30 June 2006

Scotia Capital Upgrades Power Financial

Scotia Capital, 30 June 2006

Attractive Valuation

• We are upgrading Power Financial Corporation to a 1-Sector Outperform from 2-Sector Perform based on share price weakness, attractive valuation and expected higher earnings growth.
• PWF's share price has trended sideways for nearly two years, with earnings and dividend growth of 16% and 23%, respectively over this period.
• The last time PWF experienced such a significant period of share price weakness was from February 2001 to October 2002, immediately following Investor Group's January 2001 acquisition of Mackenzie Financial.
• PWF's valuation is attractive at 11.1x 2007E earnings versus the bank group at 11.4x. PWF's trailing P/E multiple has contracted from 15.8x to 13.4x, and its multiple point premium to the banks has declined from 1.9x to 0.3x.
• PWF's discount to NAV has increased to 11.6%, more in line with the historical mean of 14% after trading at no discount in 2004 and early 2005.
• PWF's two major subsidiaries represent excellent value, with GWO share price near its 52-week low with earnings reacceleration expected (Exhibits 10, 11) to build into 2007, and IGM share price correction of 17% from its recent highs.
• We expect strong share price performance from PWF over the next few years, driven by earnings growth rebound expected in 2007 (Exhibit 8), low valuation (Exhibit 5) and defensive characteristics (beta of 0.41).

GWO Earnings Momentum / Attractive Valuation

• Scotia Capital Insurance Analyst Tom MacKinnon upgraded PWF subsidiary GWO to 1-Sector Outperform on February 17, 2006.
• We are anticipating an acceleration of GWO's earnings growth, with year over year earnings expected (Tom MacKinnon) to be up 2% in Q2/06, 6% in Q3/06, 10% in Q4/06, and 14% in 2007, expected to be the highest of the insurance group. GWO's recent earnings have been negatively impacted by the appreciation of the Canadian dollar. GWO represents 71% of PWF's NAV and for every 10% increase in GWO share price, PWF's NAV increases 7.1%.
• GWO has a high 3.2% dividend yield, versus Manulife at 2.0% and Sun Life at 2.5%, and is currently trading at 11.7x 2007E earnings, versus Manulife at 12.7x and Sun Life at 11.3x.

GWO, IGM, Pargesa Share Prices all Down

• PWF's main holdings have all experienced share price weakness over the past year or so. GWO has trended sideways since February 2005, and IGM's share price has corrected 17% from its 52-week high. Pargesa remains the most resilient of PWF's subsidiaries, down only 8% from its 52-week high as several holdings have remained strong. Pargesa subsidiary GBL recently announced an agreement to sell its stake in Bertelsmann.


• Our 2006 and 2007 earnings estimates are unchanged at $2.50 and $2.85 per share, respectively. Our 12 month share price target is unchanged at $38 based on 13.3x our 2007 earnings estimate and 12% discount to our target NAV of $43 per share. GWO and IGM 12 month share price targets are $33 and $58, respectively.
• Upgrading to 1-Sector Outperform from 2-Sector Perform.

29 June 2006

CIBC Finalizes Deal on FirstCaribbean

The Wall Street Journal, 29 June 2006

Barclays Bank PLC said it entered a definitive agreement with Canadian Imperial Bank of Commerce for the sale of Barclays' 43.7% shareholding in FirstCaribbean International Bank Ltd.

As previously announced, CIBC will pay a price of U$1.62 per FirstCaribbean share, valuing Barclays' stake at about U$1.08 billion. The transaction, which is subject to regulatory approval, is anticipated to close in late 2006.

Barclays said that, under the agreement, CIBC has the option of paying for the transaction in cash, CIBC common shares, or a combination of cash and shares, the relative proportions of which CIBC will determine before completion. Barclays wouldn't intend to be a long-term holder of any CIBC shares it may receive in connection with this transaction.

The group said that promptly after the close of the transaction, CIBC will be required to make a mandatory offer to all shareholders in FirstCaribbean. The mandatory offer will also be at a price of U$1.62 per share. Both CIBC and FirstCaribbean have reiterated their commitment to maintaining a strong minority ownership that they expect to grow in the future.

The parties have agreed to structure the transaction in two stages, with Barclays selling 90% of its holding initially and then CIBC potentially acquiring, at Barclays option, the balance through the subsequent mandatory tender offer. The consideration represents a multiple of 17.5x FirstCaribbean's operating earnings for the year ended Oct. 31, 2005 and a multiple of 3.0x FirstCaribbean's tangible book value. Assuming a sale of 100% of Barclays stake in FirstCaribbean, the post-tax gain to Barclays on the sale is about £250 million (U$455.1 million).

CIBC will also pay an additional sum to Barclays, as well as the other shareholders who tender their shares to this offer, to reflect dividends in respect of their period of ownership prior to closing.

Group Finance Director, Naguib Kheraj, said: "This transaction leaves FirstCaribbean well positioned for its future development. While the combination of Barclays and CIBC's Caribbean retail-banking assets created value for all stakeholders, the future strategy of FirstCaribbean is now best pursued with one controlling shareholder."

28 June 2006

S&P/TSX Stocks with Highest & Lowest Average Analyst Rating

Bloomberg, Wendy Allard, 28 June 2006

The following tables show the highest and lowest average analyst ratings for stocks in the Standard & Poor's/Toronto Stock Exchange Composite Index as of June 28.

Bloomberg assigns a number to each rating that ranges from 1 to 5, with 5 being the highest recommendation. To calculate the average, these numbers are added together and the total is divided by how many recommendations were made during the past 12 months. The target price is the average of analysts' 6 - 18 months predicted price. Only companies that have at least four analyst ratings are included.

Average Total # 6/27 Target 1 Year
Tkr Company Name Rating Analyst Price Price %Return
AGA ALGOMA STEEL INC 5.000 7 33.69 40.62 65.0
CCR-U CCS INCOME TRUST-UTS 5.000 6 36.27 45.25 33.0
DDV DUVERNAY OIL CORP 5.000 9 39.04 55.93 20.5
FSV FIRSTSERVICE CORP 5.000 5 28.30 35.26 15.2
HPX HIGHPINE OIL & GAS LTD 5.000 7 18.16 28.79 -13.0
OCX ONEX CORPORATION 5.000 6 22.47 26.26 14.7
RCI/B ROGERS COMMUNICATIONS 5.000 17 45.03 58.86 14.4
SIF-U ENERGY SAVINGS INCOME 5.000 7 17.40 21.10 7.0
TDG-U TRINIDAD ENERGY SERVIC 5.000 9 17.45 22.88 44.3
HBM HUDBAY MINERALS INC 4.875 8 13.00 19.98 388.7
SVY SAVANNA ENERGY SERVICE 4.875 8 23.18 39.11 18.6
GIL GILDAN ACTIVEWEAR INC 4.833 12 48.35 64.02 53.2
PWT-U PENN WEST ENERGY TRUST 4.818 11 42.14 46.65 59.4
YRI YAMANA GOLD INC 4.818 11 9.94 15.89 128.0
T TELUS CORP 4.812 16 45.60 55.73 6.7
CPG-U CRESCENT POINT ENERGY 4.800 10 22.10 24.47 33.0
ABZ ABER DIAMOND CORP 4.778 9 35.99 48.44 -2.6
TCW TRICAN WELL SERVICE LT 4.778 9 21.05 35.98 30.7
CCL/B CCL INDUSTRIES INC - C 4.750 4 31.50 38.88 19.3
EXE/A EXTENDICARE INC -CL A 4.750 4 23.75 30.37 31.4
HR-U H&R REAL ESTATE INVSTM 4.750 8 20.40 22.80 10.9
RET/A REITMANS (CANADA) LTD 4.750 4 20.30 24.33 22.1
ELD ELDORADO GOLD CORPORAT 4.737 19 5.11 7.50 68.6
ANP ANGIOTECH PHARMACEUTIC 4.706 17 13.43 21.02 -21.7
FM FIRST QUANTUM MINERALS 4.692 13 47.00 65.50 117.4
IMN INMET MINING CORPORATI 4.667 12 38.75 52.24 143.8
PEY-U PEYTO ENERGY TRUST 4.667 6 23.00 30.00 -18.8
RRZ RIDER RESOURCES LTD 4.667 6 13.51 21.00 10.3
COM CARDIOME PHARMA CORP 4.643 13 9.40 15.63 36.8
BNP-U BONAVISTA ENERGY TRUST 4.636 11 33.60 39.37 17.0
TRZ/B TRANSAT A.T. INC-CL B 4.636 11 23.73 31.00 -4.4
VET-U VERMILION ENERGY TRUST 4.636 11 32.95 37.03 47.9
SGF SHORE GOLD INC 4.625 8 4.83 9.13 -6.6
ATA ATS AUTOMATION TOOLING 4.600 10 9.97 15.12 -39.4
RUS RUSSEL METALS INC 4.600 5 25.04 29.50 89.0
TEK/B TECK COMINCO LTD-CL B 4.600 15 62.50 88.00 58.6
YLO-U YELLOW PAGES INCOME FU 4.600 10 16.10 18.05 14.6
TD TORONTO-DOMINION BANK 4.583 12 56.44 71.67 6.1
BTE-U BAYTEX ENERGY TRUST-UN 4.556 9 22.82 24.69 85.6
FLY/A CHC HELICOPTER CORP-CL 4.556 9 26.93 32.64 10.2
AL ALCAN INC 4.524 21 49.49 70.05 33.7
IUC INTERNATIONAL URANIUM 4.500 4 5.47 8.71 -0.9
TIH TOROMONT INDUSTRIES LT 4.500 8 23.75 24.74 10.2
CNR CANADIAN NATL RAILWAY 4.474 19 47.08 57.33 34.3
SC SHOPPERS DRUG MART COR 4.467 15 41.27 49.73 -1.1
MB MEGA BLOKS INC 4.455 11 22.00 29.89 3.2
NVA NUVISTA ENERGY LTD 4.455 11 14.42 19.75 0.5
PGX-U PROGRESS ENERGY TRUST 4.455 11 15.87 18.60 30.5
FNX FNX MINING CO INC 4.444 9 10.22 16.98 -9.4
AEM AGNICO-EAGLE MINES 4.435 23 33.35 47.25 116.3

Average Total # 6/27 Target 1 Year
Tkr Company Name Rating Analyst Price Price %Return
AVN-U ADVANTAGE ENERGY INCOM 1.286 7 19.75 19.75 28.5
SCC SEARS CANADA INC 1.333 6 18.15 18.50 55.1
SBY SOBEYS INC 1.857 7 38.05 39.38 -4.1
PWI-U PRIMEWEST ENERGY TRUST 2.000 10 32.85 31.22 17.6
ROC ROTHMANS INC 2.000 4 19.25 23.25 -13.6
SPF-U SUPERIOR PLUS INCOME F 2.000 6 10.99 10.75 -61.8
TS/B TORSTAR CORP - CL B 2.111 9 20.20 24.89 -14.9
MX METHANEX CORP 2.143 7 23.40 25.47 20.4
FDG-U FORDING CANADIAN COAL 2.200 10 36.45 35.55 6.9
BLD BALLARD POWER SYSTEMS 2.250 8 6.61 5.63 12.2
BCB COTT CORPORATION 2.294 17 14.65 15.11 -45.9
QLT QLT INC 2.312 16 7.70 7.80 -38.8
CF-U CALPINE POWER INCOME F 2.333 9 9.63 9.31 2.0
LB LAURENTIAN BANK OF CAN 2.429 7 29.10 34.00 11.3
EMP/A EMPIRE CO LTD 'A' 2.500 4 43.00 41.88 15.4
PVE-U PROVIDENT ENERGY TRUST 2.500 8 13.81 13.21 19.2
AXP AXCAN PHARMA INC 2.556 9 13.79 15.53 -26.8
SHN-U SHININGBANK ENERGY INC 2.556 9 20.30 23.34 6.1
BBD/B BOMBARDIER INC 'B' 2.562 16 3.14 3.33 17.2
FFH FAIRFAX FINANCIAL HLDG 2.600 5 104.15 176.52 -47.8
KER-U KETCH RESOURCES TRUST 2.600 5 11.01 11.15 8.6
IQW QUEBECOR WORLD INC 2.636 11 11.91 12.39 -47.9
BMO BANK OF MONTREAL 2.667 12 59.10 68.95 6.7
DTC DOMTAR INC 2.706 17 6.45 7.56 -29.0
CU CANADIAN UTILITIES LTD 2.714 7 36.05 40.73 7.2
WTE-U WESTSHORE TERMINALS IN 2.714 7 10.69 10.96 -3.8
TLC TLC VISION CORP 2.750 8 5.05 7.16 -51.0
TPW-U TRANSALTA POWER L.P. T 2.750 8 8.55 8.76 -5.6
PIF-U PEMBINA PIPELINE INC-T 2.800 10 15.80 16.11 21.5
POT POTASH CORP OF SASKATC 2.833 12 92.45 102.73 -20.6
MBT MANITOBA TELECOM SVCS 2.867 15 45.59 46.36 3.0
ACO/X ATCO LTD -CL 'I' 3.000 4 34.49 39.25 1.0
AGF/B AGF MANAGEMENT LTD-CL 3.000 8 19.55 26.31 20.7
APF-U ALGONQUIN POWER INC FU 3.000 7 9.60 10.11 1.7
BNQ-U BELL NORDIQ INCOME FUN 3.000 10 16.94 17.60 -1.8
CAR-U CAN APARTMENT PROP REA 3.000 10 15.80 16.74 13.1
CLC-U CML HEALTHCARE INCOME 3.000 6 14.00 14.33 10.0
CM CAN IMPERIAL BK OF COM 3.000 12 74.00 90.19 0.0
CWI-U CONSUMERS' WATERHEATER 3.000 4 13.67 15.88 -8.6
DHF-U DAVIS + HENDERSON INCO 3.000 6 17.37 20.75 -12.9
EEE-U ESPRIT ENERGY TRUST 3.000 5 11.75 12.50 12.6
EP-U EPCOR POWER LP 3.000 10 33.48 33.81 -2.5
GCD GREAT CANADIAN GAMING 3.000 8 11.47 13.72 -43.1
GMP-U GMP CAPITAL TRUST 3.000 4 22.51 27.50 87.4
HUM HUMMINGBIRD LTD 3.000 9 30.60 31.72 13.3
ITW INTRAWEST CORP 3.000 7 34.49 38.77 18.5
MAE MIRAMAR MINING CORP 3.000 5 4.10 5.25 203.7
MTL-U MULLEN GROUP INCOME FU 3.000 6 28.10 37.10 42.6
PAA PAN AMERICAN SILVER CO 3.000 6 18.44 31.55 3.1
PGF/B PENGROWTH ENERGY TRUST 3.000 12 25.78 23.80 55.7
PTI PATHEON INC 3.000 8 7.37 6.89 -18.6
RYG ROYAL GROUP TECHNOLOGI 3.000 5 12.40 13.97 -6.8

UK Banking: An Island of Profitability

Profit from the structural advantages that banks enjoy in this market.

Morningstar, Ganesh Rathnam, 28 June 2006

When the government sets up a commission to study the abnormal profitability of a certain industry, there's a good chance that industry has an entrenched economic moat. Such a study was set up by the U.K. Treasury in 1998 to study the extraordinary profitability of U.K. retail banks. That study, completed by Don Cruickshank in 2000, suggested several measures that would transfer some of that profitability from banks' coffers back to its customers, including individuals and small-and-medium enterprises. According to a paper by Jonathan Ward, some of the measures suggested include making it easier for customers to switch banks, limiting service bundling (Microsoft anyone?), providing information on competitors' products and services, and making mandatory minimum interest payments to business account deposits. Despite these potential profit-reducing recommendations and the global downturn of 2000-02, profitability at U.K. banks is back to pre-2000 levels.

An Oligopoly

As my colleague Jim Callahan pointed out in an earlier article, we believe that nearly all banks have an economic moat. And, in our opinion, banks such as Lloyds TSB, Barclays, and Allied Irish Banks have wider economic moats than the average U.S. bank because they possess large market share within their country's oligopolistic banking markets.

Arguably, size provides a huge competitive advantage in consolidated markets. Unlike the fragmented U.S. market, five banks dominate the U.K. (Lloyds TSB, Barclays, HSBC Bank, Royal Bank of Scotland, and Halifax Bank of Scotland) and four banks dominate Ireland (Allied Irish Banks, Bank of Ireland, National Irish Bank, and Ulster Bank), controlling well over 80% of market share. Counterintuitively, net interest margins are about 1 percentage point lower than the average of U.S. banks. Deeper analysis suggests that while these banks don't compete with each other on price, the net interest margins' low level prevents new entrants from earning an economic profit while maintaining the incumbent banks' high profitability. In other words, these dominant players seem to exercise their oligopoly powers tacitly to prevent new competition from breaking into their market.

In fact, we think that in a regulated industry such as banking, firms in a consolidated market have to try hard not to have a wide moat. We would hesitate to confer wide moat ratings only if banks with a dominant market presence failed to leverage that advantage to consistently generate economic profits or there was evidence of irrational competition among the existing banks. Neither of these is a factor when examining the U.K. market.

Product, Service, and Relationship-Based Banking

The U.K. and Irish banks have built high switching (or inconvenience) costs for customers by focusing on product, service, and relationship-based competition rather than price-based competition. Banking infrastructure plays a big hand in shaping the competitive dynamics. Unlike the U.S. market, banks in the U.K. and Ireland have nationwide platforms. A customer switching cities or counties in the U.K. need not switch banks as would a customer of TCF Bank moving to San Francisco. Unsurprisingly, customer churn rates are in the low to middle single digits, and market-share figures tend to stay constant over time. In addition, all these banks have heavily invested in customer relationship management software that helps banks gain "wallet share," industry speak for selling multiple products to a single retail customer. For example, an average Lloyds' customer buys 2.5 out of a possible 7.5 retail products from Lloyds.

Aside from basic retail and commercial banking products, each of these banks has other businesses that meet customers' needs. Lloyds has Scottish Widows, the third-largest insurance and pension provider in the U.K. Barclays has a credit card operation, an investment-banking arm, and an asset-management arm, providing financial products to supplement plain-vanilla checking accounts, savings accounts, mortgages, or corporate loans. Empirical evidence suggests that the more products a customer owns from a single bank, the less likely that customer is to switch banks.

These banks seem to realize the futility of competing with each other on price (by raising deposit rates or lowering loan rates). Instead, they primarily compete for customers by offering services and managing relationships. For example, Allied Irish Banks has about 1,600 relationship managers with a portfolio of retail or business customers, and each manager is compensated based on increasing the profitability of his portfolio. Moreover, Allied Irish Banks has agreements with universities to be the sole bank on campus. The bank then forms a relationship by offering student loans and continues a banking relationship with those individuals well after they've graduated, possibly acquiring customers for life.

Too Big to Fail

Despite regulators' concerns with these banks' profitability, there may not be much that regulators can do about it. Banking stability is crucial to maximizing an economy's growth. Banks need public confidence in their solvency to operate smoothly and prevent runs on deposits. Deposit insurance takes care of this problem, essentially by forcing taxpayers to subsidize bank failures. Therefore, banks and their shareholders inherently face a moral hazard: If they take a huge risk and it pays off, they win; if not, taxpayers lose. As the U.S. savings and loan crisis of the mid-1980s suggests, the combination of competition and deposit insurance may not be such a hot idea. Why deregulate and encourage outsized risk-taking by banks, putting the whole economy in jeopardy? Having banks earn economic profits while monitoring their risks might be the lesser evil.

In aggregate, the leading banks in the U.K. and Ireland control more than 80% market share in their respective countries. In contrast, Bank of America, the largest retail bank in the U.S., controls only about 10% of the deposit market. In the event of failure of one of these U.K. or Irish banks, the cost to the economy and taxpayers would be staggering, not to mention unintended consequences of triggering a liquidity crunch and causing other banks to fail if one goes under. Therefore, it is in the best interests of regulators to ensure that these banks don't fail.


We believe that the above three factors mainly account for the extraordinary profitability of Lloyds TSB, Barclays, and Allied Irish Banks. Over the past five years--a period that has included economic shocks and major stock market downturns throughout the developed world--returns on equity have remained solid. Lloyds has averaged a 20.5% return on equity, Barclays 17%, and Allied Irish Banks 19.7%. More importantly, we believe that these three banks will continue to see outsized profitability for years to come. Anytime these stocks trade at a discount to our fair value estimates, we think that it's wise to seriously consider an investment.

27 June 2006

TD Ameritrade Technical Glitch

TheStreet.com, Marc Lichtenfeld, 27 June 2006

TD Ameritrade encountered a serious technology glitch last week: Legacy TD Waterhouse customers had difficulty obtaining online access to their accounts for three days. I should know: I'm one of those TD Waterhouse customers.

After growing frustrated with the inability to access my account and long waits to reach a customer service rep, I realized the outage could put the company in jeopardy of missing their numbers or seeing a wave of defections from their newly acquired Waterhouse clients.

Spokesperson Kim Hillyer said that although the problem would naturally affect trading revenue, the company is "still within guidance." On April 24 , the company raised EPS guidance by 3 cents for fiscal 2006, which ends Sept. 30, to 94 cents. Wall Street has taken a more conservative view with a consensus estimate of 91 cents. Nevertheless, the sell side is bullish, with 10 analysts rating the stock a buy and only two holds.

Although analysts remain enamored with TD Ameritrade and potential investors may be wooed by a roughly 30% drop in share price over the past month, it's best to wait before getting involved with the stock, which was recently down 3.5% at $14.78. TD Ameritrade operates in a fiercely competitive business that is increasingly commoditized. Customers won't tolerate technical problems, and last week's glitch only further complicates the company's efforts to transition itself from its historic reliance on active traders.

In order to facilitate its goal of being a more diverse wealth manager, the company acquired TD Waterhouse in January, inheriting over 2.2 million accounts in the process and raising the firm's total to over 6 million accounts. One of the plums of the deal was the fact that Waterhouse was the third-largest player in the Registered Investment Advisor segment.

Brokers and financial planners who are not employees of a brokerage can choose where they want to house clients' accounts. These types of accounts are desirable, as the advisors tend to bring in large amounts of assets at once, and TD Ameritrade hopes to increase that part of its business.

But "everyone is courting money managers," says Lauren Bender, analyst with research and consulting firm Celent. "While [TD Ameritrade] should be, too, they need to differentiate themselves. Otherwise, what's their angle?"

The new company also has a focus on what it calls the "mass affluent"-- customers with less than $1 million in investable assets -- offering financial planning products and guidance for do-it-yourself investors who are focused on the long term.

But herein lies the problem. How does the company go about building up these new segments while maintaining the resources necessary to feed the beast that is its active-trader business? TD Ameritrade has 25% of the marketshare for online trades, according to the company. That's an impressive figure, certainly, but one that becomes worrisome in the face of falling commission rates and the commoditization of trading.

While the company undergoes its transition, trading volumes will be critical to meeting the Street's expectations. Average client trades per day have picked up in fiscal 2006. Trades have averaged over 220,000 per day during the current fiscal year, far exceeding last year's average of 156,000 and averages from the past four years.

Those figures were aided considerably by the Waterhouse acquisition, but it's important to remember that in this high fixed-cost business, additional trades are highly profitable. That also means the inverse is true. If traders and investors become discouraged with the market, trading volume could fall, hurting revenue and profitability. While TD Ameritrade is taking steps to remedy the situation, the company's performance still depends largely on active trading and the direction of the stock market.

In the wake of last week's technical problems, CEO Joe Moglia apologized to customers and the company said it is making amends on a case-by-case basis, but generally is offering free trades to investors who were affected by the outage.

The problems were unusual, because Ameritrade has a history of successful integration of acquisitions, including Datek in 2002 and JB Oxford in 2004. Celent's Bender was surprised at the technology issues. "In meetings with analysts, they boast about how good their integration of acquisitions is, so they have some explaining to do," she says.

Bender believes that if the company handles the situation well, it will be a nonevent. Both Wall and Main Streets will be watching closely for signs of any future integration problems. If any arise, don't be shocked to see investors head for the exits even before the customers.

TD Ameritrade is a solid company with very capable leadership. But good companies don't always go hand in hand with good stocks. Ameritrade is in that position. While slightly undervalued on a price-to-earnings basis compared to its peers, it is significantly overvalued based on P-E-to growth, price to book and price to sales bases, as the chart below illustrates.

Of the four companies in the above table, TD Ameritrade has the highest long-term debt-to-equity ratio, at 138.6%, followed by E*TRADE with 137.4%, Schwab at 11.1% and OptionsXpress, which is free of debt.

If the stock were cheap, I'd consider taking a shot, because Moglia and his team have a good track record. But with valuation concerns and an uncertain future, investors may be better off trading with TD Ameritrade rather than owning it.


Manulife Continues to Gain Share in US VA Market

Scotia Capital, 27 June 2006


• U.S. variable annuity (VA) quarterly (Q1/06) industry stats were released late last week.

What It Means

• While MFC continues to gain market share and positioning in terms of both U.S. VA sales and assets, the same cannot be said for SLF.

• SLF's heavy investment (we estimate $10 million) in expanding U.S. variable annuity distribution is expected, as per management, to bear fruit in 2006. We remain somewhat sceptical.

• SLF continues to be a "show me" story, while MFC, in our opinion, is already there and then some. We remain somewhat sceptical as to SLF's ability to significantly increase market share in the highly competitive U.S. variable annuity market.

• That said, we expect MFC's valuation premium to SLF (MFC is currently at a 14% premium on a NTM P/E multiple, up from 10% three months ago and 7% six months ago, well above its historical average of 6%) is more likely to remain at current levels, or perhaps modestly contract, rather than expand going forward, as we expect the exceptional rate of top-line growth in Manulife's U.S. business to moderate somewhat going forward.

MFC continues to gain share in US VA market, SLF continues to lose ground

• U.S. variable annuity Q1/06 industry statistics were released late last week.

• While Manulife continues to gain market share and positioning in terms of both sales and assets, the same cannot be said for Sun Life. Manulife's market share and positioning in variable annuity sales continues to climb, up from 6.0% in 2005 to 6.4% in Q1/06, with market positioning increasing from #7 at the end of 2005 to #5 at the end of Q1/06 (and up from #8 as at Q3/05). Despite efforts to ramp up distribution and improve product, Sun Life's market share in terms of U.S. variable annuity sales, at 1.0%, has not moved in the last four quarters, remains below its 2004 level, and well below 2001-2003 levels. Market positioning fell from #19 in 2005 to #20 in Q1/06. In terms of assets, the company's market share continued to decline (from #17 and 1.32% at Q4/05 to #18 and 1.29% at Q1/06), as negative net sales for the insurer continue to hurt asset growth. The big continue to get bigger in U.S. variable annuity, and cracking the top 10 in terms if assets and/or sales is becoming increasingly difficult in this business.

• Sun Life's heavy investment (we estimate $10 million) in expanding U.S. variable annuity distribution is expected to bear fruit in 2006 - we remain somewhat sceptical. The company notes that there is a lag before the impact of the 50 wholesalers recruited over the last 12-15 months begins to significantly impact the bottom line. We remain somewhat sceptical. Furthermore, net sales continue to be negative, and at negative US$926 million in 2005 and negative US$178 million in Q1/06, are well below top ten players such as Manulife (at positive US$4.6 billion in 2005 and positive US$1.2 billion in Q1/06), Lincoln (at positive US$3.7 billion in 2005 and positive US$1.1 billion in Q1/06), and Prudential (at positive US$1.4 billion in 2005 and positive US$0.6 billion in Q1/06).

• Manulife's exceptional U.S. VA sales growth is likely to return to more "normalized" levels for Q3/06 and Q4/06. At the company's recent Investor Day (June 13, 2006) management indicated that the 61%, 63% and 60% sales growth in U.S. variable annuity for Q1/06, Q4/05 and Q3/05, respectively, would likely not be sustainable, for two reasons. One, we are close to approaching a year following the May, 2005 launch of the Second Generation Product, the highly successful VA product that drove the growth, and two, other competitors have now copied the product to various degrees. We would expect the company to maintain market position and share (#2 in the non-proprietary channel) until its next new product launch, which we anticipate could be late 2006 or early 2007. We also expect that going forward the exceptional gains in market share experienced of late, aided by new found momentum post the Hancock close, will more likely be harder to duplicate.

• MFC premium to SLF less likely to expand going forward, and may have peaked, as we expect Manulife's U.S. sales growth to return to more "normalized" levels. We expect the valuation spread between MFC and SLF (MFC is currently at a 14% premium on a NTM P/E multiple to SLF, up from 10% three months ago and 7% six months ago, well above its historical average of 6%) to no longer significantly expand as we expect the exceptional rate of top-line growth in Manulife's U.S. business to moderate somewhat going forward.

UBS Canada Shuffles its Large-cap List

The Globe and Mail, Angela Barnes, 27 June 2006

UBS Securities Canada Inc. has added three stocks to its list of 12 recommended Canadian large-capitalization issues and dropped three. Canadian Natural Resources Ltd. and TransCanada Corp. were put on the list in the energy sector, replacing EnCana Corp. and Suncor Energy Inc., and Royal Bank of Canada joined the financials, replacing Canadian Imperial Bank of Commerce.

The other nine stocks on the list are Petro-Canada in the energy sector, Alcan Inc. and Goldcorp Inc. in materials, Bank of Nova Scotia, Sun Life Financial Inc. and Toronto-Dominion Bank in the financials and Canadian National Railway Co., Rogers Communications Inc. and Shoppers Drug Mart Corp. in the "other" category.

George Vasic, UBS Securities Canada strategist, said in a report that "the market's recent decline has changed the pecking order in some sectors, and so we are using the opportunity to rotate into some laggards."

Canadian Natural Resources has been the worst performer among the energy issues included in the S&P/TSX 60 issues so far this quarter. It is one of analyst Andrew Potter's top picks, has the highest projected return in his area of coverage as measured against his price target and is attractive for its oil sands exposure and potential for a new rating, Mr. Vasic said. TransCanada is analyst Andrew Kuske's top pick for its exposure to the Ontario power market. Moreover, it has had the poorest showing year to date among the TSX 60 energy issues, is defensive and yet still offers a potential return of 25 per cent if it reaches to the projected price target.

RBC has moved up in analyst Jason Bilodeau's ranking, "having both a more reasonable valuation and a platform that is running extremely well on multiple fronts," Mr. Vasic said.

The stocks included in the list of 12 have done considerably better than the TSX 60 itself -- with a cumulative gain of 52.9 per cent since inception in September, 2004, compared with the 36-per-cent advance for the TSX 60 over the same period.

OECD Calls for Action on Bank Mergers

The Globe and Mail, Sinclair Stewart, 27 June 2006

The Organization for Economic Co-Operation and Development is warning that Canada's effective ban on bank mergers could be hampering the country's productivity, and is urging Ottawa to remove the political red tape that has been choking the industry's efforts to consolidate.

The OECD, which released its recommendations yesterday as part of a larger economic survey of Canada, is the latest in a long line of groups that have stepped forward declaring the need for an improved merger process in the financial services sector.

Bank of Canada chairman David Dodge has speculated that the dormant merger file could be partly to blame for the industry's weak productivity growth. An internal government report, prepared for recently appointed Finance Minister Jim Flaherty, came to a similar conclusion, as did an April study on service exports conducted by the Conference Board of Canada.

The OECD said the best option is to eliminate the Minister of Finance's role in approving mergers, as a means of depoliticizing the process. Failing that, it recommended the Finance Department issue a clear set of guidelines that the industry could rely upon to form their proposals.

"Either way," the organization wrote, "the ongoing uncertainty is preventing possible efficiency gains from being explored and needs to be resolved."

So far, however, all of this pro-merger agitation has fallen upon deaf ears. Mr. Flaherty has insisted that the merger file is not a priority for Prime Minister Stephen Harper and his Conservative government. Indeed, a recent white paper on financial services legislation made no mention of the issue; nor did it tackle the equally slippery subject of bank-insurance mergers, in keeping with a pre-election promise by Conservatives.

After seeing their merger hopes dashed in 1998, and then again in 2002, and then again in 2005, you'd think bankers may have finally accepted defeat. Not all of them. There is a growing optimism in some quarters of Bay Street, however cautious, that Stephen Harper is well-positioned to win a majority government if there is an election early next year. Some influential bank executives believe Mr. Harper is ideologically sympathetic to the industry's merger ambitions, despite the populist bent of his caucus, and that with a majority hold on Parliament he would be willing to deal with the merger file early in his tenure.

"Whether it's the 30th fire drill since the year 2000 is irrelevant," one bank official said yesterday. "You'd better be ready to get the people out of the building. You can't afford to not be ready: If there is a shot here, it will likely be relatively quick and decisive."

A chief executive officer at one of the country's big banks echoed this opinion, and predicted the merger file will be rekindled in the fall if Mr. Harper appears headed for a majority victory at the polls. Bank sources say it would take between one and two months to cobble together a proposal for Ottawa. Bank of Montreal, whose merger plans with Bank of Nova Scotia were privately quashed by Ottawa a few years ago, is still seen as the most attractive and likely takeover target.

The OECD report, meanwhile, suggested that Canada's capital markets would also benefit from a standardization of securities regulation: an effort that rivals the merger debate for lack of progress. The organization noted that Canada has taken some steps to harmonize rules, but suggested it should also look to consolidate its patchwork regime of provincial and territorial regulators.

26 June 2006

Cdn Bank & LifeCo Week's Review

RBC Capital Markets, 26 June 2006

Excellent Time to Overweight Banks

Last week, the 10-year GoC bond yield moved up 20 basis points to 4.61%. At current bond yields, the sector forward P/E multiple of 11.9x remains below the 12.5x level predicted by our 25-year regression model. The group is now at an 8% discount to our target P/E of 13x forward EPS, offering an excellent entry point, in our opinion. Presently, investors can buy the banks at less than 11.5x estimated 2007 EPS. Alternatively, the current forward P/E of 11.9x equates to a yield level of ~5.00% according to our model. Banks tend to gain/lose ~1 P/E multiple for every 50bps decrease/increase in 10-year yields.

Lifecos Also Compelling

In our view, the Life insurers continue to offer excellent medium-term growth prospects, excellent dividend yield growth and continued solid capitalization. Lifeco earnings are, however, more pro-cyclical than the banks and trade on less volume, so the stocks may act just slightly less defensively.

Our P/E-to-Bond Yield valuation model indicates a 15x target P/E for lifecos under the same interest rate scenario as we have assumed for banks. Canadian lifecos are currently trading at 12.7x consensus forward earnings, just a 7% premium to the banks, and well below their 13% premium since demutualization. In our view, the lifecos offer excellent value, particularly if conditions hold with the current range of higher sustained interest rates, which are supportive of insurers’ product margins and volumes.

Share Buybacks Lift for Lifecos

MFC and SLF repurchased 11.1 million and 4.3 million shares respectively in the month of May. The repurchase activity was significantly higher than the historical monthly average (since 2003) of 2.9 million for MFC and 1.0 million for SLF. MFC’s buybacks represent ~11% of its program, while SLF bought ~15% of its program in the month of May. GWO was less active, buying back only 168,000 or ~6% of the program. IAG did not repurchase shares last month.

The Canadian banks were less active with respect to share buybacks in May. BMO was the only bank buying back stock last month, 1.2 million shares or ~8% of its program. The remaining banks with programs were not active last month - BNS, NA and RY. As a reminder, CIBC and TD do not currently have share repurchase programs in place.

CIBC Litigation Jitters Resurface

While the Global Crossing lawsuit poses a risk to the stock, we believe it is fairly well contained at this point. CIBC shares were weaker last week on news the bank is being hit with a lawsuit from the estate of Global Crossing Ltd. However, the bank indicated that the lawsuit adds no new claims against CIBC relative to an action filed in 2004; rather it seeks to add some CIBC affiliates. CIBC’s January motion to dismiss the claims is still pending, with no clear time frame for the decision. The bank maintains general legal reserves and believes they are adequately provisioned. Litigation is a sore spot for CIBC investors, as the bank is still licking wounds caused by a $2.8B settlement last August for its part in an Enron class action suit.

24 June 2006

TD Banknorth Names Masrani President

Financial Post, Duncan Mavin, 24 June 2006

Toronto-Dominion Bank is dispatching a seasoned Canadian executive to beef up the management team at Portland, Me.-based TD Banknorth as the U.S. subsidiary focuses on growth despite tough conditions for banking.

Intense competition for customers and unfavourable trends in interest rates have made for a hostile retail-banking environment in the United States, especially around Banknorth's northeastern stronghold.

At the same time, Banknorth is still trying to swallow the acquisition of Interchange Financial Services Corp. and Hudson United Bancorp bought earlier this year for a total of almost US$2.5-billion. It is also reported to be actively pursuing further growth, including potential acquisitions next year.

"The deals have definitely come faster than we thought," said Ed Clark, TD's chief executive. "But it's also fair to say that the economic environment in the U.S. has turned out to be more hostile."

That scenario has left the management team at Banknorth, led by chief executive Bill Ryan, trying to do several tasks at once, Mr. Clark said.

But yesterday, Banknorth announced it has recruited Bharat Masrani, a 19-year TD veteran, as the new president of the subsidiary.

Mr. Masrani will focus on running day-to-day operations at Banknorth, Mr. Clark said. His appointment will enable Bill Ryan, Banknorth's chief executive, to concentrate on integrating recent acquisitions that are ahead of schedule, he said.

Mr. Masrani said the challenges facing Banknorth are common to all banks in the U.S. northeast.

Deposit rates paid to Banknorth customers were driven up 30 basis points by interest-rate hikes in the first quarter of 2006. However, the rates charged on loans were held back by competition in the U.S. lending market, rising only 13 basis points in the period and compressing net interest rate margins.

Banknorth reported disappointing results in the first quarter of 2006, delivering adjusted earnings of US$115.6-million, compared with US$111.8-million for the first quarter of 2005. On a per-diluted-share basis, adjusted earnings were US55 cents for the first quarter of 2006, compared with US60 cents a year earlier.

Banknorth has already responded to the "hostile" banking conditions by, for example, introducing a "no ATM fees" card for customers in New Jersey, Connecticut, Pennsylvania and metropolitan New York, home to Hudson United.

And in April, the bank announced a US$25-million advertising push intended to garner more market share for its U.S. businesses.

Mr. Masrani is currently chief risk officer of TD. He has also been a director of Banknorth since 2005, a position he will now leave. His tenure in that role gave TD the flexibility to introduce additional management resources at Banknorth, while Mr. Masrani was able to learn more about the business there, Mr. Clark said.
The Globe and Mail, Sinclair Stewart, 24 June 2006

TD Banknorth Inc. chief executive officer Bill Ryan is "borrowing" a senior official from parent Toronto-Dominion Bank so he can concentrate on making acquisitions in the northeastern United States.

Bharat Masrani, currently vice-chairman and chief risk officer for Toronto-based TD, will head to Portland, Me., this fall to become president of TD Banknorth, where he already serves as a director. He is being parachuted into an operations role and will assume day-to-day responsibilities for the bank's retail, commercial, investment and insurance businesses.

Mr. Ryan, whose penchant for deal making over the past 15 years has transformed Banknorth from a bit player in New England into a leading regional bank, will now focus on what he does best: hunting for deals that will allow TD to further its cross-border push.

One of the things TD stressed when it bought control of Banknorth for $5-billion was the quality of that bank's management team. Nevertheless, there did not appear to be any successors within the bank who could slide into the president's role and run the operations.

"I think Bill is saying 'I could try to do two things at one time, but I don't think that's smart,' " explained Ed Clark, TD's CEO. "The debate is, if there isn't a natural person to fill that job right now in Banknorth, does he go outside, or does he essentially borrow an executive from us? And he said, 'Why don't I borrow that which I've seen and liked . . . and maybe over the next three or four years develop someone inside."

They debated this point for some time. TD has repeatedly talked about the need for strong local management in the U.S. market, and Mr. Clark conceded there would have been a "big attraction" in hiring an official from a competing U.S. bank to fill the void. At the same time, he said, it may have stunted succession plans at TD Banknorth: Mr. Masrani is expected to return to Canada at some point, which will give him time to groom the next president of the bank.

"From our point of view, it means we take one of our top executives and say you have already been there, done that," said Mr. Clark. "And as these operations get bigger and bigger as a share of our earnings, having executives at TD Canada that have been in the U.S. becomes a huge asset."

Mr. Masrani, 50, has had a varied career at TD. He headed corporate banking in Canada, established an operation in India, and ran the bank's British discount brokerage subsidiary.

However, he is heading south amidst a difficult climate for smaller U.S. banks. The flattening yield curve has squeezed the spreads these lenders depend upon to generate their profit. That, along with fierce pricing competition, has hurt TD Banknorth's bottom line and made it less of an immediate contributor to TD than many investors had hoped.

The less-than-ideal conditions only exacerbated the need to provide Mr. Ryan with additional support, Mr. Clark said, especially if he wants to continue expanding the bank.

"I think it is fair to say that the operating challenges for Banknorth are definitely more elevated now, given both the environment they're operating in, and the speed with which we're transforming it," he said. "This job is getting bigger and bigger as we grow the bank."
The Globe and Mail, Tavia Grant, 23 June 2006

TD Banknorth Inc. on Friday named Bharat Masrani as president of the bank, adding a new role to its management team.

Mr. Masrani, currently chief risk officer at TD Bank Financial Group, will assume the position in the fall and report directly to William Ryan, chairman and chief executive.

“I am delighted to have an executive with the breadth of Bharat's experience join our exceptional management team here at TD Banknorth,” Mr. Ryan said in a statement.

The move will allow Mr. Ryan to focus on making acquisitions, he said.

“With the increased size and complexity of our company, adding Bharat to our organization will assist me in managing the day-to-day operations of the company and will allow me to continue to actively pursue growth opportunities and acquisitions.”

Mr. Masrani joined TD Bank Financial in 1987 and has served in a number of international management positions in commercial, corporate banking, and global wealth management. He is currently a vice chair and the chief risk officer and has been a director of TD Banknorth since 2005.

In a separate release, TD said it will work over the coming months to find a replacement for Mr. Masrani.

22 June 2006

TD Ameritrade Technical Glitch

The Wall Street Journal, Gaston F. Ceron, 22 June 2006

Changes intended to improve TD Ameritrade Holding Corp.'s online-trading Web site instead led to a technical glitch that prevented a number of customers from logging on to their brokerage accounts.

The changes, made over the weekend, were aimed at the "legacy" clients from TD Waterhouse, an online broker that was acquired recently by Ameritrade, said Kim Hillyer, a spokeswoman for the Omaha, Neb., company.

Ameritrade wanted to change the way the clients logged on to the Web site, to make it "more secure," but in so doing ran into "some technical problems," she said.

These problems locked an unspecified number of clients out of their accounts. Ms. Hillyer said Ameritrade has put in place "some fixes," but that it isn't yet "a complete solution." She said the company continues to work on a permanent resolution to the problems.

"Obviously, it's our top priority," Ms. Hillyer said.

Judging from Internet message-board comments, Ameritrade's problems have left some clients fuming. The company saw calls into its client-services team spike, and Chief Executive Joe Moglia has apologized to clients "who experienced a long wait this week" when telephoning the company.

"Today, the calls and wait times have improved considerably," Ms. Hillyer said. She also noted that clients can access Ameritrade in other ways, such as by dropping by a branch office.

The glitch is a black eye to Ameritrade's integration of Waterhouse. Problems after acquisitions aren't unheard of in the online-brokerage industry, as E*Trade Financial Corp. some months ago also stumbled in its integration of Harrisdirect, with higher call volumes hitting E*Trade and customers facing long wait times.

Cdn Discount Brokerage Industry

The Toronto Star, Tara Perkins, 22 June 2006

The online discount brokerage industry has been more successful than many people anticipated, says the head of TD Waterhouse discount brokerage in Canada.

A darling in the late 1990s, the industry was pummelled by the bursting of the tech bubble, and took years to pick itself up and brush the dirt off.

At the peak of early 2000, online retail traders accounted for nearly one-third of the trading volume on the NYSE and Nasdaq. That figure remained at about 10 per cent from 2002 to 2005, according to a report by consulting firm Celent.

But John See, president of TD Waterhouse discount brokerage, argues that there is evidence that assets in self-directed accounts held up as well as, if not better than, assets in accounts managed by advisers.

And now, the firm's trading volumes, assets under administration and deposits all significantly exceed even the peak periods of 2000, he said.

According to Investor Economics, assets in the retail online discount brokerage industry in Canada rose from $123 billion last March to $155 billion this March.

Over the same period, assets with full-service brokers rose from $547 billion to $644 billion.

Now, as the baby boomers push into retirement, a growing number of investors with both time and money on their hands will ensure the industry's future success, See said.

"For the wealth-management industry in general, the prospects are extremely strong in the next several years," he said. Within that, he expects self-directed investing will grow at a quicker clip.

The size of TD Waterhouse's asset base has increased more than 30 per cent over the past two years, See said.

Connie Stefankiewicz, president and chief executive of BMO InvestorLine, said both the number of clients and the assets coming in have increased over the past six months.

The industry's average client is about 45, male, and highly educated, she said. There is a larger proportion of entrepreneurs and self-employed individuals.

There's still a perception that online traders are day-traders, but "that's not the reality today," Stefankiewicz said. "The vast majority of clients of online brokerages are long-term investors."

The price of trading for long-term investors — those who don't trade often — has remained fairly steady for the past few years, Stefankiewicz said, at about $25 to $30 per trade.

But the price for active traders, who make more than 30 trades per quarter, has fallen to about $9.95 or $10 per trade, she said.

While American investors have traditionally benefited from the massive scale of U.S. online discount brokerages, in Canada, "pricing and commission rates for active investors have come down to the rates that were only available in the United States until about a year ago," See said.

Active traders are a lucrative market segment, according to Celent. They not only trade more frequently, but have higher than average balances and trade on margin more than other investors.

While fees are important to active traders, "with the commoditization of trading, it is imperative that firms stay competitive in the advice and guidance area if they want to provide a compelling offer to the majority of retail investors," Celent said in its report.

"It is a very competitive market because clients are very demanding," said Stefankiewicz. "We are continually looking at opportunities to enhance our site," she added.

Focus is shifting beyond tools and resources to guidance and validation, she said. Not advice, but good information.

See said that "every single day, some new things are coming on board."

As Celent put it, "to the creative go the spoils."
Merrill Lynch analyst Andre-Philippe Hardy upgrades TD Bank from Neutral to Buy.;

21 June 2006

Cdn Banks Q2 2006 Review

Scotia Capital, 21 June 2006

Bank Valuation Compelling Historic Low Beta Reiterate Overweight Banks


• Banks reported better-than-expected second quarter earnings with growth of 16% year-over-year. Bank earnings resilience and momentum has exceeded market expectations for the past three years.
• Second quarter earnings were led by RY with 24% earnings growth followed by BMO 16%, and NA 14%. TD and CM lagged the bank group with earnings growth of 9% and 10%, respectively. TD and CM earnings reflect weak wholesale banking results with CM further suffering from revenue erosion.

What It Means

• Bank valuations are now compelling as opposed to attractive on a yield basis versus bonds, pipes & utilities and income trusts after the recent correction.
• Bank P/E multiples peaked in February at 15.1x trailing and now have retraced to 13.1x. One year betas for banks are at historical lows of 0.39.
• Reiterate 1-Sector Outperform on RY and 3-Sector Underperform on BMO and CM.
• Reiterate Overweight Banks recommendation based on superior dividend growth, strong fundamentals, compelling valuation, and low relative risk.

Banks Second Quarter Overview

Earnings Resilience

Second Quarter Earnings Yield 16% Growth

• Banks reported better-than-expected second quarter earnings with growth of 16% year-overyear. Bank earnings resilience and momentum have exceeded market expectations for the past three years.
• Second quarter earnings were led by Royal Bank (RY) with 24% earnings growth followed by Bank of Montreal (BMO) 16%, and National Bank (NA) 14%. Toronto-Dominion Bank (TD) and Canadian Imperial Bank (CM) lagged the bank group with earnings growth of 9% and 10%, respectively. TD and CM lower earnings growth reflects weak wholesale banking results with CM further suffering from revenue erosion.
• In terms of the small capitalization banks, Laurentian Bank's (LB) earnings continue to recover, increasing 35% with Canadian Western Bank's (CWB) earnings growth of 33% led by loan and deposit growth of over 20%.
• Second quarter earnings performance was driven by strong growth from wealth management and wholesale banking with solid retail bank earnings. Retail volume growth and cost containment offset a weaker retail net interest margin. The banks’ retail net interest margins (NIM) weakened a moderate 3 basis points (bp) in the quarter. Royal Bank (RY) reported the strongest NIM with a 3 bp expansion.

Retail and Wealth Management – Earnings Growth Solid

• Domestic retail and wealth management earnings were solid in the quarter, with a growth rate of 10%. RY was by far the outperformer with a 16% growth rate. TD, NA, and BMO reported solid year-over-year growth in the 8%-10% range, with CM trailing at 7%.
• Retail net interest margin weakened 3 bp in the quarter. BMO and CM had NIM declines of 5 bp, NA and TD had 3 bp declines. RY recorded the best margin performance with a 3 bp increase.

Retail Volume Growth Strong

• Retail earnings moderated slightly due to declining net interest margins and aggressive pricing. Retail loan volume growth remained strong at 8% with personal deposit balances up 3%. Retail productivity improved considerably across the group, especially at RY, and BMO.

Wealth Management - Important Earnings Driver

• Wealth management continued to be the major earnings driver in the second quarter. Unfortunately, only three banks (BMO, NA, and TD) currently segment these earnings. RY stopped reporting this business separately in Q1/05, CM in Q4/05, and BNS has never disclosed this breakdown.
• Earnings growth from domestic wealth management at BMO (excluding U.S. segment results), TD, and NA was solid at 31%, 28%, and 23%, respectively. Domestic wealth management revenue growth was strong at RY at 20%, TD at 17%, BMO at 13%, and NA at 7%.
• Mutual fund revenue for the bank group was up 19% year over year with 36% growth at RY, 19% at BMO, 14% at NA, and 12% at CM. We believe wealth management is a major contributor to the strength of RY’s underlying earnings.

International Banking

• Grupo Scotiabank (formerly Inverlat) contributed $124 million or $0.13 per share in Q2, an increase of 46% from $85 million or $0.09 per share a year earlier. Overall, international represented 32% of Scotiabank's total cash earnings in the quarter.

Wholesale Banking Earnings

Strong at RY and BMO; TD and CM Underperform

• Wholesale earnings for the bank group increased 18% year over year with RY up 49%, and BMO up 44%. Wholesale earnings declined 3% at NA, 15% at TD, and 21% at CM.
• Wholesale banking earnings were very strong in the quarter at RY and BMO with strong trading revenues, strong underwriting (BMO) and M&A activity (RY), and lower effective tax rates.
• TDSI wholesale banking performance was weak with earnings declining 15% YOY and 30% sequentially. If security gains were excluded, TD's wholesale earnings would have declined 40% sequentially. Trading revenue was particularly weak at TD, declining 21% from a year earlier versus an increase of 28% for the other major banks, due in part to losses associated with TD's exiting its global structured products business.
• CIBC World Markets earnings declined 21% YOY and 7% sequentially due to revenue erosion. Underwriting and advisory fees declined 30% YOY.

Trading Revenue Strength Indicator High - 114%

• Trading revenue for the bank group was $1,547 million, up 16% year over year. The trading revenue strength indicator (Exhibit 3, Column 10) was strong at 114% of the average of the past eight quarters led by RY at 137% followed by BMO at 123%. RY experienced record trading revenue growth of 42% year over year, while TD lagged significantly with a 21% decline in trading revenue. Excluding TD's results, trading revenue was up 28% YOY for the bank group.

Capital Markets Revenue Strength Indicator 102%

• Capital markets revenue was $2,162 million, up 5% sequentially and flat year over year. The capital markets revenue strength indictor (Exhibit 3, Column 11) was neutral at 102% with RY and BMO at 114% and TD trailing at 85%. BMO led the bank group with a 16% sequential and 8% year over year increase in capital market revenue with RY experiencing 15% growth sequentially and 6% YOY. CM lagged significantly, down 10% QOQ and 15% YOY.

Loan Loss Provisions Stable and Low

• Loan loss provisions (LLPs) remain low, as they have retreated to lower levels than anticipated by the market, and we expect them to remain lower for longer than market expectations. LLPs were $486 million in the quarter, up 11% from a year earlier but still benign at 0.21% of loans.
• In terms of the individual banks, BNS recorded the best LLP performance at 7 bps, followed by BMO and NA both at 18 bps and TD at 19 bps. CM LLPs remain high at 46 bps given its large credit card portfolio and large unsecured personal loan portfolio.
• We have reduced our loan loss provisions estimate to $2.1 billion in 2006 from $2.4 billion versus $2.1 billion in 2005, at a very modest 23 bp loss level. The reduction in our loan loss provisions forecast in 2006 is based on lower than expected LLPs driven by continued recoveries in the second quarter with consumer loan loss provisions remaining stable. Our 2007 LLP forecast is also relatively benign at $2.9 billion or 0.29% of loans.

Excellent Profitability – RRWA – ROE

• The bank group reported the second strongest quarter in history (behind Q1/06) in terms of profitability, with return on risk-weighted assets (RRWA) of 2.05%, and only the third quarter ever to be over 2.00%.
• TD holds a substantial lead in terms of profitability based on this measure with RRWA of 2.34%, followed by RY at 2.25% and BMO the laggard at 1.71%. We believe that TD’s and RY’s retail and wealth management platforms provide a competitive advantage, which is reflected in their higher profitability. However, we believe that TD's profitability is more at risk due to heavy reliance on TDCT and the disappointing performance in its wholesale operation and earnings weakness at TD Banknorth.
• Return on equity for the bank group in the second quarter was strong at 21.6% on extremely high capital levels. RY led the bank group in ROE at 23.3% with CM ROE of 24.3% aided by additional leverage. RY's ROE was supported by strong results across all business lines.

Earnings Growth Forecast for 2006 Bumped to 11.5% from 10.4%

• Our earnings growth forecast for 2006 increased to 11.5% from 10.4% due to the stronger than expected results reported in the second quarter.
• Bank earnings growth has been more resilient than market expectations for the past three years, with growth of 21% in 2003, and 16% in both 2004 and 2005. Earnings growth is expected to slow in 2007 to 10%.

Dividend Increases Continue – BMO Raises Target Payout Ratio

• Our longer-term outlook is for earnings growth in the high single-digit/low double-digit range, with dividend growth in the low to mid-teen levels, and with the dividend payout ratio expected to expand towards 50% as per our thesis in Four Decades of Dividend Growth published in March 2002.
• Dividend increases remain frequent and consistent. Banks have consistently increased their dividends every second quarter since the beginning of 2003, increasing 163% since the beginning of 2000.
• Dividend increases continued this quarter with increases from BMO, NA, and CM of 17%, 8%, 4%, and 3%, respectively. BMO also announced an increase in its target payout ratio range to 45%-55% from 35%-45%. The banks' dividend payout ratios on our 2006 estimates remain relatively low at 43%.

Bank Valuation Now Compelling Versus Attractive

• Bank valuations are now compelling as opposed to attractive on a yield basis after the recent correction.
• Bank dividend yield relative to 10-year bonds has increased to 2.9 standard deviations above the mean, versus 1.9 earlier in the year (Exhibit 14).
• Reversion to the mean on this measure would require a 47% increase in the bank index, or a 6.6% 10-year bond yield versus the current bond yield of 4.5%, without factoring in expected bank dividend increases.
• Bank valuation is now much more attractive versus Pipes and Utilities and Income Trusts as they are now back to the Strong Buy range. The relative yield of Banks versus Pipes and Utilities is now at 87% or 1.9 standard deviations above the mean, retracing from a recent low of 78% or 1.0 standard deviations above the mean in March. The relative yield of Banks versus Income Trusts is now at 50% or 1.8 standard deviations above the mean, retracing from a recent low of 45% or 1.4 standard deviations above the mean in October of 2005, and nearing its high of 51%.
• Reversion to the mean with respect to bank dividend yields relative to pipes & utilities, the S&P/TSX, and income trusts would suggest an increase in the bank index of 28%, 37%, and 41%, respectively.

Bank P/E Multiples Retrace From High of 15.1x

• The Bank P/E multiple peaked in February at 15.1x on a 12-month trailing basis and since then has retraced to current level of 13.1x. In general, the banks have been building a base in the 14x-15x range over the past three years. The bank group P/E multiple’s most recent high was in early 1998 in the 16x-17x range, aided by bank merger speculation. We continue to forecast the P/E expansion to the 16x range, with the recent decline in P/E multiples due, we believe, to the overall equity market correction.

Bank Betas at Historical Lows

• The one year average bank beta is now 0.39 compared with a three year average bank beta of 0.47 and a five year average bank beta of 0.81.

Strong Fundamentals, Attractive Valuation

Maintain Overweight Recommendation

• We continue to view bank fundamentals as the strongest in history, with record profitability and capital, high asset quality, low financial and earnings leverage to credit, diversified revenue mix, and low earnings volatility.

Recommendations - Recent Changes

TD Downgrade

• We maintain our 1-Sector Outperform rating on RY, 2-Sector Perform ratings on NA, CWB, LB, and TD, and 3-Sector Underperform ratings on BMO and CM.
• Also on June 14, we downgraded TD to 2-Sector Perform from 1-Sector Outperform based on disappointing performance in the bank's wholesale operations, continued earnings weakness at TD Banknorth, and the risk of a deceleration in relative earnings growth at TDCT led by a slowdown in insurance revenue growth.
• We maintain a 1-Sector Outperform rating on RY which has the strongest retail and wealth management operating platform and a solid wholesale banking business. We continue to expect stronger relative earnings momentum from this bank, as well as relative P/E multiple expansion.
• We downgraded LB to 2-Sector Perform from 1-Sector Outperform on June 3 based on our view that the pace of earnings recovery is now slowing and earnings growth, though still on track, is expected to take longer to achieve. Maintain 2-Sector Perform ratings on NA and CWB.
• We maintain 3-Sector Underperform ratings on BMO and CM based on lower profitability and no meaningful valuation discount and, in the case of CM, continued
concerns about revenue erosion and weakening of its competitive position in its major business lines.
• Our 12-month bank share price targets for BMO, CM, CWB, LB, NA, RY, and TD are $72, $55, $45, $36, $72, $58, and $70 per share, respectively.
• Our 12-month target for the bank index is 24,700 based on a target P/E multiple of 15.5x our 2006 or 14.1x our 2007 earnings estimates, for a total expected return of 25%.
• Maintain Overweight Banks recommendation based on superior dividend growth, strong fundamentals, compelling valuation, and low relative risk.

CIBC & Global Crossing Related Lawsuits

The Globe and Mail, Sinclair Stewart, 21 June 2006

Canadian Imperial Bank of Commerce, which is facing a $2-billion (U.S.) insider trading lawsuit from the trustee for Global Crossing Ltd., has agreed to settle a separate class-action lawsuit filed by the telecommunication company's investors.

CIBC confirmed Wednesday that it struck the agreement during the second quarter, but declined to provide financial terms, other than to say the amount would not have a material impact on the bank.

Based on CIBC's size, and the threshold for disclosing material deals, the settlement is thought to be in the range of $20-million, sources said.

That is a far cry from the massive sum being sought by Global Crossing's trustee, which filed its suit against the bank and dozens of related companies late Tuesday, and is trying to recoup money for creditors who got burned when Global Crossing lurched into bankruptcy protection in 2002.

The trustee alleges CIBC and others knew the fibre-optics company was in trouble when they sold billions of dollars worth of its stock.

In a statement Wednesday, CIBC flatly denied the allegations, and said the action was almost identical to a claim filed by the trustee against the bank two years ago. CIBC sought to have these prior claims dismissed in January, and the motion is pending.

“CIBC vigorously denies these allegations and continues to believe it has strong legal and factual defences against these claims,” the statement said.

Andrew Entwhistle, the lawyer representing the Global Crossing estate, did not return calls seeking comment.

CIBC, through its merchant bank, was an early-stage investor in Global Crossing. It acquired a 38-per-cent stake in the company in 1996 for $38-million, a stake which was worth almost $1-billion when the company launched a public offering a year and a half later.

The creditor-related suit claims that the bank and several affiliated companies, most of which were owned by former CIBC employees, made approximately $2-billion selling shares in Global Crossing. Five of these former employees also sat on Global Crossing's board of directors, and the suit alleges they “knew of the misstatements of Global's revenues, assets and obligations.”

If recent history is any precedent, CIBC investors may find some solace in the fact the bank has agreed to settle the Global Crossing class-action suit. CIBC's well-documented entanglements with Enron Corp. cost the bank $2.65-billion (U.S.) in settlements last summer — more than 10 per cent of its current market value — and dealt a nasty blow to the bank's reputation.

But with Enron, it was the class-action litigation that inflicted by far the most pain: a record $2.4-billion settlement to resolve allegations CIBC abetted the pervasive accounting scandal at the energy trader. The bank's settlement with Enron itself was just $250-million.
The Globe and Mail, Sinclair Stewart, 21 June 2006

The Canadian Imperial Bank of Commerce denied allegations Wednesday that it and dozens of its affiliates participated in a “multiyear scheme” to profit from the sale of shares in telecommunications company Global Crossing Ltd.

The insider-trading allegations, contained in a $2-billion (U.S.) lawsuit filed in court yesterday, could represent yet another black eye for CIBC, which is trying to turn the page on what has been a bruising few years.

The country's fifth-largest bank paid $2.4-billion last summer to settle a class-action suit by investors at Enron Corp., and before that paid $125-million to settle its alleged involvement in a U.S. mutual-fund trading scandal.

In a statement early Wednesday, CIBC said yesterday's action is essentially identical to claims filed against the bank in 2004, which the bank moved to dismiss in January. That motion is pending. Yesterday's claims do, however, now include additional CIBC affiliates and other third-party defendants.

“The action contains no new claims against CIBC,” the bank said. “CIBC vigorously denies these allegations and continues to believe it has strong legal and factual defences against these claims.”

Yesterday's legal salvo, filed by a trustee representing Global Crossing creditors, claims that CIBC and several related companies engaged in insider trading of the fibre-optics company's shares. The suit contends CIBC and others made roughly $2-billion in profit from this trading, even though they allegedly knew Global Crossing was in poor financial health. Many of these related companies were controlled by former CIBC executives.

“While the defendants were making a fortune from insider trading because the company's financial statements were manipulated to appear robust, in truth many of Global's operations were struggling and the company was at all relevant times insolvent,” alleged the suit, filed in a New York bankruptcy court.

It claimed that a handful of CIBC employees, who were appointed to Global Crossing's board of directors, “knew of the misstatements of Global's revenues, assets and obligations,” and that these misstatements eventually helped push the company into bankruptcy in 2002.

A CIBC spokesman declined to comment on the matter yesterday.

Global Crossing was an undisputed cash cow for CIBC, and heralded as the bank's single most successful merchant-banking victory. In late 1996, the bank paid $38-million for a 38-per-cent stake in the upstart fibre-optics carrier; less than 1½ years later, when the company launched its initial public offering, the bank's stake was worth nearly $1-billion.

A group of junk-bond executives who worked for CIBC in the United States, and who had previously worked with Global Crossing's founder, jump-started the bank's involvement. Five of these executives served on Global Crossing's board, but the last of them retired in 2000, when CIBC sold $710-million worth of its stock. The suit claims the bank wanted to divest its position “anonymously,” so it would not alert other investors that Global Crossing's main underwriter was “dumping stock.”

The CIBC executives who sat on Global Crossing's board “acted together with others to repeatedly violate their fiduciary duties of loyalty to Global,” the suit said.

CIBC helped take Global Crossing public, and over the years it received $58.7-million from the company from investment banking and advisory fees, according to the suit.

Global Crossing emerged from bankruptcy protection in 2003. The trustee says creditors still have more than $6-billion in outstanding claims.

RBC Centura's Hockey Ties May Pay Off

The Toronto Star, Tara Perkins, 21 June 2006

Hockey hasn't traditionally been the biggest sport in the North Carolina area known as the Triangle.

The region around Raleigh, Durham and Chapel Hill is known for its three major universities — North Carolina State, Duke University and the University of North Carolina — and their athletics programs.

Sunny Raleigh, home to the Carolina Hurricanes, is also known as North Carolina's "sweatiest" city, according to a Procter & Gamble study released this week that predicted how much sweat an average man would secrete after an hour of standing in Raleigh's average summer temperature.

But, thanks to this season's performance of the Carolina Hurricanes at the RBC Center, the Triangle is learning more about one of winter's great sports.

"Right now, hockey's the main sport in town," says Scott Custer, chief executive of RBC Centura, the Royal Bank of Canada's Raleigh-based U.S. consumer bank, which operates in five states. And as Carolina learns more about Canada's favourite sport, it's also learning more about just who this "RBC" company is.

On Monday night, eyes across North America watched as the Hurricanes took Game 7 against the Edmonton Oilers, winning the Stanley Cup final on home ice, in the RBC Center.

Last week, the Raleigh News & Observer printed a headline declaring "Cup run puts RBC on the map."

The article quotes RBC Centura chief operating officer Ron Day saying, "We're in a place in the southeast where there are still a lot of people not familiar with RBC."

Canada's biggest bank bought Centura Banks Inc. in 2001 for $2.3 billion (U.S.), renaming it RBC Centura.

Just over a year later, the bank secured the naming rights to the Raleigh Entertainment and Sports Arena, renaming it the RBC Center.

The $80 million (U.S.) deal gives RBC Centura the naming rights for 20 years.

At the time, there was criticism RBC was paying too much.

"People always want to look and try to throw some stones at what you do," Custer said on a cellphone yesterday as he drove from the airport past the RBC Center to last evening's parade.

"If you look back, I think we did a very good deal. It was fairly priced," he said. Adding that, in fact, "you could argue that we got a pretty good bargain."

"We root for the Hurricanes, but does it translate into better business performance (for RBC Centura)? ... I think we can show it's absolutely had a tight connection," Custer said.

The Triangle area is outperforming the rest of RBC Centura's operations, he said.

"We got a lift when we did the naming-rights deal. We got a lift when we announced we were moving our headquarters here. We got a lift when the Hurricanes did well," he said.

RBC Centura moved its corporate headquarters down the highway from Rocky Mount to Raleigh last year.

Chequing accounts are up by more than one-third over the past year, Custer added.

All told, RBC Centura has positioned itself "as kind of the hometown bank here," he said, although acknowledging "we're not the biggest bank by market share, but probably second or third."

And the Raleigh area is learning more about the Canadian owners of its "hometown bank."

"Typically, we're not really associated with a Canadian bank," Custer said. "But here, because of hockey, because we call it the RBC Center, there's more of a Canadian connection."

Custer, who has been with RBC Centura and its predecessors for more than 17 years, said that Monday's "game was the biggest event that we've had in this town that I know about."

"I hated I was not here, but I watched it with a bunch of people on TV," he said.

Custer was stuck at a bankers' convention.

The greater Triangle area is home to about 1.3 million people, he said. Greater Raleigh is home to about 650,000.

20 June 2006

RBC Cdn Bank Day – Highlights

RBC Capital Markets, 20 June 2006

Last week, RBC Capital Markets hosted investor meetings with four of the big six banks. On average, we came away from the meetings more inspired on the group. We believe the themes supported our Outperform ratings for RY and NA, while our Sector Perform ratings for BNS and CIBC seem about right in the context of an over-weight recommendation for the sector as a whole.

Royal Bank of Canada – Explaining Wholesale

CEO Gord Nixon was very comfortable and forthright is his discussion. He demonstrated a sharpened bankwide knowledge base and dealt head-on with investor concerns that wholesale is growing too fast and contributing too much (implying RY could fall harder in a downturn on revenue pull-back and loan losses).

RBC provided some new slides and disclosures in its current investor package: (i) trading still represents only 10% of total revenue (low end of the range since 2003); (ii) trading volatility, at 14% standard deviation to the mean, is half the peer average of 29%; (iii) RY and its Canadian peers are below global banks on a risk / return basis (daily trading revenue versus 1-day VaR) and resisting internal pressure to match, and; (iv) business loans, at 13% of total, is still below 16% average. Further, RBC has executed 21 deals in last 5 years, all of which have been directed at P&C and none at wholesale banking.

CIBC – Revenue Concerns Persist

CEO Gerry McCaughey and team spoke to several areas of concern, from which we believe the key takeaways were: (i) get ready for another round of cost cuts at year end, as we mused in our last note it could be $300MM+ this time (up from the current $250MM program), and; (ii) CIBC seems more optimistic for revenue growth in second half of 2006, but we are still concerned they will be disappointed.

Revenue in retail is still vulnerable as the bank continues to shift from variable to fixed mortgages as well as unsecured to secured loans, which means poor sales and lower spread in the mean time. Credit cards remain under pressure – CIBC is no longer taking the monoline approach. The bank’s in-branch sales offer includes a total of 25,000 Aeroplan points available for balance transfers, chequing and deposit accounts. The wealth management cross-sell was actually uninspiring to us and we think the bank may be under-promising on this front. It sounds like wholesale will start growing again in 2007, as CIBC is convinced they can turn on the tap and hit the ground running again, which we think is reasonably compelling.

Bank of Nova Scotia – International Keeps Growing

We had a great expansive meeting with CEO Rick Waugh. At least half the meeting was focused on Scotia International, including the Costa Rican Interfin deal and the political environment. Waugh outlined the very cogent and compelling macro outlooks for Central American and Caribbean growth: (i) CAFTA for internal trade, and (ii) few foreign bank competitors make for a good pricing environment. Clearly BNS is a lot more comfortable than the market with the various Latin American and Mexican political concerns. There were lots of anecdotal stories of how most regions are following Mexico’s lead of opening the bank system and avoiding dictatorial regimes.

Scotia’s domestic revenue growth has been the bank’s weak link. Management argues BNS’ spread will recover more now as they attribute funding costs more directly to retail. They stress that looking at bank-wide spreads, which appear more stable, is more instructive. If and/or when domestic retail spreads outperform or catch up to the group, a negative could be lifted from the stock. To address the revenue issue, Waugh indicated the bank needs a material improvement in its wealth leverage, which we read as an acquisition.

National Bank of Canada – Perspective on Partners

Investors continue to look for more granularity on the Partners Program and the influence on volumes and margins in the P&C bank. However, we recognize that National must balance confidentiality agreements in place with its partners with the need for additional disclosure. We will watch for progress on this front over the course of the next 12-18 months.

Pierre Desbiens, SVP Sales and Personal Banking, gave us a better understanding of the client segmentation strategy and distribution network of the retail bank. To facilitate cross-selling, the bank has: (i) 1500 financial advisors, which are typically associated with specific products (ie. GICs); (ii) 300 personal bankers, which deal with assigned clients, and; (iii) 325 financial planners, which deal with the wealthy clientele. NA is focused on expanding all three layers, particularly through internal growth, and continues to “assign” a growing proportion of its client base. All of these in-branch advisors, planners and bankers are separate from NB Financial’s full service brokers.

15 June 2006

TD Banknorth No ATM Fee Card

Brandweek, Constantine von Hoffman, 15 June 2006

TD Banknorth continued the roll out of its “Bank Freely” campaign this week with efforts in Connecticut and the mid-Atlantic states. The campaign is built around the bank’s promise to re-pay any and all ATM fees charged by other banks to customers using the new No ATM Fees Visa debit card.

Thomas J. Dyck, evp and director of marketing, said the new product is part of an effort to make the bank, which is headquartered in Portland, Maine and operates throughout the Northeast, more convenient for its customers to use.

“We knew we needed to expand our ATM network and we knew that that would take time,” said Dyck. “So we felt this was the best way to give our customers this convenience while expanding the network.”

The campaign is by The VIA Group, Portland, Maine. The print efforts will run in regional editions of 40 magazines from Forbes to Parenting to Cosmo and in more than 30 major daily papers throughout the area. The TV spots will run in prime time during CSI, Lost, 60 Minutes as well as during major sports events and local news.

In addition to print and broadcast, the campaign uses guerilla marketing materials, like coffee and popcorn cup holders, newspaper belly-bands, door hangers and mock up newspapers, distributed by "free agents" riding in customized Honda Elements. The campaign will center around Connecticut and the mid-Atlantic states, where the bank recently acquired 200 new branches.

“There is just so much marketing clutter for financial services in these markets that we thought this would be the best way to break through that,” said Dyck. “Banking is a local business and we think this emphasizes how people can find us in their neighborhood.”

Dyck also believes that actually providing the customers with something for free is another way to break through the marketing clutter. The bank’s new branches in Connecticut, New York, New Jersey and Pennsylvania has made it a much bigger player in these highly competitive markets. They researched what would make them standout to consumers and came up with the Bank Freely positioning, as well as the No ATM Fees card offer, Dyck said.

“Consumers just don’t believe it when banks use the word free,” said Dyck. “They expect to be hit with minimum balance requirements and the like. So if we wanted to make an impression it was essential that when we said free, we meant it.”

BMO Nesbitt Burns & Harris Nesbitt become BMO Capital Markets

Canadian Press, 15 June 2006

After 94 years, the name of A. J. Nesbitt is being scaled back in the Canadian securities business.

Bank of Montreal announced Thursday that its investment and corporate banking businesses, BMO Nesbitt Burns and Harris Nesbitt, are being renamed BMO Capital Markets.

The change signifies the bank's "commitment to provide a full range of capabilities to clients in North America and other key international markets," BMO stated.

The BMO Nesbitt Burns name will live on as the brand for the bank's private client group in Canada and will continue to be used by the firm's 1,300 investment advisers.

Arthur James Nesbitt was a young salesman when he was hired by Max Aitken, later Lord Beaverbrook, to open a Montreal branch of Aitken's Royal Securities. Nesbitt quit Royal Securities in 1912 to form his own firm, Nesbitt Thomson, with P. A. Thomson, whom he had met when they were both door-to-door salesmen in the Maritimes, Nesbitt selling dry goods and Thomson pushing pickles.

Nesbitt Thomson grew through the decades - among its offshoots was Power Corp. of Canada, formed in 1925 with Nesbitt as president - and the firm was acquired by BMO in 1987.

Harris Nesbitt, which has more than 1,000 employees in 10 U.S. cities, grew out of the Toronto-based bank's 1984 acquisition of Harris Bank of Chicago.

"This name change represents the significant lending power, global trading proficiency and innovative investment banking expertise that have long been associated with BMO Financial Group, and communicates the firm's ability to deliver the full suite of wholesale products and services that define a leading universal investment bank," stated Yvan Bourdeau, CEO of BMO Capital Markets.

BMO Capital Markets will have about 2,200 employees in 26 cities around the world.

While the Nesbitt Burns name remains with the Canadian investment advisory business, the Harris name continues as the brand for BMO's U.S. retail and private banking operations.

BMO Capital Markets, with revenue in the past year of $2.74 billion and earnings of $853 million, has about 70 equity and debt research analysts.

The name change will be supported by a multimedia advertising campaign that "targets the c-suite executives of public and private companies" with the tagline: Ambition, meet execution.

"We are leveraging our renaming as an opportunity to dramatically increase our brand exposure, particularly in the U.S.," said Martha Durdin, director of marketing for BMO Capital Markets.

Manulife Investor Day Highlights

RBC Capital Markets, 15 June 2006

• Price Weakness A Buying Opportunity. After holding in better than other large cap Financials, Manulife was caught in the market downdraft yesterday, in our view, creating a buying opportunity. We target-price Manulife at 16.5x estimated forward earnings of $2.89, for $43.

• Acquisitions Not Required. At Tuesday’s Investor Day CEO Domenic D’Alessandro stressed organic growth alone should make MFC’s 16% EPS growth and ROE targets. He also reiterated his 5-year employment commitment, reminding there are 3 years to run on that covenant.

• New Disclosure Attests to High Quality Earnings. New disclosure highlighted the diversity inside MFC’s $28B of Provisions for Adverse Deviations (PfADs), including $10.8B in reserves for adverse investment returns, providing a layer of protection against equity and/or fixed income market melt-downs. PfaD’s are now double the pre-Hancock level, and at 16% of General Account liabilities, slightly higher on a percentage basis as well. PfAD reserves currently reflect ~7-10 years of after-tax earnings.

• Sustainable Lead Position in U.S. Life. MFC now ranks 1st in sales among U.S. lifeco’s (past 12-months). In our view, MFC is in an excellent position to hold its top position based on key competitive advantages including brand strength, superior service and leading product innovation.

• Domestic Shifting to Group & Wealth. Group Retirement is gaining market share with honed products and improved roll-over retention. Manulife Bank has grown to $7 billion in assets and now contributes 12% of domestic earnings. MFC is focused on payout annuities and health care benefits as Canadians shift from the wealth accumulation to the wealth distribution stage of life and require additional medical care.

• New Asian Opportunities Abound in Tested Markets. Potential changes to health care legislation in Hong Kong that would shift health care expenses to individuals/employers could lead to a slew of new product offerings. In Japan, MFC is well positioned to increase life insurance sales by leveraging its existing relationships with domestic banks as banks are permitted to begin selling life insurance in 2008.

• Valuation. Our $43 target (unchanged) is based on 16.5x our forward EPS estimate, a 10% premium to our Canadian lifeco peer average of 15x, wider than the historical 3% premium to reflect the superior growth and capitalization as well as MFC’s enhanced global position. EPS risk centers on accelerated USD translation as nearly 2/3 of earnings are USDbased, and not hedged. Also, Manulife could be susceptible to a downturn in claims experience, unusually bad credit markets, or to an acquisition
BMO Nesbitt Burns, 14 June 2006

Investment Thesis and Outlook

Manulife held its annual investor day on June 13, 2006. Overall, we believe the outlook for Manulife is unchanged: strong top and bottom line growth in the U.S. and Japan accompanied by continued expense gains and excess capital generation in Canada. We believe the company has at least $4 billion in excess capital and that it has been quite active in its share repurchase program over the last four to six weeks. We continue to expect 15%+ dividend growth from MFC over the next couple of years. Management reiterated its medium- to long-term EPS growth target of 15% and ROE target of 16%.

One clear message that came across during the presentations was the enhanced franchise value that is being created from the merger of Manulife, which provided operational discipline and accountability as well as product development, and John Hancock, which provided a very strong brand name. The beneficial combination shows up clearly in the earnings and business growth results, even analyzing growth in the businesses assuming they were combined prior to the acquisitions (Table 1).

Also noteworthy during the presentations was the company’s enhanced disclosure on the level of PfADs and the composition of PfADs. We applaud this move to crack open, ever so slightly, the “black box” of insurance. Of note is the fact that the relative level of PfADs after the JHF acquisition is higher than pre-JHF. While management ascribed most of the increase in PfADs relative to reserves to the recent strength in equity markets, we believe that the business mix at JHF required relatively higher levels of PfADs.

Manulife remains Outperform rated. In volatile markets, we believe that the shares of global franchises like Manulife are likely to perform relatively well. The company continues to enhance its franchises in North America and Asia and has the financial resources to drive organic growth.

Investor Day Summary

We have summarized the important information from the investor day below.

United States

• Combination of Manulife’s operating discipline, product development and distribution relationships with Hancock’s brand name is creating a formidable franchise. Over the last 12 months, Manulife has been the number one seller of life insurance in non-proprietary channels, up from a combined number four (MFC+JHF) prior to the acquisition. The company has also experienced similar gains in variable annuity sales. JHF’s neglected mutual fund operations have also been generating consistent net inflows and appear poised to have another strong year with the addition of GMO funds in June. While difficult to quantify, Manulife has experienced significant revenue synergies from the acquisition, which is unique in acquisitions in financial services.

• In individual life, the company continues to focus on broadening its penetration in new distribution channels resulting from the acquisition of JHF, particularly JHFN, the M Group and banks. While encouraged by Manulife’s strong sales performance over the last 12 months, it is not sustainable. We suspect that the company has carved out a top three (or five) position in terms of sales in the U.S. over the next few years. MFC is also introducing some new LTC products, which should help rejuvenate sales through this market over the next few years.

• In wealth management (annuities, mutual funds and 401(k)s), business momentum is good in all three segments. The company is moving “up-market” in the 401(k) from the micro-case level ($million, less than 250 lives) to $3–10 million range. The company continues to dominate the very small case market with over 1.4 million participants. In mutual funds, the company has revamped the product offering and increased the wholesaler force to 60 from 28. Net flows have been positive and in a positive trend since the acquisition, and the addition of GMO to the fund line-up should provide a unique new line-up of funds. At the time of acquisition, it was unclear whether MFC would keep the mutual fund operations but it appears that the economics and outlook for the business have improved sufficiently that it is likely to remain among JHF’s suite of products.

• In variable annuities, the company introduced a unique product with attractive withdrawal benefits that have sold extremely well. While products are important, the company has been very successful at nurturing new distribution relationships as a result of the combination with JHF. In all the major channels—banks, regionals, wirehouses, financial planners and JHFN—sales have increased at double-digit rates. Investors should not expect these sales results to be sustainable, as large competitors have introduced competing products that are likely to squeeze out some MFC sales.


• Results from Japan remain on track to deliver another good year in terms of sales growth and earnings. In wealth management, the success of the BOTM-UFJ relationship continues to drive annuity sales and the company continues to foster new distribution relationships to mitigate its exposure to this one bank. In individual insurance, transplanted North American products adjusted to local customs continue to drive new business. The biggest challenge in Japan is to grow the professional career sales force. Bank deregulation in 2008 offers interesting potential to sell more insurance via bank branches.

Hong Kong

• MFC operates an impressive business in Hong Kong, where it is number two in in-force life premiums and number two in the Mandatory Provident Fund (MPF) in terms of AUM. The key to growing insurance sales is to grow career agency and the company did add 200 agents in 2005. The real growth opportunity remains in wealth management given high savings rates and small competitors. Health insurance also appears to be a burgeoning market in Hong Kong. The company is hosting an Asia investor day on September 12, 2006, and we expect to get more details at that time.

Other Asian

• Other Asian territories continue to experience high rates of growth, particularly out of China. The key to success is building a career sales force; however, the competition for qualified individuals is intense. While certain regions, like Indonesia, generate reasonable earnings, other areas, like China, are unlikely to generate material earnings over the next few years.


• Earnings in Canada are reasonably well balanced between individual insurance, wealth management and group businesses. Most of the big three Canadian lifecos have experienced success in the DC market and all are introducing new products to entice retirees to roll over their DC plan assets into a life company annuity or other product. Manulife has been experimenting with different products and we believe that the insurance industry is well positioned to capitalize on this opportunity. Individual insurance continues to perform well and the acquisition of Maritime Life has given Manulife enhanced access to the MGA channel to complement its dominant position in the IDA channel. Pricing in UL remains competitive—a situation that is likely to persist for the balance of 2006. Manulife has experienced good sales growth in mutual funds and seg funds, particularly in income-type products. Overall, Canada is performing well and the oligopoly appears to be behaving favourably for investors.

Actuarial Review

• One of the noteworthy events during the day was the presentation by the company’s chief actuary, Simon Curtis. Manulife disclosed that it has $26.5 billion in PfADs in 2005, up from $24.3 billion in 2004 and $10.6 billion in 2003 (prior to the closing of the JHF acquisition). Relative to general account reserves and segregated fund liabilities, the PfADs rose from 8.9% in 2002 to 10.0% in 2005. The rise in the ratio of PfADs to reserves reflects the positive impact of rising equity markets on reserves required on segregated funds.

• The company also compared the level of reserves in Canadian GAAP versus U.S. GAAP and cash surrender values. CGAAP reserves are $1.1 billion higher than U.S. GAAP reserves and exceed cash values on “surrenderable” policies by 14%. The company also showed the components of PfADs. As one would expect, PfADs on interest rate risks have increased (i.e. lower long-term interest rate assumptions require higher provisions), which were offset by lower PfADs on credit losses (this has been disclosed extensively by the company).

• What does all this mean? The added disclosure should provide investors with greater comfort as to the level of conservatism in the reserves and open a small crack in the “black box” of insurance accounting. We also have another theory. The new investment accounting rules expected on January 1, 2007 have the potential to increase earnings volatility (please see our report released December 14, 2005). Improving disclosure and the understanding of how earnings are released (PfADs are effectively future earnings) should help partially alleviate concerns on increased earnings volatility related to changes in investment accounting rules.


The target price of $40 is unchanged, representing 14.4x 2007E EPS and 2.4x2006E BVPS, both in line with current trading multiples.


Manulife remains Outperform rated. The company reiterated its 15% EPSgrowth forecast over the medium to long term and a 16%+ ROE. There was nomaterial new information to impact our outlook on the shares. However, thecompany’s top and bottom line outlook remains robust in the U.S. and Japan.Results from Canada are expected to continue to generate good returns andprovide significant excess capital. We believe the company has been very activein its share buyback over the last month. MFC significantly improved itsdisclosure by not only providing the level of PfADs but also the composition ofPfADs. We applaud the company’s efforts on this front and encourage other life insurers to follow. In these volatile markets, we expect quality institutions likeManulife to perform relatively well. The company has significant excess capital,strong business momentum, growing franchises in the U.S. and Asia, and credit metrics are improving.
• S&P Equity Research upgraded Manulife Financial Corp. from Sell to Hold. S&P says shares have slipped to our 12-month price target of U$31. S&P is encouraged by MFC's strong variable annuity sales and growing life insurance marketshare from its John Hancock operations. However, competition from banks remains a challenge for fixed annuity products, and a difficult interest rate environment could hamper earnings growth. S&P thinks MFC may benefit from future growth in Asia.

• Keefe Bruyette upgrades Manulife Financial from Market Perform to Outperform.
Scotia Capital, 14 June 2006

Investor Day Highlights

• Manulife held its annual Investor Day in Toronto on June 13, 2006. As is usual for such events there was no significant new news. In opinion, the breadth and depth of the company's management team, its superior market positioning in growth markets globally, its solid topline growth and its conservative balance sheet and reserving practices continue to support an increasing premium multiple relative to the group. That said, unlike the group the stock has not "corrected" of late, pushing its premium to the group up from 3% to 6% (well beyond its 2% average, but not as high as its 8% peak we saw in 2002), while the others have fallen to discounts below their historical means. While we continue to believe a superior premium, above normal levels, is justified, we believe the likelihood of further significant expansion relative to the group is less likely, as we expect the recent exceptional EPS growth (17% in 2005, ex one-timers, and 16% in Q1/06), in part attributable to the John Hancock synergies, to return to a more moderate 13%-14% level, and the recent pace of the exceptional top-line growth to moderate slightly. We highlight several takeaways below.

• Strong management team - with significant breadth and depth. With a total of fourteen speakers from all divisions of the company, Manulife clearly showed the depth and breadth of its management team. The company definitely has the bench strength for what we believe to be a seamless transfer of duties if and when senior management step down. That said, we believe such an event is several years down the road. President and CEO Dominic D'Alessandro, at age 59, has a minimum of three years left to fulfill his promise of staying at the helm at least five years after the close of the Manulife/John Hancock merger.

• Not in Europe or South America because fully engaged in opportunities the company has in existing markets - likely to continue as such unless significant opportunity presents itself. On Europe, a market that is highly competitive and increasingly consolidating, D'Alessandro said its only entry would be to buy an existing insurer, and on South America, he noted the "promise is greater than the reality". A disciplined acquirer, we expect the company to stick to its current North American and Asian markets, unless a significant market shakeout presents an extremely attractive opportunity. On India, D'Alessandro cited displeasure with joint ventures as the largest deterrent (maximum ownership is currently 49%).

• Potential for more top-line growth in Japan in 2008, when deregulation will allow for banks to distribute life insurance products. Manulife's strong relationship with MUFG, its strategic partner for VA sales and the largest bank in Japan, continues to drive sales growth in the Japanese variable annuity market. The company continues to add relationships of late, including Nomura Securities, the largest security dealer in Japan, and Resona Bank and Saitama Resona Bank, the 4th largest banking group in Japan, and now has over 22 banks and security dealers selling its VA products. The company is extremely well-positioned when sales by banks are further deregulated at the end of 2007 to allow for the sale of life insurance products as well.

• Continued aggressive expansion in China - and with operations in 15 cities, has more licenses than any other foreign insurer. Management remains bullish about this market, where the company has nearly 5,000 agents (up from just over 3,000 two years ago) and has seen 43% CAGR growth in premiums and deposits since 1999.

• Exceptional U.S. VA sales growth likely to return to more "normalized" levels for Q3/06 and Q4/06. As we somewhat expected, management indicated that the 61%, 63% and 60% sales growth in U.S. variable annuity for Q1/06, Q4/05 and Q3/05 would likely not be sustainable, for two reasons. One, we are close to approaching a year following the May, 2005 launch of the Second Generation Product, the highly successful VA product that drove the growth, and two, other competitors have now copied the product to various degrees. We would expect the company to maintain market position and share (#2 in the non-proprietary channel) until its next new product launch, which we anticipate could be late 2006 or early 2007.

• #1 seller of individual life insurance in U.S., up from #4 pro-forma pre-merger - demonstrates the acquisition was indeed a revenue growth story. With strong and diversified distribution relationships, a superior product and superior brand (John Hancock), the company continues to ride the wave of expansion of brokerage in the U.S. individual life insurance market. With a focus on the older affluent market, the fastest growing market, and the brokerage distribution channel, the fastest growing channel (accounting for 36% of sales in 1983 and 60% in Q1/006), the company has climbed to #1 in the U.S. market, a market that overall traditionally grows in the 2%-3% range. While we continue to believe the company's sales growth will outpace the industry (MFC sales were up 78% in Q1/06 and 60% in Q4/05, versus the industry at 12%-15%) we have to believe that as the company's sales get larger the level at which the company outpaces the industry will subside to some degree.

• If we get another Katrina the hit could be in the $0.12-$0.13 per share range - the same level (spit adjusted) as last year. While the company has increased attachment points (from an aggregate one-time catastrophe loss of US$20 billion to US$30 billion before the company would pay a claim), and increased premium rates, a modest increase in capacity at the layer of coverage beyond the attachment point puts the loss for a Katrina-type hurricane at the same level as last year. However, should any one storm have total damages less than US$30 billion, the company's loss on its retrocession business should, in all likelihood, be zero.

• Conservative actuarial practices. The company updated its disclosure from two years ago as to the level of PfADs (provisions for adverse deviation) as a percentage of general account liabilities. Manulife's PfADs, traditionally in the 10%-15% range as a percent of general fund liabilities, have climbed from 14.2% in 2002, to 15.3% in 2003 and to 16.3% in 2005, despite the fact that the acquisition of John Hancock more than doubled the company's balance sheet liabilities. Simply said, the company's reserving practices are increasingly conservative, and remain at the high end of their historical range. The natural release of these PfADs is a large and sustainable driver of earnings and future earnings growth, and has consistently been 60%-65% of pre-tax earnings growth.
Canadian Press, Rita Trichur, 14 June 2006

Manulife Financial Corp. continues to see plenty of growth opportunities abroad even as industry consolidation in Canada draws to a close, its chief executive officer said yesterday at an investor conference.

"Perhaps in Canada ... the consolidation is nearing completion but there are other developments in Canada that might be of interest in the periods ahead," said Manulife CEO Dominic D'Alessandro.

"I think in the United States there continue to be opportunities and I think, of course, in Asia the organic growth prospects are very, very good."

Asked to elaborate on the Canadian scene, Mr. D'Alessandro pointed to remarks he made last month at the company's annual meeting, advocating that financial institutions should be allowed to merge -- "whether bank with bank, bank with insurer, or insurer with insurer" -- largely without government restraint.

Mr. D'Alessandro -- who reportedly contemplated a combination with Canadian Imperial Bank of Commerce in 2002 -- said Canadians need to rethink the financial services industry.

"If you look at it and say, 'How might the financial services industry organize itself going forward?' you'd come up with a different set of scenarios, perhaps," he said.

"I don't want you to conclude from that somehow I'm lusting after acquiring a bank or merging with a bank -- that's not the case at all. I'm just saying that, perhaps, that ought to be a possibility that should be available."

The Conservative federal government has already said that dealing with the issue of big bank mergers, which have been off limits since 1998, isn't a priority.

In the meantime, Manulife considers Asia -- especially China -- to be the "new frontier" for growth.

The company has been opening new branches in China every couple of months, particularly in high-growth coastal areas, and is already in more cities than any other foreign insurer.

"There's still plenty of places for us to open in the next 20 years," said Victor Apps, senior executive vice-president and general manager of Manulife's Asian division.

"We'll keep growing on the branch expansion over the next few years from our current numbers . . . until we have 50 [to] 100 branches in China eventually, I'm sure," Mr. Apps said.

Chinese expansion is also a key priority for chief rival Sun Life Financial Inc., which also has a foothold in the world's most populous country.

For his part, Mr. Apps said Manulife is not influenced by its rival's moves: "The market is huge -- we all know that. The secret of China is to build the business well and profitably."

Its Asian division -- which also includes operations in Japan, Taiwan, Hong Kong, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam -- produced profit of $141-million (U.S.) in its latest quarter, representing 17 per cent of the total company's shareholders' earnings.