation risks specific to NA that may prevent the stock from attaining our target price are: a) Unfavorable interest rate movements; b) Quebec sovereignty (we view this with a low probability); c) Lack of scale and financial flexibility; and d) Irrational pricing behavior from non-public competitor Desjardins.

Investment Conclusion

NA reported solid Q2/06 results, and our earnings projections for 2006 and 2007 assume above average growth for the bank. Trading at 10.6 times estimated 2007 earnings, the bank is trading at a 1.4 times discount to the bank group, which we believe is unwarranted given its better growth prospects.

In our opinion the bank will continue to benefit from a dominant market position in Quebec, expansion of its partnership loan program, minimal US$ exposure and strong beta-sensitive operations. We continue to rate the stock an Action List BUY, with a $71.00 target price.

TD Bank Q2 2006 Earnings

Scotia Capital, 26 May 2006

Second Quarter Earnings

• TD Q2/06 operating earnings were $1.09 per share, an increase of 9% versus $1.00 per share a year earlier, below expectations, due to disappointing results from Wholesale Banking with weak trading revenue, particularly in interest rate and credit portfolio products.

• Retail and Wealth Management earnings continue to be strong, increasing 16% and 54%, respectively, year over year (YOY). Wholesale Banking (TDSI) earnings declined 15% YOY.

Weak Wholesale Banking Earnings

• TDSI earnings declined 30% QOQ and 15% YOY to $140 million due to relatively weak trading revenue. Operating earnings from Wholesale, on a comparable basis with Q1/06, were down almost 40 percent if the impact of higher security gains was excluded.

Trading Revenue Weak

• Trading revenue was $251 million, versus $375 million in the previous quarter and $319 million a year earlier with weakness in interest rate and credit portfolio products.

• Interest rate and credit portfolios trading revenue declined significantly in the quarter to $55 million from $199 million in the previous quarter and $127 million a year earlier. The Bank continues to record trading losses on global structured products as it continues to exit this business. The Bank indicated that it is 50% complete in exiting this business.

Capital Market Revenue

• Capital Market revenue of $376 million is not comparable to previous quarters due to the sale of TD Waterhouse U.S.A. and the fact that TD Ameritrade earnings are accounted for on an equity basis (i.e. one line).

• Full service brokerage and other securities services revenues of $242 million increased 5% YOY but were down 5% QOQ due to a decline in M&A and underwriting revenues.

Unrealized Security Surplus at $706 Million

• Security gains were $82 million or $0.07 per share compared with $58 million or $0.05 per share in the previous quarter (excluding a $52 million balance sheet restructuring charge at TD Banknorth and including $17 million loss on merchant banking portfolio) and $47 million or $0.04 a year earlier.

• Unrealized security gains remain high at $706 million but were down from $806 million in the previous quarter.

TDCT Earnings Increase 16%

• Canadian Personal and Business (TDCT) earnings increased 16% YOY to $465 million driven by strong loan growth.

• Revenues at TDCT increased 10% YOY while non-interest expenses increased 7%.

• Average loan growth was very strong at 10% YOY while average deposits growth was 7%.

• Insurance revenue growth was modest at 6% YOY in comparison to YOY growth rates in the 20% range in the past two quarters.

• Loan securitization revenue declined $28 YOY ($0.03 per share) and $20 million ($0.02 per share) sequentially to $72 million with lower securitization activity and lower securitization gains due to the spike in interest rates.

Canadian Retail NIM Declines 3 Basis Points QOQ

• Canadian retail net interest margin (NIM) declined 3 bp QOQ but increased 3 bp YOY to 2.98% due to mix shift in volume growth toward lower margin real estate secured lending products.

TD Banknorth Earnings Under Pressure

• U.S. Personal and Business (TD Banknorth) earnings were $59 million, a decline of 9% QOQ due to margin compression and higher expenses for merger related and restructuring charges and the Hudson acquisition.

• Net interest margin at TD Banknorth declined 13 basis points QOQ to 3.83%.

Significant Growth in Wealth Management Earnings

• Wealth management earnings, including the Bank's equity share of TD Ameritrade increased 54% YOY and 10% QOQ to $152 million.

Canadian Wealth Management

• Canadian Wealth Management earnings increased 28% YOY to $133 million.

• Mutual fund revenue was $156 million in the quarter with mutual fund assets under management (as reported by IFIC) increasing 22% YOY to $49.8 billion.

TD Ameritrade

• U.S. Wealth Management earnings of $39 million reflect TD's equity share in TD Ameritrade's earnings. Adjusting for the one month timing lag, earnings were $14 million or $0.02 per share higher. TD Waterhouse U.S.A. earnings were $33 million in Q1/06 and $11 million in Q2/05.

Operating Leverage High at 4%

• Operating leverage was high at 4% with total revenue increasing 8% YOY to $3.2 billion while non-interest expenses (excluding amortization) were relatively controlled, increasing 4% YOY to $2.0 billion.

LLPs Low at 19 Bp

• Specific loan loss provisions (LLPs) were $76 million (excluding a $60 million general allowance reversal) or 0.19% of loans compared with $97 million or 0.24% of loans in the previous quarter.

• We are reducing our 2006 LLP estimate to $375 million or 0.23% of loans from $450 million or 0.28% of loans.

Gross Impaired Loans Remain Low

• Gross impaired loans declined to $349 million from $365 million in the previous quarter. Net impaired loans were negative $942 million versus negative $993 million in the previous quarter.

TD – Ownership of TD Ameritrade at 39.4% from 32.5% at Deal Close – Board Seat Retained

• TD Bank continued to invest in its two main U.S. businesses, TD Ameritrade (AMTD) and TD Banknorth (BNK), in the second quarter.

• TD invested a further US$263 million in AMTD, purchasing 12.9 million shares at an average price of US$20.42 per share, increasing its ownership to 34.3% as at April 30, 2006 from 32.5% as at January 31, 2006. Subsequent to the end of the second quarter, TD has purchased 28.4 million shares at an average price of US$18.09 per share for US$514 million, increasing its ownership in AMTD to 39.4%.

• TD announced on February 22 that it intended to purchase up to 15 million shares or 2.5% of AMTD stock by August 15, 2006, and that it aimed to own 37.5% of AMTD by January 2007. TD has already increased its ownership to 39.4%, well ahead of January 2007, allowing TD to keep the one board seat.

TD – Modest Additional Investment in TD Banknorth

• TD’s additional investment in BNK was modest in the second quarter at US$27 million or 0.8 million shares purchased in the open market. TD also acquired an additional 0.9 million BNK shares through BNK's dividend reinvestment program. These transactions results in TD increasing its ownership in BNK to 56.2% at the end of the second quarter from 53.5%, aided by BNK net repurchases of 8.5 million shares of its own stock.

• On April 13, BNK announced the acquisition of Interchange Financial Services Corp. of New Jersey for US$480.6 million cash. The deal is to be financed mainly through the sale of 13 million BNK common shares to TD Bank.

VFC Inc. Acquisition

• As at May 15, TD had acquired 99.99% of the outstanding common shares of VFC Inc, a provider of automotive purchase financing and consumer instalment loans, for a total consideration of $328 million.

Earnings Estimates Unchanged

• Our 2006 and 2007 cash earnings estimates are unchanged at $4.60 per share, and $5.10 per share, respectively.

• Our 12-month share price target is $75, representing 16.3x our 2006 earnings estimate and 14.7x our 2007 earnings estimate.


• 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.

The Globe and Mail, Richard Blackwell & Sinclair Stewart, 26 May 2006

Toronto-Dominion Bank's strong Canadian wealth management and retail banking operations drove a 22-per-cent profit increase in its second quarter, but investors were apparently not satisfied as the company's shares lost ground yesterday.

With share profit coming in a few cents below what analysts had predicted, TD stock fell almost 2 per cent just after the earnings release, closing the day down 1.3 per cent or 83 cents to $61.

TD Bank chief executive officer Ed Clark acknowledged the results were slightly short of expectations, but he described the numbers as "strong and consistent with our view that we are positioned to outperform. Particularly, we see our results in 2006 at the upper end of our 7- to 10-per-cent [growth] range, and we see a very strong 2007," he said on an analyst conference call.

TD's profit was $732-million in its second quarter, compared with the previous year's $599-million. TD made $1.01 a share, compared with 86 cents a year ago.

On a cash basis, a measure that analysts use to forecast results, TD delivered profit of $1.09 a share, about 4 cents less than what Bay Street had been expecting.

It was no surprise that there was a negative reaction from the market, analyst James Keating of RBC Dominion Securities Inc. said, partly because the bank has been the top performer in the sector in the past month

He said TD's core businesses still seems healthy, "just not as robust as we had been predicting."

Jason Bilodeau of UBS Securities Canada Inc. described the results as "a bit light" but he, too, remains optimistic about the bank, characterizing it as "one of the better growth outlooks in the group."

TD's wealth management business, buoyed by the inclusion of its stake in brokerage TD Ameritrade, showed the greatest growth in the quarter, with profit rising 54 per cent to $152-million. Revenue was boosted by "strong markets, which generated higher transaction revenue and higher mutual fund fees," the company said.

The Canadian personal and commercial banking business had a profit jump of 16 per cent to $465-million. The two revenue streams in this business -- interest income and fees -- appear to be growing strongly, the bank said.

Profit from personal and commercial banking in United States was $59-million -- dramatically higher than the $19-million earned the year earlier. However, last year's numbers included only one month's results from TD's acquisition of Portland, Me.-based TD Banknorth, which closed in that quarter.

Mr. Clark suggested that one of the reasons that analysts' estimates were slightly above the actual numbers is that it is complex to determine the impact of the U.S. operations, where the company has made a number of acquisitions. "There's a lot of moving parts in us right now," he said. "So we maybe have to give a little more hint here as to what's going on."

Still, the company is particularly pleased with TD Ameritrade's results, he said. With the expanding Banknorth operations south of the border, "you'll see growing U.S. earnings from us."

TD has just finished its purchase of shares of the TD Ameritrade operation, and now has an ownership stake of 39.5 per cent.

Investment banking was one of the weakest parts of TD's business, with profit of $140-million in the first quarter, down about 7 per cent from a year earlier. One reason for this, Mr. Clark said, is that the company is getting out of the derivatives business more quickly than it expected, taking more wind-down expenses and trading losses than expected.

The bank's provision for credit losses was down to $16-million in the second quarter from $20-million in the year-earlier period. The bank reduced its general allowance for losses by $60-million.

Loan losses are now at "historically low levels," chief financial officer Colleen Johnston told the analysts on the conference call.


AP, 25 May 2006

The Toronto-Dominion Bank Thursday posted a 22 percent jump in profit for its latest quarter, but the results fell short of Wall Street's expectations.

Shares of Canada's second-largest bank dropped 64 cents, or 1.2 percent, to U$54.73 in afternoon trading on the New York Stock Exchange.

The Toronto-based bank reported earnings of 738 million Canadian dollars (U$658 million) or 1.01 Canadian dollars (U$90 cents) a share from 599 million Canadian dollars, or 86 Canadian cents a share, a year earlier, the bank said.

Adjusted earnings were 780 million Canadian dollars (U$695 million), or 1.09 Canadian dollars (U$97 cents) a share, for the second quarter ended April 30, compared with 672 million Canadian dollars, or 1 Canadian dollar a share, a year earlier.

Analysts polled by Thomson Financial had been expecting second-quarter earnings, excluding items, of 1.13 Canadian dollars (U$1.01) a share.

Revenue grew 10 percent from a year ago, to 3.12 billion Canadian dollars (U$2.8 billion). Expenses rose 7 percent over the year and 1 percent in the quarter.

Genuity Capital analyst Mario Mendonca noted that the bank has long been considered Canada's retail deposit leader, so a drop in its net interest margin in its Canadian retail operations from one quarter to another may have disappointed investors.

Michael Goldberg of Desjardins Securities said investors may be worried about the increase in expenses, as well as the bank's move to release 60 million Canadian dollars (U$53 million) in general loan provisions. That move added 5 Canadian cents (U$4.5 cents) to the bottom line and slightly reduced its surplus allowance.

Income from Canadian personal and commercial banking rose 16 percent from a year earlier to 465 million Canadian dollars (U$414 million), but was down 2 percent from the previous quarter.

The U.S. personal and commercial banking segment, which includes the TD Banknorth Inc. unit, reported revenue gains on the acquisition of Hudson United Bancorp in February, but margins fell by 13 percent from the first quarter and deposits declined after the impact of Hudson is stripped out. Expenses in the U.S. banking unit rose by 17.7 percent from a year ago, mostly reflecting restructuring charges and the Hudson acquisition.

TD Banknorth, which is based in Portland, Maine, had weaker earnings this quarter because of the conditions in the U.S. banking market, Toronto-Dominion said.

Wealth management net income, which includes the bank's investment in TD Ameritrade, soared a record 54 percent to 152 million Canadian dollars (U$136 million).
The Globe and Mail, Roma Luciw, 25 May 2006

Toronto-Dominion Bank reported a 22 per cent rise in second-quarter profit driven by domestic consumer banking and wealth management operations, but its shares dropped after results missed analyst expectations.

TD, Canada's second-biggest bank by market capitalization, said Thursday that profit attributable to shareholders climbed to $732-million or $1.01 a share in the three months ended April 30 from $599-million or 86 cents a year ago.

On an adjusted basis, TD earned $1.09 a share in the second quarter. Analysts polled by Thomson First Call were calling for a profit of $1.12 a share.

Shares of TD fell $1.30 or 2.1 per cent to $60.53 in Toronto on Thursday. The stock has edged 1.l per cent higher so far this year.

Profit at the bank's wealth management division jumped 54 per cent to a record $512-million, amid surging trading volumes and solid sales of mutual funds. TD said strong domestic markets generated "higher transaction revenue and higher mutual fund fees."

TD's Canadian consumer banking unit saw its profit rise 16 per cent to $465-million in the quarter.

Profit at the TD's U.S. personal and consumer banking business climbed to $59-million from the $19-million it reported last year, when TD Banknorth results were not fully included. However, the U.S. operation's earnings were lower than in the previous three quarters.

TD's operations south of the border consist of both its U.S. banking arm, TD Banknorth, and its 39.4-per-cent-owned brokerage business, TD Ameritrade Holding Corp. In April TD increased its U.S. presence, buying Interchange Financial Services Corp. of Saddle Brook, N.J., for $481-million (U.S.) in cash.

Profit at the bank's investment banking arm was also weaker, dropping 6.7 per cent to $140-million (Canadian).

”While investors tend to focus on TD's U.S. strategies, it's important not to overlook a solid domestic platform that appears to be performing relatively well in a competitive environment,” Jason Bilodeau, an analyst at UBS Canada, wrote in a note.

He described the overall quarter as ”a touch light” but better than Bank of Montreal's Wednesday morning results. "TD continues to grow and gain share in domestic wealth management, an under-appreciated element of the domestic story in our view,” Mr. Bilodeau said.

BMO' surprised investors by saying it would pay out as much as 55 per cent of its annual profit in dividends and raising its quarterly dividend by 17 per cent yesterday, a move that analysts suggested could put pressure on other Canadian banks to follow suit.

TD's provisions for credit losses in the second-quarter dropped to $16-million from $20-million a year ago and from $114-million in the previous quarter. The second quarter 2006 provisions included a $60-million reduction of the bank's general allowance.

Return on common equity fell to 16.5 per cent from 17.2 per cent a year ago.

Ed Clark, the bank's chief executive officer, said TD's goal was to consistently grow per-share earnings by between 7 and 10 per cent.

”We're doing that this year and we expect to do that next year,” he said in a statement.

TD left its quarterly dividend unchanged at 44 cents a share.

Power Financial Cashes Out Bertelsmann Stake

The Globe and Mail, Bertrand Marotte, 26 May 2006

The Desmarais family's Power Financial Corp. and European partner Frère Group have cashed out of their jointly held 25-per-cent stake in global media titan Bertelsmann AG, leaving Power Financial with a gain estimated at about $450-million on an investment made five years ago.

The deal, announced yesterday, also means that Desmarais family-controlled Power Financial no longer has a seat at one of the world's largest media companies whose holdings include dominant book publisher Random House and a half-stake in the powerhouse Sony-BMG music partnership.

Brussels-based Groupe Bruxelles Lambert (GBL) and Bertelsmann -- based in Guetersloh, Germany -- said in a joint press release yesterday that Bertelsmann is buying back GBL's 25.1-per-cent stake for about $5.8-billion (U.S.).

Power Financial is a partner, through subsidiary Pargesa Holding SA, in GBL with Frère Group. Power Financial is, in turn, part of holding company Power Corp. of Canada. Both are based in Montreal.

Paul Desmarais, the 79-year-old Sudbury-born financier who built up Power Corp. over the past 40 years, has for more than two decades been a business partner with Belgian billionaire Albert Frère, head of Frère Group.

In 2001, they turned over their 30-per-cent stake in European television company RTL Group to Bertelsmann in exchange for a 25-per-cent position in the privately held German media giant, founded in 1835 as a publisher of hymn books.

GBL became the sole outside shareholder of Bertelsmann, controlled by the Mohn family.

GBL announced this year that it intended to exercise its option to publicly list -- any time beginning at the end of May -- its stake in Bertelsmann.

The move forced Bertelsmann to decide on a course of action: either agree to an initial public offering -- firmly opposed by family matriarch Liz Mohn -- or buy back the GBL stake. It chose the latter.

The buyback is effective July 1.

The $5.8-billion price tag was reported to be at the high end of the market's expectations.

Power Financial's effective interest in GBL works out to 13 per cent, and rough, preliminary calculations put its share of the gain of about €2.4-billion on the sale at about $450-million (Canadian).

Power Financial's key holdings include insurance provider Great-West Lifeco Inc. and mutual fund giant IMG Financial Inc.

The sale of the Bertelsmann stake leaves GBL focused on investments in four European industrial companies: oil and gas behemoth Total SA; utility and energy giant Suez; industrial minerals and building materials conglomerate Imerys; and cement producer Lafarge SA.

How CIBC Got Caught Up in Enron's Wake

The Globe and Mail, Sinclair Stewart, Paul Waldie, with files from Andrew Willis, 25 May 2006

Two-and-a-half years ago, not long before Christmas, 2003, a group of lawyers and officials from Canadian Imperial Bank of Commerce filed into a Washington, D.C., conference room to meet with representatives of the U.S. Justice Department.

The two sides had come together to discuss a possible settlement over CIBC's alleged involvement in the demise of Enron Corp., although “discuss” would probably be the wrong word.

“It's a little bit like a game of chicken,” one U.S. source explained. “They know that we really don't like to indict public companies, and we know that they don't want to be on the brink of that indictment.”

They, being CIBC and its nervous executives, also knew who carried the bigger stick. To no one's surprise, the bank folded first, agreeing to an $80-million (U.S.) settlement with both the Justice Department and the U.S. Securities and Exchange Commission. This was a mere precursor to the record $2.4-billion CIBC paid last summer to settle a class-action lawsuit by aggrieved Enron investors.

Yesterday's guilty verdicts against the disgraced energy trader's founder, Kenneth Lay, and its former chief executive officer, Jeffrey Skilling, provide some closure to one of the most costly business collapses in history. Roughly $60-billion worth of Enron's stock market value was vaporized, as were $2.1-billion worth of pensions and 5,600 jobs. Yet with the crush of scrutiny on the individual convictions, it's easy to lose sight of the sheer breadth of devastation left in Enron's wake.

This damage filtered across the Canadian border, affecting the reputations of some of the country's biggest financial institutions, and shaking the foundations of CIBC, in particular, which was one of Enron's top lenders.

The bank has since rebounded, of course. Its former CEO, John Hunkin, resigned unceremoniously last fall, and was replaced by Gerry McCaughey, who has pared down the bank's risk profile. Corporate governance policies have been given more teeth, senior management ranks have been overhauled, and the balance sheet is regaining its health. But the effects still linger.

“The Enron fallout is now embedded in CIBC culture,” said one former employee of the bank. “They're afraid of ever getting into that kind of situation again. It brought a profound change in the way the organization looked at risk, at doing business in the United States. It influenced the type of leaders the bank embraced.”

Toronto-Dominion Bank and Royal Bank of Canada, who were also targeted by investors for their dealings with Enron, have set aside hundreds of millions of dollars in legal reserves, but have not yet settled the class-action suit. They could face litigation unless they do so by this fall. Investors claim that a number of the world's largest banks abetted a massive accounting fraud at Enron, helping the company to disguise its debt and artificially inflate profit. TD and RBC have denied any wrongdoing, and none of the allegations have been proven.

Nick Le Pan, the federal superintendent of financial institutions, was involved in the settlement negotiations between CIBC and the U.S. authorities, but played down any idea that Enron threatened the stability of Canada's big banks.

“Enron was a huge bankruptcy that did not cause direct financial harm to the banking system,” he said in an interview.

CIBC shareholders, however, certainly felt the pain: The bank's settlement with Enron investors represented more than 20 per cent of the bank's entire book value at the time, and caused more than a bit of nervous hand-wringing in the company's board room.

CIBC became involved with Enron in 1991 when it participated in an underwriting for a British power project that was co-owned by the Houston-based energy company. Over the next eight years, CIBC was involved in nine other Enron financings.

The bank's relationship with the company became much closer in 1999, at the invitation of Andrew Fastow, Enron's hot-shot chief financial officer. At the time, Mr. Fastow was already something of a legend on Wall Street for transforming Enron from a pipeline operator and into a global energy giant.

Enron designated CIBC one of its “Tier 1” banks in January, 2000, sparking celebration inside the bank, according to court filings.

In an e-mail at the time sent to several bank officials including Mr. Hunkin, Billy Bauch, then managing director of CIBC World Markets' oil and gas group, congratulated his own team on obtaining the designation.

But he noted that along with the prestige came “the burden and responsibility of participating in certain unattractive transactions.” CIBC officials have said the comment related to low-margin business and not to anything improper.

25 May 2006

Cdn Banks: Global Leaders in Total Returns Over 5 Years

The Globe and Mail, Sinclair Stewart, 25 May 2006

Canadian banks may complain about losing relevance on the world stage, but it's hard to see how this has hurt their investors. The banking industry here has posted a total return of 15.5 per cent annually over the past five years, the best performance of any country in the world, according to a study by the Boston Consulting Group.

The study, to be released today, says that Canada's Big Six banks have found ways to create shareholder value by looking inward, rather than outward, and fine-tuning their operations in what is a very mature market. Despite suffering through tighter margins in their retail business, the result of both fierce competition and a low interest rate environment, four of the largest Canadian banks reported record profit last year.

They managed this in large part by streamlining their management structures, cutting costs, dramatically reducing their risk profiles, and focusing on new products with higher profit margins, according to the study. They were also helped by a robust economy that has witnessed a stock market rebound and a boom in house purchases.

The findings appear to challenge conventional wisdom that Canadian banks need scale to be competitive. The current restriction on mergers may have limited their ability to keep pace in terms of scale with larger peers to the south, but has done little to curb profitability.

"Even though Canadian banks have historically had lower multiples than banks in the United States, the Canadian institutions have not only managed to catch up, but today enjoy higher valuations, on average, than their peers south of the border," the study noted.

Indeed, U.S. banks ranked a distant fifth in the total return rankings, at 5.8 per cent, a figure that includes both stock appreciation and dividend payouts between 2001 and 2005. Australia finished second, at 14.3, and France was third, at 13.8. Britain was in eighth spot, at 4.7 per cent.

Three of Canada's Big Six banks, meanwhile, were ranked among the world's top 10 stock-market performers in this period, based on risk-adjusted total returns to investors. Bank of Nova Scotia was third, at 11 per cent, Royal Bank of Canada, spurred by its stock market revival, was fifth at 8.3 per cent, and Bank of Montreal was eighth, at 6.4 per cent.

Canadian Imperial Bank of Commerce finished 10th in a separate mid-capitalization category, at 5.9 per cent.

For 2005, alone, Canadian banks collectively finished seventh, with a total return of 25 per cent. On a return-on-equity basis -- a key yardstick of banking profitability -- the domestic industry was ranked fifth, at 15.7 per cent.

Big Six ahead of the pack

Canada's banking industry has posted the best performance of any country in the world over the past five years, according to a Boston Consulting study

* * *

Total annual shareholder return^ (2001-2005)

• Canada 15.5
• Australia 14.3
• France 13.8
• Japan 9.1
• U.S. 5.8
• Switzerland 5.6
• Spain 4.8
• Britain 4.7
• Italy 2.6
• Germany 0.9

^ Total shareholder return comprises capital gains and dividend yields. All TSRs were calculated in local currencies

* * *

Top 10 large-cap performers (2001-2005)

• Bank of America 14.2
• Sberbank 11.5
• Bank of Nova Scotia 11.0
• Wachovia 10.0
• Royal Bank of Canada 8.3
• Lehman Brothers 7.4
• Société Générale 6.7
• Bank of Montreal 6.4
• HBOS 6.3
• BNP Paribas 6.2

Note: the sample comprises the 50 largest banking companies by market capitalization as of the end of 2005. Risk-adjusted relative total shareholder return.

Sources: Thomson Datastream & BCG Analysis

The Globe and Mail, Allan Robinson, 25 May 2006

The heavyweight Canadian banking sector continues to roll out its second-quarter results today after several weeks of declining share prices, and the latest results could bolster the group at a time when cyclical sectors of the stock market are getting crushed, strategists say.

On tap for today is Toronto-Dominion Bank. The bank is a "unique growth situation among Canadian banks" because of its U.S. exposure, said Michael Goldberg, an analyst with Desjardins Securities.

Much of the growth is expected to be generated by both its U.S. banking arm, TD Banknorth, and its 38-per-cent-owned wealth management business, TD Ameritrade Holding Corp., he said.

Analysts forecast TD Bank earned $1.13 a share during the second quarter, compared with $1 a year earlier, according to Thomson First Call. They forecast profit for fiscal 2006 at $4.65 a share, compared with $4.14 a year earlier. The shares closed yesterday at $61.83 on the Toronto Stock Exchange.

"One of the areas where [shares] are a good deal is the financial sector," said Jim Hall, director of research for Calgary-based Mawer Investment Management and portfolio manager for its Canadian equity fund. "The banks are a good place to be." Reporting season for the Canadian banks got under way yesterday with Bank of Montreal reporting second-quarter profit growth of 7 per cent and it increased its dividend by 17 per cent.

"BMO's dividend [increase] suggests that at least one big bank isn't overly worried about the future earnings picture," said Myles Zyblock, chief institutional strategist at RBC Dominion Securities Inc. "Domestically generated rate pressure on the banks should ease," now the Bank of Canada's has decided to stop raising rates, he said. "It is probably a good time to add positions in TSX banks in Canadian-dedicated equity portfolios."

The decline in the Canadian banking sector during the past few weeks as a result of interest rate fears and slower earnings growth has restored valuations to a more normal level at a time when the energy and diversified metal sectors look expensive on a historical basis, Mr. Zyblock said.

Among the risks facing TD Bank is its susceptibility to weakness in the U.S. dollar, according to RBC, which has an "outperform" rating on the bank and a 12-month share price target of $72. Desjardins Securities has a 12-month target of $73.50.

Although there is a potential for strong earnings gains from TD Ameritrade, under the terms of the deal in which the bank's U.S. brokerage operations were merged with Ameritrade, a discount broker, TD Bank's ownership is capped at 39.9 per cent until January, 2009, unless it bids for the entire company, said Genuity Capital Markets. TD Ameritrade is expected to account for about 6 per cent of TD's second-quarter earnings.

TD Bank began to report the results of TD Ameritrade on a consolidated basis beginning Jan. 25.

National Bank of Canada is also scheduled to report second-quarter results today and Royal Bank of Canada tomorrow.


BMO Q2 2006 Earnings

TD Newcrest, 25 May 2006


BMO reported core EPS of $1.16, after adjusting reported cash EPS of $1.25 for a significantly lower Q2/06 tax rate (23.5% versus a more normalized level of 30.0%). This result was below our estimate of $1.19 and consensus of $1.21, and down from $1.24 in Q1/06, but up from $1.09 a year ago. The quarterly dividend was increased 17% to $0.62 per share, and the payout ratio to 45-55%.


Negative. We are increasing our 2006 EPS estimate to $4.90 (from $4.85) to reflect a lower tax rate, but reducing our 2007 EPS estimate to $5.05 (from $5.15). We are also lowering our 12-month target price to $66.00 (from $72.00), but maintaining our HOLD recommendation on the stock.


Total retail banking results were weak, with cash earnings of $294 million, down from $308 million in Q1/06 and $302 million in Q2/05. We have meaningfully reduced our earnings projections for this operation. P&C Canada results were lackluster, with the division reporting cash net income of $261 million, down from $269 million last quarter (partly due to fewer days in the quarter), and down from $265 million a year ago. Solid asset growth, (average assets increased 9% year over year to $114 billion) was offset by margin compression, with net interest margins declining 6 bps sequentially to 2.52%, and down from 2.64% a year ago. Margin pressure reflected aggressive loan pricing, particularly in mortgages, in an attempt to defend declining market share.

P&C Chicagoland results were also weak, with cash net income of US$28 million down 20% sequentially and 7% year over year. The decline was driven by higher expenses to upgrade the branch technology platform, and higher origination and marketing expenses.

The investment banking group was clearly the outperformer during Q2, reporting cash net income of $245 million (closer to $217 million after adjusting for the unusually low tax rate), versus $229 million in Q1/06 and $173 million in Q2/05. Trading was a key driver of the improvement year over year. Total trading revenues were $179 million, down from $231 million in Q1/06 but up from $131 million a year ago reflecting favourable trading conditions and increased client activity in energy markets.

Wealth management results were reasonable, with the group reporting cash net income of $98 million, up slightly from $95 million in Q1/06 and $87 million a year ago. Sequentially, results reflected higher revenues in full service and direct investing. While a reasonable result, we were somewhat disappointed that earnings were not stronger, given RRSP season, and that assets under management fell.

Credit performance was still solid, with the bank’s PCL ratio increasing slightly to 0.14%, from 0.12% last quarter and 0.11% a year ago, however the increase in PCL’s does create an earnings headwind. Impaired loan formations also increased to $173 million, up from $78 million last quarter, and the highest level since Q2/04, which may indicate an end to the unsustainably low levels reported in recent years.

Tier 1 capital was 10.2% versus 10.4% last quarter, and management repurchased approximately 1.9 million.


Trading at 12.2 times 2007 earnings versus a peer group average of 11.6 times 2007 earnings, and given our reduced 2007 earnings estimates, particularly given the lack of any clear catalyst for future growth, we believe BMO is fairly valued at current prices and are maintaining our HOLD recommendation.

Justification of Target Price

Our $66.00 target price is a product of adding 90% of our fundamental target price to 10% of our acquisition value. Our fundamental target price of $60.25 is calculated by adding 50% of the $58.55 value derived from our 2007 P/E valuation of 11.6 times, to 50% of the $61.96 value derived from our 2007 price-to-book valuation of 1.99 times. Our acquisition model derives a BMO acquisition value of $78.75.

Key Risks to Target Price

We believe that the four key valuation risks specific to BMO that may prevent the stock from attaining our target price are: 1) unfavourable interest rate changes; 2) the competitive environment in the United States constraining Harris Bank’s profitability; 3) the bank making a larger than expected U.S. acquisition at premium valuation multiples; 4) the Conservative government stating they will not permit mergers and 5) a deterioration in the credit environment.

Investment Conclusion

We are unconvinced of the direction of BMO, and are concerned that relative to the other Canadian banks that earnings growth will be modest. Over a period of 2-3 years, the bank engaged in a significant cost-reduction strategy (150 bps per year reduction in the efficiency ratio was the mantra), that led to solid EPS growth, despite concurrent market share losses in the ever important Canadian domestic bank.

We believe that with the cutting done, the bank finds itself in a difficult competitive position - branches and ATMs need upgrading, more marketing spend is required, etc. We speculate that the initial trigger reaction was to cut rates to stem the bleeding, but with margins having been hurt so badly, the bank finds itself in a very difficult position.

In our opinion, a strategy to resolve the issue was not articulated. The increase in the quarterly dividend and the dividend payout ratio were eye-catching, but we do not believe the fundamentals of the bank support such a move. We have reduced our valuation multiples to reflect what we consider to be BMO’s difficult situation.

We expect the other banks in the group to report stronger results, and believe the shares of the group to be oversold.

The Globe and Mail, Sinclair Stewart, 25 May 2006

Bank of Montreal surprised investors yesterday by committing to pay out as much as 55 per cent of its annual profit in dividends, a sign of just how desperate Canadian banks have become to rid themselves of their excess capital -- and an indication of just how few places there are to spend it.

BMO announced its second major dividend increase in as many quarters, pledging to boost its quarterly payment to 62 cents a share from 53 cents, representing a 26-per-cent jump since the fourth-quarter of last year.

More importantly, though, the bank raised its dividend payout target from between 35 and 45 per cent of profit to between 45 and 55, the highest among the country's Big Five banks.

Canadian banks are notoriously cautious about toying with this range, since an aggressive increase can handcuff their ability to make future acquisitions or reinvest in their existing businesses.

Robert Wessel, an analyst with National Bank Financial, said he was surprised by BMO's dividend commitment, since it could have strategic implications for the bank when it is preparing for succession. Chief executive officer Tony Comper is expected to step down early next year and pass the reins to chief operating officer Bill Downe.

"It's extremely large and the timing is quite unusual given that there's going to be a change in CEO in the short term," Mr. Wessel said. "For better or for worse, we find it hard to imagine it doesn't limit the bank's flexibility going forward with respect to longer-term acquisition plans."

The dividend announcement overshadowed BMO's second-quarter financial results.

But it was not enough to keep the bank's stock from sliding a penny to $61.50 on what some analysts described as a weak performance.

The bank reported a profit of $636-million or $1.24 a share, a 7-per-cent improvement that was driven by stronger investment banking and wealth management results, better trading revenue, and a lower tax rate. BMO's cash profit of $1.25 a share did manage to beat consensus estimates of $1.21, but some observers suggested the number was inflated by the favourable tax rate.

The bank's flagship retail operation, however, continued to show problems, partly because of price-cutting on products like mortgages, which has undermined profit margins.

The retail bank's profit of $286-million has now slid for three successive quarters, and is at its lowest level since the end of 2004. BMO's head of retail, Rob Pearce, resigned abruptly earlier this month, and the division will be run temporarily by Mr. Downe, who told analysts during a conference call yesterday he was "optimistic" it will be able to deliver better performance.

Mr. Downe also insisted that BMO has sufficient capital on hand to continue with the bank's U.S. acquisition strategy and at the same time provide investors with a juicier dividend yield.

All of the banks have been coping with the problem of excess capital, which has only been exacerbated by declining provisions for loan losses over the past couple of years.

"Frankly, I think Canadian banks are sitting on more excess capital than any other banks in the world," chief financial officer Karen Maidment said during the call.

Ms. Maidment said the altered dividend policy has not changed the bank's plans or appetite for acquisitions.

BMO has repeatedly said it would entertain purchases of as much as $2-billion (U.S.), but yesterday bank officials emphasized they are focusing more on small to medium-sized deals in the Chicago market, where its Harris Bank subsidiary is based.

Some analysts believe the dividend payout increase is a sign BMO doesn't see anything on the horizon.

"It would seem to me that opportunities for acquisitions in the Midwest may be limited," said Mario Mendonca, an analyst with Genuity Capital Markets. "It may reflect management's perspective that acquisitions aren't in the cards, at least in the short term."

Mr. Wessel predicted the dividend move could slow the growth rate of excess capital to virtually nothing, especially now that loan-loss provisions -- one of the biggest earnings drivers recently in the industry -- begin to creep up again.

Many had expected the banks to begin revisiting their dividend plans after Ottawa announced late last year that it would increase the dividend tax credit, making dividend-paying stocks that much more enticing to investors.

Royal Bank of Canada and Canadian Imperial Bank of Commerce are currently at between 40 and 50 per cent, while Toronto-Dominion Bank and Bank of Nova Scotia (along with BMO, before its announcement) were all at between 35 and 40.

Scotiabank, which is awash in excess capital and has been the stock market laggard among its peers over the last year, is viewed as the most likely to respond with a change to dividend policy.

TD, which has had little trouble finding ways to deploy its cash through U.S. purchases, is viewed as the least likely to follow suit.

Sharing the wealth
BankDividends Paid (2005)Dividend Payout Ratio (%)Targeted Payout Ratio (%)
^ CIBC posted a loss in 2005, so the payout ratio as a percentage of earnings is not meaningful.


The Globe and Mail, Roma Luciw, 24 May 2006

Bank of Montreal reported a 7.4 per cent profit increase, hiked its dividend and raised its dividend payout ratio to the highest level among the big banks, a move analysts say could pressure its rivals to follow suit.

Early Wednesday, the Toronto-based bank raised its quarterly dividend from the previous quarter by 9 cents, or 17 per cent, to 62 cents a share. It also increased its dividend payout range by 10 per cent to between 45 per cent and 55 per cent of earnings.

"The most significant event in the quarter was the increase in the dividend and more importantly, the increase in that target payout dividend range," said Tom Kersting, an analyst with brokerage Edward Jones in St. Louis. He believes the bank's payout range is now the highest among the large Canadian banks.

"That really shows that BMO is committed to returning capital to shareholders as opposed to potentially investing it in unwise business decisions," he said, adding that he had not supported the bank's decision to pour money into its Harris Bank operations in the United States.

BMO said profit attributable to shareholders climbed to $636-million or $1.24 a share in the three months ended April 30 from $592-million or $1.16 a share a year ago.

On a cash basis, the bank earned $1.25 a share in the second quarter. Analysts polled by Thomson First Call were expecting earnings of 1.21 a share.

Shares of BMO slumped 44 cents or 0.72 per cent to $61.07 after the release of the results on Wednesday. The shares have dropped 5.4 per cent so far this year, making it the worst-performing of the big six bank stocks to date this year, outside of Bank of Nova Scotia.

UBS Securities Canada Inc. analyst Jason Bilodeau said the dividend hike puts pressure on Scotiabank to follow suit.

He said BMO's core banking may be lacking growth momentum. "Management has talked of efforts to invigorate the bank - particularly in domestic personal and commercial - but it is an outstanding issue and is likely to remain so in coming quarters," Mr. Bilodeau said.

BMO's quarterly profit was boosted by its private client group, which reported a 25 per cent rise in earnings to $96-million. The bank's mutual fund business was one of the key drivers of that rise in profit.

The other strong performer was the investment banking arm, where earnings climbed 19 per cent to $245-million.

"Investment banking group earned record net income and private client group's results were its second-best ever, surpassed only by the final quarter of last year when we recorded significant gains on sales,” BMO chief executive officer Tony Comper said in a statement.

A rise in stock trading volumes, merger advisory fees, stock and debt underwriting and mutual fund sales all contributed to the quarter's gains, offsetting slowing profit in consumer banking.

BMO's personal and commercial banking operations saw its profit slide 2.4 per cent to $286-million. The bank's corporate support group also reported lower profit of $17-million, a drop of $7-million.

BMO is the first of the large Canadian banks to report its second-quarter financial results and according to Mr. Kersting, the rest of the bank's results will likely mirror the ones investors saw today.

"We are going to see strong trading results from all of them on the back of equity markets," he said. "On the negative side, competition is high in commercial and retail banking and that is being reflected in the weaker margins."

BMO's return on equity fell to 19.1 per cent from 19.5 per cent a year earlier.

The bank said it took $66-million in provisions against specific loans, above $46-million a year ago and $52-million in the first quarter. That brings the total so far this year to $118-million, up from $89-million a year ago.

BMO said it still expects to book a total of $325-million or less for fiscal 2006.


Reuters, Frank Pingue, 24 May 2006

Bank of Montreal reported a 7 percent jump in second-quarter profit on Wednesday and upped its dividend 17 percent as strength in its investment banking arm offset a decline in its retail banking division.

Canada's fourth-biggest bank, kicking off the banking sector's reporting season, said it had a net profit of C$644 million ($575 million), or C$1.24 a diluted share, for the quarter ended April 30, up from a profit of C$600 million, or $1.16 a share, in the same period last year.

On a cash basis, Bank of Montreal said it earned C$1.25 a share, which beat expectations of C$1.20 a share, according to analysts polled by Reuters Estimates.

Revenue during the quarter rose 3 percent to C$2.5 billion, while return on equity, a key measure of financial performance, was 19.1 percent compared with 19.5 percent last year.

Bank of Montreal recorded a provision for credit losses of C$66 million in the quarter, compared with C$46 million. That brought total provisions for credit losses to C$118 million this year compared with C$89 million last year.

BMO's quarterly earnings were given a lift by its investment banking arm, which posted a 19 percent jump in profit to C$245 million. Earnings at its private client group rose 25 percent to C$96 million.

The personal and commercial banking unit weighed on earnings, however, as profit there dropped 2.4 percent to C$286 million, while profit at BMO's corporate support group dropped 29 percent to C$17 million.

"P&C banking is one of the bigger things to take out of this, which is it wasn't really all that strong and it was down for the third consecutive quarter," said Robert Wessel, an analyst at National Bank Financial.

"That's pretty key ... it's the heart of every Canadian bank and is probably taking on a greater significance in the market than the dividend increase."

Bank of Montreal also said it raised its quarterly dividend by 17 percent, to 62 Canadian cents a share.


Paul Desmarais to Hand Over Power Reins Sooner

The Globe and Mail, 25 May 2006

Paul Desmarais' plan to withdraw gradually from the affairs of Power Corp. of Canada has been accelerated in recent months, as the lingering effects of a stroke suffered a year ago force the 79-year-old Canadian business icon to hand the reins to his sons.

"He would not any more be the leading light in doing anything significant at Power," Barrick Gold chairman and Desmarais family friend Peter Munk says in an article appearing in the June issue of Report on Business Magazine, to be distributed with most copies of The Globe and Mail tomorrow and made available at globeandmail.com.

Stints in hospitals in Canada and the U.S., and an extended convalescence caused Mr. Desmarais, chairman of the executive committee at Montreal-based Power, to miss three of six board meetings in 2005. He appeared frail at Power's May 11 annual meeting in Montreal.

Although sons Paul Desmarais Jr., 51, and André Desmarais, 49, have been co-chief executive officers of Power since 1996, their father, who has a 63-per-cent voting stake, retained most of the decision-making power. During that period, companies in the Power family executed some of their biggest acquisitions, including the purchases of London Life Insurance Co., Canada Life Financial Corp. and Mackenzie Financial Corp., in addition to amassing large positions in European giants Suez SA, Total SA and Bertelsmann AG.

Paul Desmarais Sr. has made painstaking efforts to ensure the succession at Power would be a smooth one, in contrast with the uncertainty that has plagued many family-controlled corporations facing generational change. The Desmarais sons have spent more than two decades preparing for their ultimate rise to the top.

Power Financial May Get U$747 Mln on Bertelsmann Sale

Bloomberg, 25 May 2006

Power Financial Corp., which controls Canada's biggest mutual-fund firm, may receive about 585 million euros (U$747.8 million) from the sale of Groupe Bruxelles Lambert SA's 25 percent interest in Bertelsmann AG, Europe's biggest media company.

Bertelsmann today agreed to buy back the stake owned by Groupe Bruxelles Lambert for 4.5 billion euros to thwart a proposed initial public offering. Power Financial has a 13 percent "effective interest'' in GBL, the Montreal-based company's Senior Vice President Edward Johnson said in a telephone interview.

Johnson declined to comment on how much GBL paid for its Bertelsmann stake. GBL said in a release on its Web site its Bertelsmann stake has a "book reference'' of 2.10 billion euros. He also wouldn't say if Power would record a gain from the sale.

Power Financial, run by Montreal's billionaire Desmarais family, indirectly held a 3 percent stake in Guetersloh, Germany- based Bertelsmann through a European unit's ownership in GBL, Johnson said in January. The company participated in a 2001 transaction to obtain the Bertelsmann stake, he said today.

Bertelsmann, controlled by Germany's Mohn family and owner of publisher Random House and Europe's biggest broadcaster, plans to buy back the stake after Belgian financier Albert Frere, who controls GBL, said in April he might pursue a share sale to the public. The buyback will be effective July 1, Bertelsmann said.

Frere, 80, had the right to demand an IPO starting this month as part of the transaction that gave him his stake in the company five years ago. GBL first indicated on Jan. 27 it was considering a possible stock offering of its stake.


Power Corp. & the Desmarais Family

As Power Corp.'s Paul Desmarais quietly steps out of the picture, he's giving his progeny the keys to a $3.8-billion family fortune and a legacy of political clout that will be nearly impossible to maintain

The Globe and Mail Update, Konrad Yakabuski, 26 May 2006

The Desmarais family, a London Daily Telegraph reporter explained to her readers in 2004, is "Canada's equivalent of the Rockefellers or Vanderbilts." A European can be forgiven for making such an unsatisfying analogy: Lumping the Desmarais in with America's best-known dynasties of the Industrial Age is a stretch. The Vanderbilts and Rockefellers amassed (and, in the case of the former, mostly blew) their wealth and influence in the 19th and early 20th centuries. The Desmarais are nouveaux riches by comparison. The family fortune is not even 40 years old, if one chooses the 1968 takeover of Power Corporation of Canada as paterfamilias Paul's establishment consecration.

No one knows whether the Desmarais aura will outlive—for long, at least—its 79-year-old founder. The Canadian business landscape is littered with evidence that it won't. Entrepreneurs of Paul Desmarais's brilliance, charm—and, as the French say, envergure, or breadth—do not come along every generation.

Desmarais may be merely the fifth-richest Canadian—with an estimated worth of $3.8 billion (U.S.), according to Forbes—but he is without rival as the most consequential business leader of his time. He is universally admired, even if he is not unanimously loved, by his peers. Desmarais has been personally consulted by prime ministers on every major federal economic and constitutional initiative since the 1970s. Most of the time, they've taken his advice. "If you think wealth automatically makes you hugely influential, you're wrong," says Tom d'Aquino, head of the Canadian Council of Chief Executives, of which Desmarais is a founding member. "There are many examples of wealthy people who have had zippo influence on public policy because they don't have any good ideas."

Paul Desmarais has not always gotten his way. Over the years, regulators, business rivals and/or politicians stopped him from taking over a Quebec TV network, Argus and Canadian Pacific, for instance. But what impresses everyone in the business world is Power's astonishing knack for avoiding mistakes, its anti-herd mentality and, of course, its foresight.

But is the House of Power bigger than its reigning prince? No one on Bay Street has bought the company line that Paul Sr. has given up calling the shots. After all, people don't refer to sons Paul Jr., 51, and André, 49—who've technically been running Power as co-chief executive officers since May 10, 1996—as "the boys" for nothing. Besides, Paul Sr. may have ceded his executive titles to his sons, but he did not give them ownership of his stock. His 127 million participating preferred and subordinated voting shares in Power Corp. give him 63.1% of the votes and provide him with dividends of more than $85 million annually. With all that on the line, who really believes that any one of the major deals Power has done in the past decade—from buying London Life, Canada Life and Mackenzie Financial at home, to amassing major positions of influence in European giants Total, Suez and Bertelsmann—has not started and ended with the father?

If undergoing risky heart surgery in 1997 did not seem to slow down Paul Sr., a stroke a year ago has taken its toll. He's made a remarkable recovery, friends say. But for someone who is almost 80, "remarkable" is a relative term. Doubters on the Street notwithstanding, the handover of power has indeed finally, quietly, happened. "He would not any more be the leading light in doing anything significant at Power," says Desmarais's long-time friend Peter Munk, chairman of Barrick Gold. "From a succession point of view, this recent setback came at the right time. I am exceptionally impressed by those two boys—in every respect."

That the transition has scarcely been noticed is testimony to Paul Desmarais's stature as the last of the long-term planners. Nothing is done at Power without anticipating consequences decades down the road. Acquisitions are not made to please the market. While most CEOs surrendered long ago to the terrorism of short-term investors and hedge funds, the "P" in Power also stands for patient planning.

The archetypal Canadian business icon seems to enjoy cultivating ambiguity—and fear—about what happens after they're gone. (Laurent Beaudoin and Ted Rogers, come on down.) But as far back as anyone can remember, Desmarais made it known, particularly to the hired hands who might have aspired to become more, that he was grooming his boys, and only his boys, for Power. Naturally, they've turned out to be different from one another. André is a political animal, a cocksure card who, despite the comedy act, does not suffer fools gladly. Paul Jr. is the steady, erudite type, more worldly and aristocratic in demeanour than his brother, and decidedly more interested in policy than politics. If it wasn't for the finishing of these two, Paul Desmarais might have sold out long ago. Then he could have retired with his wife, the luminous, opera-loving Jacqueline, to hunt pheasants and entertain the power elite at their 75-square-kilometre Sagard estate in Quebec's mountainous Charlevoix district. But he has stuck around to mentor the boys, if not to mediate between them. "He was very lucky," says Peter Munk. "He had two boys who were not only very eager, but who have the ability. Paul built that business with an enormous capability for networking that no one in Canadian history has ever matched. And the boys got introduced to his contacts. They were educated well, they married well. And they've behaved."

But can Desmarais's grand plan to see Paul Jr. and Andy, as the second son is known to all, run the family business as an equal partnership really work? It would be a first. The three Irving boys split the empire into autonomous business units after father K.C.'s death; Érik Péladeau didn't even challenge younger brother Pierre Karl for the crown when Papa Pierre passed on; the McCain brothers left blood on the floor before their power struggle ended in a permanent split. Even Munk, an unapologetic Desmarais partisan, is skeptical. "I have a bias against kids inheriting major businesses from their parents. It becomes a self-defeating strategy," says the mining magnate, whose own children have forged independent careers. "But I bet [Paul Jr. and André] fully intend to try to do with their own kids what their father did with them. They have been brought up in this ethos."

Even starting out from that premise, it is not easy to discern what Power, sans père, might look like. The boys shun the media more than their father ever did, and declined requests to be interviewed for this story. Even though they run a publicly traded company, they seem to believe that any discussion of corporate strategy is not a matter for public consumption. "We're not very talkative," concedes a Power insider. "We just don't feel it's constructive."

Even the boys' fans are hesitant about speaking publicly, lest they say some little thing to tick them off. Several powerful and successful people—the kind you'd think wouldn't need anyone's permission—declined requests for on-the-record interviews for this story. Most of them right off the bat; others, after checking with the Desmarais. "We seek, to the extent possible, to maintain discretion, just as the Desmarais [do], whom we are delighted to have as partners and friends," Gérald Frère, whose father, Albert Frère, is the family's key European associate, wrote in an e-mail reply. "Despite our desire to be agreeable, we regret that we cannot, in this instance, grant your request."

Paul Desmarais mingles so easily with European elites that they probably sometimes forget—even though he definitely cannot—that his character was forged not in the salons and grandes écoles of the old continent but on a rump of Precambrian rock in the Canadian woods. A franco-Ontarian, Desmarais learned his English in the pool halls of Sudbury. After earning a commerce degree in French at the University of Ottawa, he got into Toronto's Osgoode Hall Law School. But he left without graduating, returning to his hometown in 1951 to rescue a struggling family-owned bus company. He married Jacqueline Maranger, a nurse, in 1953. Paul Jr. was born in Sudbury the following year; Andy came two years later, by which time the family had relocated to Ottawa. There Desmarais took over Gatineau Bus Lines, which connected the sleepy national capital and lively Hull. It turned out to be a lucrative route, especially on boozy Saturday nights. A couple more bus company turnarounds later and Desmarais had become wealthy enough to move to Westmount with his family, which had grown to four children with the births of Louise and Sophie, in 1959 and 1962, respectively.

Within a few years, Desmarais had bought control of Power Corp., a utility owner that turned itself into an investment company after the 1962 nationalization of Quebec's hydroelectricity industry. That purchase, along with the 1967 acquisition of La Presse, signalled Paul Desmarais's arrival. Yet he didn't do it for the glory. "He always got much more pleasure going home after a major deal and telling Jackie about it than he ever did making the deal itself," says Brian Mulroney, who became a Desmarais protégé as a young Montreal lawyer-in-a-hurry in the mid-1960s. "His family shaped his personality, his ambitions and his achievements. His devotion to Jackie and the children is total."

Naturally, succession planning was on Desmarais's mind. By the 1980s, the first phase of the boys' preparation was complete, and they were ready to come in-house (see "How 'the boys' were groomed for Power," page 48). They spent the decade close by their father's side, and out of the limelight. André seemed to be getting the juicier mandates. In 1984, his father named him, at only 28, CEO of Gesca Ltée— the unit that oversaw Power's newspapers—and CEO of Power Broadcasting. The following year, Power tried to take over Télé-Métropole, the forerunner to TVA, Quebec's largest private television network. Federal regulators blocked the transaction. Power subsequently set its sights on satellite TV; however, there, too, regulators set what Power considered impossible limits on its activities, and the venture was abandoned.

Still, André seemed to be the favoured son. He accompanied his father on his frequent visits to the People's Republic of China, the elder Desmarais having sensed before most of the world that there was a sleeping capitalist giant beneath the communist veneer. "A lot of effort and money was put into building this relationship [with China] knowing that there would not be any return to the shareholders of Power for a long time," says Mulroney. "But, today, Andy is probably the best-connected Canadian operating in China." Power owns 4.6% of CITIC Pacific, a massive Hong Kong-based conglomerate that invests in power generation, aviation (it's a large shareholder in Cathay Pacific Airlines) and infrastructure proj-ects in China. When Quebec Premier Jean Charest led business leaders on a trade mission to China last fall, it was André who got the VIP treatment from state officials, not Charest.

André's other job in the 1980s was overseeing Power's controlling interest in Consolidated-Bathurst, then one of Canada's largest newsprint producers and on whose board he sat with his father-in-law, Jean Chrétien. Paul Desmarais had named Chrétien a director of Connie-B, as it was known, during his exile from Liberal politics. In one of the transactions that would cement Power's reputation as the shrewdest of investors, it sold Connie-B at the height of the economic boom in 1989 to Roger Stone for $2.6 billion, a 50% premium over the company's stock market capitalization. The following year, North America fell into its worst recession since the Depression, and newsprint prices fell like, well, a stone. At the time, everyone marvelled at Power's timing. But only now, 17 years later, can one fully appreciate it. The Eastern Canadian forest industry has never fully recovered from the early-'90s recession. Today, Abitibi-Consolidated—North America's largest newsprint producer, formed out of the mergers of Abitibi-Price, Stone-Consolidated and Donohue—has a market cap of about $2.2 billion, below the price Connie-B alone fetched in 1989.

Power also saw structural change coming to the financial services industry before many others clued in. The same year it sold Connie-B, Power unloaded its controlling stake in Montreal Trust for a 23% premium. The buyer: BCE Inc., which was pursuing an ill-fated diversification strategy. The late-1980s real-estate boom had been a bonanza for the trust industry, which specialized in commercial mortgages. But the recession and regulatory reforms that removed barriers between the bank and trust businesses doomed the trust industry to oblivion. BCE sold Montreal Trust to Scotiabank a few years later, at a loss.

Without Montreal Trust, Paul Jr., it seemed, needed to find something to do. For most of the 1980s, he had toiled as vice-president, then president, of Power Financial Corp., the unit that oversaw Power's controlling stakes in Great-West Lifeco, Investors Group and Montreal Trust. Great-West and Investors were based in Winnipeg and, with solid management teams of their own, pretty much ran themselves.

In April of 1991, Paul Sr. promoted both of his sons: André became president of Power; Paul Jr. vice-chairman. "I have complete faith in the team, which includes the boys. If I dropped dead tomorrow, the boys could handle things," Paul Sr. said. But it was clear from the job descriptions that accompanied the boys' new titles that these were not equally weighted mandates. André's responsibilities did not seem to change much. Paul Jr., on the other hand, was given a special mission: Augment the family's standing on the old continent.

Paul Desmarais Sr.'s European odyssey began in the late 1970s, when the most blue-blooded of French banks, Compagnie financière de Paribas, did a reciprocal share deal with Power. Paribas bought a small stake in Desmarais's firm; Power acquired 2.3% of Paribas, enough to earn a seat on the bank's board and an introduction into the elite quarters of French business. Paribas's headquarters, off Place Vendôme in Paris, dates to the 1790s; the chairman's office was in the same room in which Napoleon married Josephine. For Desmarais, a simple French-Canadian boy from Sudbury with a passion for the history and nobility of la mère patrie, it didn't get any better than this.

However, within a couple of years of Desmarais's ascension to the Paribas board, the Socialist François Mitterand had come to power and nationalized vast tracts of the French economy, including the bank. Desmarais teamed up with fellow Paribas director Albert Frère—another self-made multimillionaire, and, as a Belgian high-school drop-out, an outsider in Parisian society. Together, they negotiated the hiving off of the bank's Swiss unit, Pargesa, from the French state. By 1990, the two men had gained control of Pargesa through a single-purpose Dutch holding company, Parjointco. Power Financial owns one-half of Parjointco, and Frère's Compagnie Nationale à Portefeuille the other half.

The Pargesa portfolio was Desmarais's ticket to respectability among the upper echelons of European society. Mitterand made him an Officer of the French Legion of Honour for "outstanding service to the Republic." The intimate 1991 ceremony at the home of the Canadian ambassador in Paris was attended by Desmarais friends including Mulroney (by now prime minister) and Maurice Druon, a lifetime member of the Académie Française—a seal of approval that Desmarais had been accepted by the French nobility. Also in attendance: Bob Rae, then Ontario's New Democratic premier.

Arriving in Paris in 1991, Paul Jr.'s task was to oversee Power's investments, through Pargesa SA, in a number of major European corporations. Handing Paul Jr. the job of managing a portfolio so close to his heart was not only a test of his elder son's abilities but also a testament to his faith in him.

Paul Jr.'s five-year stay in Paris allowed him to develop his analytical skills, his world view and his social network. On all counts, observers say, it enabled him to establish himself as the more worthy of the heirs apparent. "Paul is more mature, more solid," says a Montreal financial executive who has worked with Power. "André seems a bit insecure, always needing to make jokes." Says another source close to Power: "The big difference in the boys' training is that Paul Jr. went to Europe, where he was able to acquire a fair degree of independence and maturity. Andy, on the other hand, has always worked closely with Paul Sr., who, of course, has made all the decisions."

As of 1991, Pargesa was a hodgepodge of investments. Aside from its 17% stake in Petrofina, Belgium's largest oil company, its holdings were in companies that were all relatively minor players in their fields. Paul Jr.'s job was to work with Albert Frère and his son Gérald, now 80 and 55, respectively, to restructure the portfolio. The mandate was classic Desmarais: Sell off the non-strategic investments and build a large enough stake in a small number of big companies so Pargesa, or its 48%-owned affiliate, Groupe Bruxelles Lambert (GBL), could wield real influence over their affairs. By the time Paul Jr. returned home to Montreal in 1996, to become co-CEO of Power, he could boast of having met his father's objectives in Europe. GBL by then held almost a quarter of Petrofina, 12% of French waste and water utility Suez-Lyonnaise des Eaux and 51.6% of Compagnie Luxembourgeoise de Télédiffusion (CLT), one of Europe's largest media companies.

Each of those investments has proven to be a springboard to even more power and influence for the Desmarais-Frère partnership. Petrofina merged with Elf Acquitaine and later Total SA to form Europe's largest oil company. GBL has a 3.8% stake in Total, and Paul Jr. sits on its board. He is also a director of Suez, which in February unveiled plans to merge with state-owned Gaz de France to form a colossal utility. GBL and Pargesa together also control 54% of French building-materials concern Imerys. And earlier this year, GBL spent about 1.3 billion euros to buy 8.1% of cement colossus Lafarge SA.

As for the CLT stake, GBL swapped it in 2001 for a 25% holding in Bertelsmann AG, the German-based media and entertainment giant that includes the Random House publishing group and 50% of the Sony BMG music company. GBL's Bertelsmann stake alone is estimated to be worth at least 5 billion euros, leading to much speculation about what the Frère and Desmarais clans plan to do with the proceeds when they cash in their Bertelsmann shares in an initial public offering expected this year.

In scouting the business landscape for opportunities for the Bertelsmann cash, Paul Jr. will tap an elite network, just as the family does at home. In Europe, he can draw on not only an impressive list of CEO friends but also the many high-powered politicians and celebrities with whom he and his wife have become acquainted in Paris. Paul Jr. maintains a residence in the French capital. When there, he socializes with Bernard Kouchner, a founder of Médecins sans frontières and a former Socialist cabinet minister, and his wife, Christine Ockrent, France's version of Diane Sawyer. In France as in North America, the Desmarais are politically catholic: Nicolas Sarkozy, the French right's leading contender in next year's presidential race, became a friend of Paul Jr.'s through former prime minister Édouard Balladur, a decades-old pal of Paul Desmarais Sr.

Luc Ferry, one of France's leading philosophers and a former education minister, is one of Paul Jr.'s more intriguing connections. Ferry is an avowed atheist—he considers philosophy the "doctrine of salvation without God." Paul Jr., for his part, remains a practising Catholic. But the two men share a passion for debating life's big questions. Paul Jr. also befriended Laval University philosopher Thomas De Koninck when the two were part of a delegation accompanying then-Governor-General Adrienne Clarkson to Germany in 2001. "We discovered we had an interest in common. And it wasn't business, because I'm not very strong in that area," says De Koninck with a laugh. At Paul Jr.'s instigation, Power donated $1 million to Laval last year to fund a philosophy chair tackling contemporary quandaries, from assisted suicide to human cloning.

At the ceremony announcing the donation, Paul Jr. confessed to being "bugged" by the "cult of the individual" at the core of modern life. Ironically, one of his closest friends in France is the man considered in that country to epitomize the cult of the individual, Bernard Arnault. At 57, Arnault is France's richest man and the world's seventh-richest, with a fortune estimated by Forbes at $21.5 billion (U.S.). He first became friends with Paul Desmarais Sr. and Albert Frère when the trio served on the Paribas board. His friendship blossomed with Paul Jr. during the latter's stint in Paris, particularly after Arnault married Québécoise pianist Hélène Mercier in 1991. Arnault was then plotting the takeovers that eventually gave him control of the world's premier luxury-goods conglomerate, the LVMH Group, purveyor of Louis Vuitton purses and Moët & Chandon champagne. The marriage last September of Arnault's daughter from his first marriage, Delphine, to Alessandro Gancia, the heir to an Italian wine empire, was attended by Spanish royalty, a couple of Rothschilds, Sarkozy and the wife of French President Jacques Chirac. But only one Canadian couple got an invite: Paul Jr. and Hélène Desmarais.

On this side of the Atlantic, an invitation to Paul Jr.'s sprawling country estate on Lac Memphrémagog in Quebec's Eastern Townships is a sign of one's initiation into the rarefied circles of the rich and powerful. As out of character as it may seem, the couple hold a country-and-western themed party there each summer, and there isn't a society wannabe within a 500-kilometre radius of Montreal who wouldn't kill to be on the guest list. If you are, you're apt to bump into actor Donald Sutherland, a neighbour. Or Oscar-winning filmmaker Denys Arcand. Or former BCE chief Jean Monty, with whom Paul Jr. is building a pro-level private golf course nearby. Or Francesco Bellini, founder of BioChem Pharma and now CEO of Neurochem, which is developing drugs to treat Alzheimer's disease. Bellini and Power are joint partners in Picchio Pharma, which owns a third of Neurochem. Bellini and Paul Jr. hunt pheasants together on Île Province, the sanctuary in Memphrémagog that they jointly own. "If they were not simple people, I would not be with them," the Italian-born Bellini says of the Desmarais. "I don't like to deal with people who think too highly of themselves. I came from a poor environment, yet I feel comfortable with them."

It is no coincidence that Paul Jr. chose to build his country estate at Memphrémagog. It puts him at a comfortable distance from his father's Domaine Laforest at Sagard, which is 500 kilometres down the St. Lawrence River from Montreal. André, on the other hand, is never far from the father. He built his summer house at Sagard.

A frequent guest at André's place is Robert Charlebois, Quebec's quintessential rock star of the psychedelic era. In the 1970s, Charlebois's music became closely associated with the nationalist movement that brought the Parti Québécois to power; as a result, he has, in recent years, taken a lot of heat from Quebec intellectuals for cavorting with such unapologetic separatist-bashers as the Desmarais. Indeed, to associate with the Desmarais in Quebec, where the family's influence over business and politics is both feared and resented by many, is to risk ostracism in certain circles. Lucien Bouchard's friendship with the family made him suspect among sovereigntists and undermined his leadership of the PQ. There is widespread sentiment in Quebec—unfounded or not—that La Presse, along with Gesca's six other French-language dailies, are house organs of the provincial Liberal Party. Questioning federalism is off limits. In the last election, La Presse, always a federal Liberal supporter while Jean Chrétien ran the party, backed Stephen Harper's Conservatives. That's not surprising, according to many Quebec commentators, considering that Liberal leader Paul Martin, a former Power employee himself, was the nemesis of André Desmarais's father-in-law when he was in power.

"To say what's written on the editorial page of La Presse represents the Desmarais's thinking would be a caricature of reality," says the paper's chief editorialist, André Pratte. "As in any newspaper, the owner sets out a framework. Within that framework, we have a large degree of freedom." Pratte voted "yes" to sovereignty in both the 1980 and 1995 referendums. He is a convert to the federalist cause, however, a prerequisite for his appointment as chief editorialist in 2001.

Pratte discovered the limits of the Desmarais's tolerance back in 1994, when, as a columnist, he was demoted for a provocative missive entitled "Everything is rotten." Quoting a reader who had called him with his gripes, Pratte wrote: "Power Corp. controls everything, everyone knows that. Chrétien, [then Quebec premier Daniel] Johnson, it's Power Corp. ...Chrétien doesn't know how to read or write, and even I speak better than him. Take a trip to Shawinigan; they elected him [MP] nine times, he was a minister; it's a ghost town." La Presse's deputy publisher at the time, Claude Masson, reportedly admitted to newsroom employees that Paul Desmarais Sr. personally intervened to demand Pratte's demotion. "When you bite the hand that feeds you, there are consequences," Masson told reporters. Pratte's union, however, stood by him, and he got his column back.

Still, the sentiments expressed in Pratte's offending column strike a nerve. For the Power-controls-everything camp, it is no coincidence that executive vice-president John Rae oversaw Chrétien's Liberal leadership challenge in 1990—and his three successful election victories as PM—all from his Power perch, and that he is now the chief strategist behind brother Bob's race for the Liberal crown.

In his 1994 column, Pratte said he felt compelled to pass on his caller's conspiracy theories about Power because "there are tons of people like that. They call reporters, they're regulars on the radio phone-in shows, they vote. And also maybe because, like every caricature, this one has a basis of truth."

If there is any truth to the mantra "Power controls everything," then the boys, André and Paul Jr., have a big reputation to live up to. Luckily for them, they can count on many of their father's most trusted advisers to guide them. Power Financial chairman Robert Gratton, chief financial officer Michel Plessis-Bélair and John Rae have worked with Paul Sr. for 24, 20 and 35 years, respectively. Should the boys ever be tempted, say, to mimic Edgar Bronfman Jr., who bet (and blew) the family's Seagram fortune on an ill-fated merger with Vivendi, they would face stiff resistance from this inner circle. For better or for worse. "The boys are conscious of their limits; they know that they need to be surrounded by seasoned advisers," says the Montreal financial executive quoted earlier. "The team, and the decision-making structure it implies, prevents Power from making mistakes. But it also stops it from taking big risks, from being entrepreneurial."

Eventually, the team, like the ownership, must face generational change. Plessis-Bélair is 64, Gratton is 62 and Rae is 60. Turnover is almost non-existent at the House of Power, but there are signs of renewal among senior management. Jeffrey Orr, 47, joined in 2001 and was named CEO of Power Financial a year ago. Also in 2005, Power recruited Daniel Friedberg, 44, from Bain & Co., and gave him a vice-president's position. And Luc Jobin, 47, swapped the CEO's job at Imperial Tobacco for an executive vice-president's post at Power. This trio may emerge as the brothers' inner cabinet.

Or is that brother's? Managing a successful succession is hard enough; a bifurcated CEO's office almost certainly makes it harder. Especially if the father is no longer around to mediate. Power insiders deny there will be problems: The boys get along famously, after all. "They don't move without being ad idem," says one.

Anyway, a family feud would be, well, so bourgeois. The aristocracy does not air its laundry in public. So even if the brothers do fight, they'll do it the way Power does everything: behind several sets of closed doors. And we'll probably never be the wiser for it.