RBC & China Minsheng in Joint Venture

The Toronto Star, Tara Perkins, 31 October 2006

Canada's biggest bank is tip-toeing into the Chinese mutual fund market, hand-in-hand with one of China's fastest-growing banks.

The Royal Bank of Canada is teaming up with China Minsheng Banking Corp. Ltd. to create a $25 million (U.S.) fund management company.

The new joint-venture company, to be based in Shanghai, will create, manage and sell mutual funds to Chinese retail and institutional investors, using the local Chinese currency.

The Royal Bank will hold a 30 per cent stake, China Minsheng Bank will hold 60 per cent, and Three Gorges Finance Co. Ltd. will own the remainder.

George Lewis, chairman and chief executive officer of RBC Asset Management Inc., said the new fund company will give RBC an entry point into the rapidly expanding Chinese asset management market.

Chinese assets available for management could hit as much as $300 billion in as little as five years, says Ed Legzdins, president of BMO Mutual Funds.

Legzdins said he welcomes RBC's entry. "I think it's good when foreign firms go into the Chinese market and help Chinese mutual fund companies become better — or become established, as is the case with RBC — because that's going to benefit all the participants in the Chinese mutual fund industry," he said.

BMO was the first foreign firm to invest in an established fund management firm in China, picking up a 17 per cent stake in Fullgoal Fund Management Co. in 2003, and then boosting its interest to 28 per cent the next year.

Its partners in China are Haitong Securities Co. Ltd. and Shenyin & Wanguo Securities Co. Ltd.

The deal between China Minsheng and RBC had been rumoured since early this year.

Lewis yesterday said in an interview it took some time to find a third joint-venture partner, as required by regulators.

"This is a very long-term investment and initiative from our point of view, so taking the extra time to make sure we had a good fit with our partners and understood the business was important," Lewis said.

China Minsheng has 240 branches and outlets in China's major cities, ranking among the country's top 10 banks with widely held ownership.

While the joint venture with China Minsheng is not financially material to Royal Bank, it is important to the bank's overall strategy in China, Lewis added.

Banks around the world are flocking to take part in the massive economic growth China is experiencing as the government relaxes regulations over the financial services industry.

The relationships Canadian banks are establishing in China will come in handy as new opportunities present themselves, Legzdins said.

He explained that China has the highest savings rate in the world — about 40 per cent of income — building a savings pool of about $1.7 trillion.

"These are monies that are sitting in bank accounts not earning very much," he said, noting that much of the growth in Canada's mutual fund industry in the 1990s was fuelled by money coming out of bank accounts and other low-yield instruments.

China's high savings rate is a result of "the turmoil that they've gone through in past decades," Legzdins said, but now people are starting to feel wealthier.

"I think you're going to see a lot more of that money go out of very low-yielding deposits and instruments, into more aggressive investments," he said.

Last year, Chinese regulators granted approval for Chinese commercial banks to set up and manage their own funds. The banks were already the country's biggest distributors of mutual funds.

Competition has heated up a bit, but it's "not having a big impact yet," Legzdins observed, adding that the majority of funds sold by banks are still those created by other firms.

"They sell a little bit of their own. I think in time that will increase," he said.

While the Chinese mutual funds market is growing rapidly and regulations are easing entry, Legzdins suggested it won't all be smooth sailing.

"When we started with Fullgoal, we bought into one of the 10 original (Chinese) fund companies," he said.

"The industry has grown to now over 50 firms and there are another 20 seeking approvals or in negotiations.

"So, you're looking at an industry that is going to have 70 to 80 fund companies a year from now. And yet, you only have six to eight significant distributors, which are the banks. So, for people entering the industry right now, it's pretty tough to fight for shelf space."

BMO does not disclose its profits from Fullgoal, which now has 11 funds and assets of $2.5 billion. Legzdins described the joint venture as being "very profitable," even with Chinese financial regulators capping management fees on its equity funds at 1.5 per cent.

In June 2005, China's stock market hit an eight-year low, but "even when the market was going down, the fund industry expanded substantially," Legzdins said.

Stocks have since rebounded, and "the market has gone from $10 billion to about $65 billion in the last five years," he said.

"That kind of shows you what can be done."

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Bloomberg, Luo Jun & Doug Alexander, 30 October 2006

China Minsheng Banking Corp., the nation's fastest-growing bank, agreed to set up a 200 million yuan ($25 million) fund management joint venture with Royal Bank of Canada.

Beijing-based Minsheng Bank will own 60 percent of the venture while Royal Bank of Canada, that country's biggest bank, will control 30 percent, the Chinese firm said in a statement today. China Three Gorges Project Corp. will own the remaining 10 percent of Minsheng Royal Fund Management Co., based in Shanghai.

Royal Bank of Canada is joining Bank of Montreal and Allianz AG among other overseas banks that have set up fund ventures to tap China's $2 trillion of household savings. The Chinese government has been encouraging banks to set up fund management companies to diversify their revenue sources and increase the number of institutional investors in the nation's stock market.

Royal Bank invested about $7.5 million in the partnership to gain an entry into mutual fund asset management in China, RBC Management Chief Executive Officer George Lewis said today in an interview.

"This is a very modest investment on our part," Lewis said. "We recognize we will be learning more about the market and relying a lot on our local partner."

China's 49 fund companies managed 469 billion yuan of assets by the end of last year. Schroders Plc, JPMorgan Chase & Co. and Fortis AG are among foreign companies that have set up fund ventures in the country.

Bank of Montreal, Canada's fourth-largest lender, bought a 17 percent stake in Fullgoal Fund Management Co. in May 2003 through a venture with Haitong Securities Co. and Shenyin & Wanguo Securities Co. The bank increased its stake to 28 percent in 2004. Fullgoal had 20 billion yuan in assets at June 30th, and is the 11th largest in the country, according to Bank of Montreal figures.

"It's terrific for foreign firms to be entering the Chinese markets," BMO Investments CEO Ed Legzdins said today in an interview. "The more foreign players that are there, the better the Chinese fund industry will develop, and that'll benefit all of us."

Royal Bank also said today its RBC Capital Markets unit helped manage the sale of stock to institutional investors by the Industrial & Commercial Bank of China Ltd., in the world's biggest initial public offering.

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The Globe and Mail, Tavia Grant, 30 October 2006

Royal Bank of Canada said Monday it was a co-lead manager of the institutional tranche for the Industrial and Commercial Bank of China's estimated $21-billion (U.S.) initial public offering, the largest IPO in financial market history.

Bank of Montreal also confirmed it participated as co-manager in the ICBC offering, though it wouldn't give any further details.

Both Canadian banks are aiming to capitalize on growth in one of the world's strongest economies. China will further open its financial services industry and may raise the cap on foreign ownership in the industry, the country's central bank said Monday.

For Canada's largest bank, the move should serve as a springboard for further deals in China.

“It's viewed by the capital markets as a proxy investment opportunity for China as a whole,” said Doug Guzman, head of investment banking for Canada, Europe and Asia, in an interview. “It's important for us, as an institution, to have secured quite a senior role in the group.”

RBC officials wouldn't disclose details about the degree of their involvement in the IPO. It said it was in the second-tier of firms involved in the transaction but played a “significant role” in the transaction.

ICBC is the largest commercial bank in China in terms of total assets, loans and deposits. It serves more than 2.5 million corporate customers and has more that 150 million personal customers.

RBC has 20 employees in China, according to Edwin Ball, RBC's head of financial institutions in Europe, Middle East, Africa and Asia, and that number is almost certain to balloon in the years ahead.

“From a strategic point of view, you can't be a bank with global aspirations and not have aspirations in China,” Mr. Guzman said. “We are very, very actively thinking about what is the next step.”

In a press release Monday, RBC said it plans to make investments in areas such as global debt markets, global financial institutions, private banking and fund management.

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Sun Life Q3 2006 Earnings

BMO Capital Markets, 27 October 2006

Investment Thesis & Outlook – An Interesting Week

It has been an interesting week for SLF shareholders. On Monday, the company announced that it had concluded its strategic review of MFS and decided not to merge with any partners. The potential of finding a partner for MFS was a significant catalyst and the lack of a transaction deflated the shares. However, yesterday the company reported some of the strongest quarterly earnings results in years. Fully diluted EPS of $0.93 in Q3/06 compared with $0.82 in Q3/05, our estimate of $0.85 and the First Call Mean of $0.88. The higher earnings were driven by improved results in the U.S. and a higher contribution from the U.K. slightly offset by weaker than expected earnings in the other Canadian operations. Annualized ROE increased above 14% —the strongest result since the IPO.

In-force profits rose for the second quarter at 20%+ and excluding acquisitions, still rose at 16% in the quarter—a very strong result. Sales of protection products across all geographic segments and premiums & deposits also showed continued momentum from a good Q2/06. A benign credit environment, rising spreads, and good equity markets drove U.S. annuity earnings. The company achieved these excellent results while maintaining the highest level of reserves on seg fund secondary guarantees of CTE 80. Pre-tax margins at MFS rose to 30% and are projected to rise to 32% in 2007.

The Best Medicine for an Ailing Share Price: Improving ROE

Since upgrading the shares in June 2005, we have consistently indicated that a rising ROE was the key to improving shareholder returns. The “ROE-gap” has started to narrow between Sun Life and the other major Canadian financial services companies, which have ROEs in the high teens to low twenties. The company’s ROE languished relative to its peer group in Canadian financial services due to the acquisitions of Clarica and Keyport in 2001. Annualized ROE was 14.4% in Q3/06, up from 10.3% in 2003. Higher ROE should translate into higher valuations for the shares.

The ROE has improved for a variety of factors that have been underway for sometime but are becoming more evident now. These factors include the beneficial impact of the company’s share buyback program (34 million shares have been re-purchased since the end of 2003), improved efficiencies in the U.K., rising margins at MFS (MFS is a very high margin business), and improved productivity in Canada. ROE in Canada has increased from 12.0% in 2003 to an average of 14% in 2006. Also very importantly has been the improvement in profitability in the U.S. annuities operation which has benefited from improved spreads, benign credit, and good equity markets. ROE in the U.S. has improved from 7% to 12%. As importantly, SLF has been able to improve ROE despite some heavy investment required for Canada in distribution and technology as well as distribution initiatives in the U.S.

Although disappointed, the company did not find a partner for MFS, good quality quarterly earnings combined with solid new business growth create a favourable backdrop for earnings and ROE improvements in 2007. We revised our 2007 ROE estimate to 14.3% from 13.8%. Although we believe the company has some important operational challenges, key financial metrics are trending in the right direction.

The challenges mainly focus on the company’s U.S. wealth management operations: variable annuities and MFS. Gross sales of domestic variable annuities remain low but are rising. MFS remains in net outflows particularly in the mutual fund segment. While MFS is in the process of launching a number of new initiatives, which should help improve net flows, these initiatives only surfaced after a strategic review and after four years of net redemptions in U.S. mutual funds.

We expect to scrutinize the developments in the Clarica agency sales force. SLF initiated a productivity program in this distribution channel (i.e., weed-out unproductive advisors) but we believe that this process is largely complete and we expect to see growth in the ICA channel over the next few years.

Sun Life remains rated Outperform. Sun Life bought back 1.9 million shares in the quarter. We expect the company to remain active in its share repurchase program. Given good results in the quarter, we raised 2006E and 2007E EPS to $3.58 and $4.00 from $3.45 and $3.80, respectively. The higher earnings reflect higher expectations from U.S. annuities, the U.K., and a lower tax rate. A summary financial model is included at the end of this comment. We also increased the target price to $53 from $51, representing 1.8x 2007E BVPS and 13x 2007E EPS. SLF is the cheapest large cap financial services stock on a P/E and P/B basis in Canada.

Canada

Earnings in Canada increased 5% to $240 million from $228 million in Q3/05, and were lower than our expectations of $258 million, due to weaker results in individual life and group retirement services, which were somewhat offset by strong results in group benefits. Increased investment in distribution and IT systems also negatively affected earnings in the quarter. Premiums and deposits were $3.7 billion, up from $3.5 billion in Q3/05.

Results from group wealth rose 3% to $32 million from $31 million in Q3/05 due to increased income on higher AUM, which was offset by less favourable investment experience in the quarter (i.e., investment gains in Q2/06 were not as robust as in Q2/05). DC plan assets are 8% higher than the same quarter last year and are up 4% from the previous quarter due to stronger sales. Sun Life is the largest DC provider in Canada, with a 38% market share of DC sales in 2005 and leads the market with asset retention levels of four times its closest competitor for the 12 months ended June 30, 2006.

Earnings from individual insurance and investments declined 4% to $123 million in Q3/06 from $128 million in Q3/05 largely due to less favourable investment experience in Individual Wealth (similar to the experience in group wealth) and new business strain. Sales in individual life and health insurance were $38 million in Q3/06, up 6% from $36 million in Q3/05, but down from $42 million last quarter. The wholesale channel is gaining traction, while sales results were flat in the Clarica channel compared to the same quarter last year.

The earnings contribution from group benefits rose 23% to $85 million from $69 million in Q3/05, largely attributable to the favourable reserve impact of better cash-flow matching totalling $18 million and strong investment results, which were somewhat offset by unfavourable morbidity experience of $15 million. Gross sales are down 1% year over year, while business in-force increased by 11% from Q3/05. Retention rates remain solid: in excess of 97%.

Overall, growth in Canada is somewhat below expectations due to some heavier investments in infrastructure and distribution that should help drive earnings in future years. We continue to expect SLF Canada to generate earnings growth of 10% over time and generate an ROE of 15%. Over the last couple of years, the size of the company’s Clarica distribution channel has declined as it focused on agent productivity. We believe that this process is at an end and we will increasingly focus on growth in the Clarica channel. While we are encouraged by the company’s success in the third party channel, Clarica advisors remain key to its long-term competitive advantage.

U.S.

Earnings in the U.S. rose 11% to US$121 million compared with US$109 million in Q3/05, but increased only 2% in Canadian dollar terms due to the appreciation of the Canadian dollar. The stronger results were due to better equity markets, improved spreads in fixed annuities, benign credit and the favourable impact of the lower cost funding solution for UL product reserves in Individual Life. These were partially offset by higher new business strain and the reserve impact of increased reinsurance rates on new business in Individual Life.

Spreads within fixed annuities have increased to 202 basis points from 172 basis points in Q3/05. The rise in spreads reflect higher earned rates and the fact that rates on some multi-year guarantee business written by Keyport can now be reset. While clearly positive for parts of the fixed annuity block, reset periods on these multi-year agreements do not unfold in an orderly fashion. The favourable credit environment is also helping spreads. We expect spreads within fixed annuities to be roughly 180-190 basis points over the next few quarters.

Over the last year, Sun Life has issued roughly $2.7 billion of MTNs (including $900 million in Q3/06), or what we prefer to call institutional spread based products. We are not believers in these products because it is hard to develop and sustain a competitive advantage in this segment. Clients tend to be large institutions that are very price sensitive. We would prefer the company to build its business around the core retail annuity, individual life, and group benefits businesses as opposed to institutional, or wholesale, spread-based product. The company maintains that spreads meet targeted hurdle and return rates but we believe that the capital used for these products could be best used to support the other businesses or buyback shares.

The trend in sales of variable annuities appears to show very early signs of improvement. Net redemptions in domestic VAs continued to moderate to US$236 million from US$291 million in Q3/05 and US$277 million in Q2/06. While redemptions will likely remain steady given a relatively mature block of variable annuity assets, the key to net sales will be to reinvigorate gross sales. Gross sales were fairly flat in the quarter at US$547 million from US$545 million in Q3/05, although gross sales of domestic variable annuities rose 16%. Reserves on secondary guarantees remained at a level of CTE80 in the quarter, the same level as last quarter. The rise of the equity markets enabled SLF to maintain the highest reserves on secondary guarantees and release roughly $12-14 million in pre-tax earnings from reserves in the quarter.

Individual life reported earnings of US$22 million up 5% from US$21 million in Q3/05 largely attributable to the favourable impact of the lower cost funding solution for UL product reserves and a higher proportion of earnings from lower tax jurisdictions, partially offset by higher new business strain and reserve strengthening due to increased reinsurance rates. The company does sell substantial individual life sales in the offshore market. Sales results were very strong, increasing to US$150 from US$36 million in Q3/05 and US$97 million in Q2/06, primarily due to several large case wins in the COLI/BOLI channel, combined with a new core UL product launched in the quarter, which was re-designed and re-priced to help reduce sales strain. Excluding COLI/BOLI product sales, individual life sales rose to US$80 million in the quarter from US$29 million in Q3/05 and US$67 million in Q2/06. The new distribution arrangements announced by SLF appear to be gaining traction.

Earnings in the group life and health business rose 10% to US$11 million from Q3/05 due to improved claims experience, which was slightly offset by increased infrastructure investment. Business in-force in U.S. group life and health rose to US$1.1 billion in the quarter from US$928 million in Q3/05. Sales declined 12% to US$57 million from US$65 million in Q3/05 despite increased sales through the Medical Group Insurance Services partnership. New business growth should continue to provide a solid backdrop for earnings over the next couple of years.

MFS

MFS reported US$52 million in earnings during the quarter, improving from US$38 million in Q3/05 and US$47 million from last quarter. Revenues for the quarter were US$352 million versus US$342 million in Q3/05, reflecting higher average net assets in the quarter to US$170 billion from US$155 billion in Q3/05. The mix of assets continues to favour institutional products versus retail mutual funds (discussed below).

MFS recorded total net redemptions of US$0.1 billion in the quarter, as net outflows from retail mutual funds outpaced the inflows from institutional business. In the quarter net redemptions from retail mutual funds declined to US$1.2 billion, down from net outflows of US$1.6 billion in Q2/06, but up from net redemptions of US$0.7 billion a year ago. Institutional net inflows totalled US$1.1 billion, which is lower than the US$2.1 billion in net sales in Q3/05 and US$1.2 billion the prior quarter. The key to improving net sales is to drive gross sales as redemption rates will likely remain near current levels. The company is currently working on improving performance, focusing on marketing and sales as well as developing new products to capture market share in areas where it has not had a presence in the past (e.g. fixed income, international and global equity).

We continue to believe that MFS is an excellent franchise but the stubborn net redemptions in retail mutual funds are discouraging. While pre-tax margins continue to improve to 30% in the quarter from 27% last quarter and 22% a year ago, this is still lower than the industry average in the high 30s. MFS set a target margin of 32% by the end of 2007, which we believe is achievable, and is based on “normal” market growth of 5-6% in 2007.

Recently, Sun Life announced that it has concluded its strategic review process of MFS with no transaction at this time. While we believe there was significant interest in acquiring MFS, the challenge was finding the right partner. While it is disappointing that the strategic review concluded in this manner, we maintain that no deal is better than a bad deal. Nonetheless, the company’s mutual fund operations have experienced consistent net redemptions for at least the last four years. While the build-out of the company’s institutional platform has met with some considerable success, we continue to believe that MFS is at risk of becoming marginalized in the U.S. mutual fund business. During the conference call, MFS announced a number of new initiatives to improve its net inflows including using outside managers for different types of mandates. These outside advisors will manage MFS-branded funds and use the MFS distribution capabilities. These developments are certainly encouraging but we continue to believe that the future of MFS, and SLF’s investment, is more secure in a partnership.

Asia

Earnings from Asia increased to $13 million in the quarter from $10 million Q3/05 primarily due to the CMG Asia acquisition and business growth, which was somewhat offset by reserve strengthening in Indonesia. The CMG acquisition contributed to strong sales results in Hong Kong, which were up 111% in local currency from a year ago. In China, sales grew 149% from Q3/05 as the company opened three new sales offices in the quarter.

Sun Life’s Indian operations, while small, are expected to show good growth as it expands the direct sales force in the region. At the end Q3/06, the number of agents increased to 21,500, surpassing its target of 20,000 agents. While India offers significant long-term growth prospects, over the next 5–10 years, it is not expected to be a material contributor to earnings.

Corporate & Other

Earnings from the U.K. operations were $57 million during the quarter compared with $48 million in Q3/05 and our expectations of $45 million. The improved earnings were primarily due to the reimbursement of certain mortgage endowment costs, net of other provisions. The U.K. operations are in run-off and we believe that sustainable earnings from this operation are approximately $50-53 million per quarter, up from our previous estimate of $45 million per quarter. The reinsurance operations reported net earnings of $25 million in Q3/06 compared to a loss of $6 million in Q3/05, due to better mortality and the absence of reserve strengthening that occurred in Q3/05. The other operations reported a gain $12 million in the quarter versus a loss of $29 million in Q3/05, as results in the prior year were negatively affected by an after-tax loss of $51 million related to the sale of the company’s Chilean investment.

Credit Quality

Credit remains strong at Sun Life as net impaired assets declined to $111 million from $145 million in the previous quarter, and from $182 million in Q3/05. Net impaired assets as a percentage of invested assets were 0.11% in the quarter, down from 0.15% in Q2/06 and 0.19% in Q3/05. In addition, there was an increase in credit provisions of $4 million in the quarter, compared to a reversal of $3 million in the same quarter last year. We believe the company’s credit profile remains very strong.

A strong credit profile is supported by a strong capital ratio, with an MCCSR of 225% in Q3/06. The company repurchased 1.9 million shares in Q3/06 for $85 million, for a total share buyback of $484 million year-to-date. We continue to believe that the share buyback is the most appropriate use of capital and that Sun Life should continue to be active in its share repurchase program. We are projecting a share buyback of 12 million in 2007.

Conclusion & Recommendation

Sun Life remains rated Outperform. Overall, results were good in the quarter. In-force profits rose 21% in Q3/06 (15% excluding $16 million from CI’s conversion) and value of new business rose 4.5% (6.5% excluding MFS). Premiums and deposits rose 5% in Canada and 51% in the US driven by individual insurance and group. Pre-tax margins at MFS improved to 30% from 22% a year ago and net outflows improved to US$100 million, but the mutual fund operations continue to experience significant net outflows of US$1.2 billion. ROE improved to 14.4% from 13.1% a year ago and Sun Life bought back 1.9 million shares in the quarter. We continue to believe that the major capital allocation decision over the next 12 months will focus on the timing and size of share repurchases.

Given results in the quarter, we increased our 2006E and 2007E EPS to $3.58 and $4.00, respectively from $3.45 and $3.80, reflecting improved earnings from the U.S. (mainly due to better spreads in fixed annuities) and an upwards revision to the quarterly sustainable earnings estimate from the U.K. to $50-53 million from $45 million, combined with a reduced share count. Our $53 target price represents 13x 2007E EPS and 1.8x 2007E BVPS.

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Scotia Capital, 27 October 2006

• A good steady clean quarter - above consensus. Sun Life reported Q3/06 with $0.93 (fd) EPS, $0.03 per share above our estimate, and $0.05 above consensus. With about $0.03 per share in one-time reserve releases, we peg the underlying number at $0.90 per share, in-line with our estimate and $0.02 per share above consensus. After modest misses in Q1/06 and Q2/06 (incorporating a series of one-timers), we believe the relatively clean and respectable Q3/06 results, albeit assisted to some extent by buoyant equity markets, should help the stock "catch-up" in terms of valuation relative to its peers, namely Manulife and Great-West Lifeco.

• Increasing EPS estimates by $0.05 in 2007 and $0.03 in 2006 to reflect the "beat" in the quarter. Our EPS estimate increase reflects better-than-expected margin improvement at MFS, better-than-expected new business volumes in U.S. individual insurance, and larger than-expected asset values at the end of Q3/06 due to buoyant equity markets. MFS margins continue to improve at a faster clip than we anticipated, up from 22% (pre-tax) to 30% YOY and up from 27% in Q2/06. The distribution arrangements established earlier this year with the M Group and National Financial Partners (two large and well-established distributors in the U.S.) are certainly bearing fruit in terms of top-line growth in U.S. individual insurance, where sales were up over 300%, after nearly doubling in Q2/06. Finally, buoyant equity markets, especially in the U.S., up 5% QOQ in Q3/06 and a further 4% since the end of Q3/06, contributed to the increase in estimates. We forecast a 7% increase in yearly average levels of the S&P500 and the S&P/TSX in 2007, with Sun Life being more sensitive to changes in the S&P500. We estimate each 10% change in the growth rate for equity markets impacts our EPS estimate by approximately $0.20 per share.

• Multiple versus the group looking attractive - while valuation is certainly a "catalyst," a number of new members in the senior management team give Sun Life a "fresh new look." Sun Life is trading at a 7% discount to the average forward (NTM) P/E multiple of the Canadian lifeco group, well below its 4% average discount. Versus Manulife, Sun Life is currently trading at over twice its historical discount (currently Sun Life is a 15% discount on a forward P/E basis, versus its 7% average). We counted only three times the spread has exceeded 15%. Once, for two months shortly after Sun Life launched its IPO in 2000, another time, for two months in 2002 when 10-year treasuries in the U.S. fell below 4%, and another time, for nearly two months in the summer of 2006, as Sun Life shares fell to their 2006 lows in August. As well, two months ago Sun Life announced the addition of a new CFO (Rick McKenney, former CFO for U.S. insurer Genworth), as well as Stephan Rajotte (President, Sun Life Asia) and Dean Connor (Executive VP). We believe the compelling valuation, combined with a new fresh look to the senior management team, could be the necessary catalyst to move the stock, provided we continue to see quarters similar to the one we just saw in Q3/06.

• After strategic review of MFS, Sun Life decides to continue with current structure - citing opportunities in institutional market - looks to further improve margins to 32% (from current 30%) by end of 2007 . The company outlined the conclusions of its strategic review of MFS on the call. Management explained it came to the conclusion that MFS was very well positioned to grow and seek out opportunities, particularly in the global institutional marketplace, and that the economics of institutional and domestic retail were not significantly different (lower commissions, stickier assets). Institutional business makes up roughly one-half of MFS's assets, is a much larger potential market, and the company has taken advantage of its global institutional platform, where assets under management have increased 38% in the last 12 months. For the U.S. retail line, where the company is experiencing heavy redemptions in its growth category, MFS is opening up proprietary distribution to third-party products, and adopting funds that have track records and rebranding them MFS. Finally the company will continue to focus on cost containment, back office efficiencies, real estate, and outsourcing.

• Q4/06 MFS net flows will be negatively impacted by the media speculation in September/October 2006 - we've reflected this in our estimates. We forecast the rapid earnings growth rate in MFS in Q3/06 and YTD Q3/06, 36% and 32% respectively, to moderate to a 20% rate in Q4/06, to reflect an increase in net redemptions from US$100 million in Q3/06 to over US$1.3 billion in Q4/06. We believe our estimates are conservative.

• All in MFS appears to be on the right track - with earnings up 36% in the quarter and 32% YTD. MFS, which is only about 10% of Sun Life's bottom-line, has in-fact grown earnings (ex f/x) from 2004 through Q3/06 at a CAGR of 19%, faster than the Canadian division (10%) and at a greater clip than the entire company's EPS growth (14%).

• Canadian division (45% of bottom line) continues to be weak - with earnings up 5% YOY and 4% YTD. The Canadian market continues to be very competitive, and, despite being on the verge of an oligopoly, the market is not behaving as such. Excluding reserve releases (about $0.03 per share, due to cash flow methodology refinements in the group benefits segment), earnings were down 1% YOY in the quarter, as claims experience was slightly worse than normal (by about $0.02-$0.03 per share). Earnings were up just 8% in 2005 (7% excluding the contribution from CI funds), and we believe that earnings growth will be in the mid-single digit range through 2008. We expect 6% growth in 2007 and 2008. Group businesses continue to be the bright spot, with exceptional sales growth and increasing profitability. Individual insurance sales, up 6%, continue to pace ahead of the market, but pricing remains very competitive.

• U.S. division (25% of bottom line) - up 11% (ex f/x) YOY and up 10% YTD - we look for 12%-13% earnings growth in 2007, as the strain issue subsides. As the early August 2006 re-pricing has dealt with the Q2/06 individual insurance strain issue, we expect modestly appreciating equity markets (expected to be up 7% per annum) and continuation of the current high level of interest rates to help propel the bottom line, helped to some extent by continued strong individual sales (tripled in Q3/06 YOY, and doubled in Q2/06 YOY) and good variable annuity sales (domestic gross sales up 16%).

• Buybacks and CMG Asia acquisition help the company achieve its 10% EPS growth - we are introducing 2008E EPS estimate of $4.35. We look for 11% EPS growth in 2006 and 2007 and 10% growth 2008, which combined with aggressive buyback levels should add 100 bp to ROE over the next two years, just shy of the company's target of 75 bp per year.

• Asset quality remains strong. Net impaireds at 11 bp remains exceptionally low. With only 3% of bonds below investment grade, we believe Sun Life’s balance sheet is well protected should the credit environment become unfavourable.

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RBC Capital Markets, 27 October 2006

Strong Result Amid Rising Volatility – Raising Estimates 6% and Target by 8%

Sun Life beat consensus by 7% this quarter, impressive after the rather weak result last quarter. In our view, certain of the divisions reported above trend (e.g. U.S. Annuities and Domestic Group Benefits), however, on the whole the result was solidly above expectations. Strong equity markets and improved fixed income spreads were significant factors. Management also cited efficiency gains, such as 300 fewer employees in the domestic operation, among others. We do believe there was a small benefit from a variable annuity guarantee reserve release, perhaps in the 1¢ range, but not enough for which to make an adjustment. Overall, we gave serious consideration to a rating upgrade from Sector Perform to Outperform, but based on: (i) our lack of EPS estimation confidence combined with (ii) higher total return outlooks for others in the sector, we stayed with our current rating.

Raising Estimates. We are raising our 2006 estimate 6% from $3.44 to $3.65, and our 2007 estimate rises 6% to $3.91 from $3.70. We are also lifting our price target from $49 to $53. This is set at 12.5x our new 2008 estimate of $4.25. It is also roughly in line with our previous method of targeting 14x our 4-quarter forward earnings estimate, now raised to $3.84. Thirdly, the $53 target is 1.79x our projected book value of $29.57 as at Q4/07, again roughly in line with today’s valuation of 1.75x.

MFS Ordeal is Over. Management confirmed the MFS strategic review was never in contemplation of an outright sale, rather just to choose between a joint venture option and a go-it-alone strategy. It seems that MFS will now remain with Sun Life and we do not expect there are any ‘Plan B’s’ in motion, such as an IPO or other, at least not until management has a chance to stabilize flows.

Expecting Higher EPS Volatility. While we can identify no major “items of note” this quarter, we do see continued volatility in Sun’s earnings, in particular on a divisional basis. Factors include wide shifts in the tax rate and sales strain, both largely dependent on product mix. Increasing sensitivity to equity markets and bond yields is also at play as the U.S. wealth division profit margins improve.

Corporate Division and Annuities Were Big Positive Variance Against Our Model. Sun registered positive variances versus our model across four of six divisions: (i) U.S. Annuities (5¢ on positive spread and equity-related reserve gains, both are unlikely to repeat to the full extent in future quarters); (ii) Corporate (7¢ on a more normal earnings level from reinsurance and the closed U.K. block of business); (iii) MFS (1¢ on improved margins); (iv) U.S. life (2¢ from a variety of items, likely sustainable in aggregate). U.S. individual life net income improved $10 million more than expected to $25 million, but the underlying remains clouded by heavy sales strain as reflected in unusually high sales, likely unsustainable, and an offsetting AXXX reinsurance funding gain. Earnings from Canada and Asia came in a collective $28MM below our estimated level (5¢) on a combination of sales strain and reserves taken. Fortuitously, the company-wide tax rate at 22% looks closer to the new sustainable range, and while down from ~28% a year ago, was still well above the most recent quarterly tax rates.

Canada – Earnings of $240M - 44% of Total – Up 5% YoY – We See Moderate Growth in 2007

SLF Canada missed our estimated contribution by about 5% this quarter. SLF reported Q3/06 earnings of $240M, 5% below our estimate of $251M, but up 5% YoY. By our calculation, half the realized growth rate can be attributed to a low tax rate. The divisional tax rate of 26.7% in Q3/06 was down from 29.7% in Q3/05 and accounted for ~$7M of the $12M YoY increase in earnings. Normalizing the tax rate would imply a 2% YoY growth rate. The trailing 6-quarter average earnings growth rate for this division is 6.8%.

Sun’s Canadian business is underpinned by the Individual Insurance operation, which has contributed 60% of divisional profit year-to-date (27% of overall company net income). Individual insurance profit dipped 4% YoY, and was also down 20% from the H1/06 run rate of $153 million. The sequential decline likely reflects a significant pull-back in the CI Funds contribution, expected down on lower gains this quarter (CI Funds does not report until next quarter, so Sun ‘buried’ an undisclosed ‘estimate’ of the CI profit this quarter, pending the public release next week).

Following in the footsteps of competitors IAG and GWO last quarter, SLF also felt the sting of increased sales strain this quarter. This, we estimate in the $10 million range on its level COI universal life product sales, hinting to us just how very competitive the Canadian market has become. Domestic insurance sales of $38M were up 6% YoY from $36M in Q3/05 and in line with our estimate of $38M. Clarica, the direct distribution channel sales of $30 million remained flat YoY and in line with our estimate of $31 million. The independent channel sales at $8 million, while up 33% YoY, have yet to make a break-out, tracking the same level as the prior two quarters. Looking forward, we expect this division has modest upside.

The domestic Group Benefits division was a star this quarter, growing earnings 23% YoY to $85 million to match its Q4/05 record level. Strong investment income was the driving factor, although the 97% retention rate and an 11% lift in business in-force were also solid underpinnings. This division now contributes 15% of profit. Group health sales of $70M were in-line with Q3/05 sales of $69M and down from $155M in Q2/06. Group health earnings and sales tend to be lumpy from quarter to quarter. Our Q4 earnings estimate for the division is $75 million, assuming added morbidity and less robust investment income.

The domestic Group Pension division (GRS) earned $32 million, up $1 million YoY to contribute 6% of earnings, level with the year ago result. We are factoring a $35 million contribution next quarter.

SLF U.S. Division - Earnings of $121M – 22% of Total and Up 11% YoY – Near a High Water Mark

Sun’s U.S. earnings benefited from the strong equity market performance and unusually high annuity spreads. We also think the division spawned a $7 million variable annuity reserve release, roughly 1¢ / share. Management confirmed this is probably the last quarter in which there will be any measurable earnings release from annuity guarantee reserves.

Management disclosed that the annuities division earnings pick-up division from these two factors was ~$15 million or 3¢ EPS. We expect these macro-factors will continue to be the principal earnings drivers for the U.S. division in the next few quarters. We estimate that every 10 bps change in US division annuity spreads is worth $2 million in after-tax earnings and that every 10 points on the S&P 500 is worth ~$8 million in annuity fee earnings.

We also anticipate annuity and fund redemptions will persist for a while yet. The Q3/06 total was another US$1.2 billion in fund redemptions, well into the high end of the range of the past couple of years. Worse, MFS may be poised to lose more momentum in mutual fund sales and institutional mandates starting this quarter as fall-out from their very public strategic review.

U.S. Insurance Bolstered by Lower Quality COLI/BOLI Sales. U.S insurance sales of US$150 million, were up 3-fold, roughly double our estimate of $70 million. SLF reported US$70 million of wholesale COLI/BOLI sales, $55 million higher than our estimate of $15 million. COLI/BOLI is a wholesale form of business insurance, typically lower margin than individual. The very high individual sales at $80 million beat our $55 million estimate, likely owing to continued off-priced product with key distributors. Insurance sales spiked up on Sun’s now-out-of-date pricing model, so we expect should revert lower to a more sustainable range starting next quarter. The higher-gain cost of new business sales strain was largely offset by an AXXX funding benefit, so the underlying insurance contribution was probably near a normal run-rate.

Watching for Annuity Earnings To Level Off Here. Contributing about 16% of overall Sun Life profit, we believe the annuity division earnings are near a high-water mark, at least until flows turns positive. We are anticipating a slight decline in annuity earnings next quarter to US$80 million from the $89 million just realized as (i) spread normalizes and (ii) no more reserve guarantee releases. The annuities sales force has yet to gain traction despite some eight-five wholesalers in the market. One would think this has got to improve in 2007, but we have no real visibility yet – net redemptions remained near all-time highs.

We are factoring a flat contribution from the U.S. individual and group life & health businesses in Q4/06 at about 7% of total earnings.

MFS – Earnings of $58M – 11% of Total – Up 26% YoY – Now Also Reaching Potential

MFS registered a 300 bps improvement in operating margin (i.e. from 27% to 30%) on fixed cost leverage, in part driven by the market-driven AUM gains. Management signaled that the 30% operating margin is nearing potential, which they indicated and targeted at 32% for next year.

Revenues do not appear to be growing, flat in USD and down 7% in CAD, though this just reflects the mix shift to institutional from retail.

Mutual fund redemptions remained surprisingly high at US$1.2 billion, while the US$1.1 billion in new institutional mandates nearly offset the retail outflows. The MFS game plan to go after international institutional mandates is working very well, but now management should apply that magic to their mutual fund business.

SLF Asia - Earnings of $13 million – 2% of Total – Set To Rebound Slightly

SLF Asia earnings were down roughly 50% from the prior two quarters on a reserve strengthening taken in the Indonesian operation. We would expect this to normalize next quarter, helping earnings rebound $8 million to $21 million. Revenue grew 58% YoY driven by the recent Hong Kong-based acquisition of CMG and fast-paced expansion in both India and China. Sales were up 53% in CAD. Under normal circumstances, SLF Asia should be contributing about 5% of total earnings, but growing at twice the pace of the parent company.

Corporate Division - Earnings of $94M - 17% of Total – Up 67% YoY – Probably at Full Potential

SLF U.K. earnings on a closed block of business were $57 million, up 50% YoY owing to the reimbursement of certain mortgage endowment costs. We are assuming this is a fair indication of a run-rate for our forecast period. Reinsurance profit improved to $25 million from a very low level a year ago, but similar to last quarter and the divisional run rate, in our view. Better mortality and absence of reserve strengthening in the prior year were the YoY drivers.

Valuation

Our new $53 price target, up $4, is set at 12.5x our new 2008 EPS estimate of $4.25. Our Sun Life target P/E is set a half multiple below our 13x sector target P/E to reflect Sun’s growth challenges in domestic insurance and U.S. wealth (annuities and mutual funds). We also believe Sun’s financial performance is more sensitive to interest rates and equity markets, in most part through the U.S. annuity portfolio, than for the peer group. Last, we are layering in consideration for a lack of transparency on earnings. In our view, the extreme volatility in segment earnings is creating a serious challenge to earnings predictability. Impediments to achievement of our target price include: (i) another round of extra-low interest rates; (ii) an equity market correction; (iii) poor execution on the U.S. Annuities sales turnaround and/or domestic independent retail insurance platform re-build.

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The Globe and Mail, Andrew Willis, 27 October 2006

Some of Sun Life Financial Inc.'s clients have a rather high opinion of their worth. This month, the company began offering $100-million of life insurance to individuals, the largest single policy ever flogged in this country, as part of a push to be a market leader with the country's richest families.

Offering massive amounts of insurance to entrepreneurs and business owners is part of Sun Life's drive to win over wealthy clients and differentiate its products in a sector where one insurer looks a lot like the next. Policies this large can be a tax-efficient way to move money from one generation to the next. In the past, an agent who wanted to buy this much coverage would typically have been forced to buy a series of $20-million policies.

"If you look at the enormous wealth creation that's taken place in Canada, with Calgary entrepreneurs for example, you can see there's a need for this type of service," said Sun Life chief executive officer Donald Stewart, who has already signed off on policies this big at the company's U.S. and Bermuda operations. He added: "Sun Life has been a leader in the high-net-worth category in the U.S. and we're bringing that expertise to this market."

Sun Life's coffers won't be drained if it writes a $100-million cheque to a bereaved spouse, as the risks are shared with three reinsurance firms.

Increasing insurance sales and improved money management boosted Sun Life earnings, released yesterday, to a record $541-million in the third quarter, a profit of 94 cents a share that topped the 88-cent consensus forecast.

Mr. Stewart forecast both profit and Sun Life's return on equity will improve in 2007, partly because the company's investment in Asia should begin to pay off.

Profit from Canadian operations, the largest segment, was up 5.3 per cent from the previous year to $240-million, while the U.S. division earned $136-million, up 2.3 per cent. Asian earnings jumped by 30 per cent, but amounted to just $13-million, as Sun Life continues to build networks in India and China.

Sun Life boosted its return on equity to 14.4 per cent, up from 11.5 per cent a year ago, and the company is targeting 15-per-cent-plus ROE for next year. UBS Securities analyst Jason Bilodeau said U.S. and Canadian insurance sales were strong, amid intense price competition in the American market. He said, "Sun Life continues to make progress against objectives."

Sun Life's profit margins trail those of domestic rivals, which have larger U.S. operations. Manulife Financial Corp. posted ROE of 16.3 per cent in its most recent results, while Great-West Lifeco Inc. came in at 20.2 per cent.

This week, Sun Life ended talks with potential buyers of its U.S. mutual fund arm, MFS Investment Management. Rather than sell the company for a minority stake in a larger player, Sun Life opted to try improving fund performance.

Analysts have said Sun Life could do an initial public offering of a portion of MFS, to demonstrate the value of a company with $175-billion (U.S.) in assets that's currently buried within Sun Life. Mr. Stewart said an IPO is not in the cards. "Our clear priority at MFS is to focus on improving operations. Anything else we undertake, such as an IPO, would only be a distraction."

Profit at Boston-based MFS rose 26 per cent to $58-million, driven by a rise in international fund sales. Sun Life disclosed the division results earlier this week.

Mid-sized U.S. insurers such as UnumProvident Corp. have been mentioned as takeover targets, with Sun Life seen as a potential buyer. Mr. Stewart said Sun Life has the capital for large acquisitions, and further consolidation is expected in the insurance market. But the CEO cautioned: "We're always looking at a number of potential deals, but we have a strong discipline that we bring to any transaction."

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Financial Post, Duncan Mavin, 27 October 2006

While speculation about the future of MFS Investment Management mounted in recent weeks, the Boston-based company was growing assets under management and recording a jump in earnings that contributed to a record quarter for parent Sun Life Financial Inc.

"The results this quarter are a little ahead of plan, but the plan to improve margins at MFS has been around for the entire year," said Don Stewart, Sun Life's chief executive.

"The strategy at MFS is to stay focused, because inevitably speculation can be distracting," Mr. Stewart said.

MFS has struggled in recent quarters because of high expenses relative to its peers as well as net redemptions. Analysts have also said the value of MFS -- estimated at between $4.5-billion and $5.5-billion -- was not adequately reflected in Sun Life's share price.

In September, Sun Life revealed it was reviewing "alternative strategies" for the unit. However, when the strategic review concluded on Monday with the announcement that Sun Life will hang on to MFS after all, some investors were disappointed and Sun Life's stock drooped.

But MFS' third-quarter results -- including a profit margin up to 30% from 22% last year -- could mark a turnaround for the unit.

MFS delivered net income of US$52-million for the third quarter of 2006, up 37% from US$38-million last year. Assets under management grew to a record US$175-billion. The company is expected to reduce costs further in future quarters through a variety of measures, including outsourcing some areas.

"Despite some disappointment at not being able to sell part of MFS, it really posted quite strong results," said Tom Kersting an analyst at Edward Jones Investments.

Mr. Kersting said Sun Life's wealth-management businesses including MFS in the United States and its interest in CI Financial in Canada are "something a little unique that not all life insurance companies offer."

Mr. Stewart said it was never Sun Life's intention to sell all of MFS, whose future has been the subject of "an unusual amount" of speculation.

"I saw the phrase 'on the block,' used for MFS and that was simply not the case," Mr. Stewart said.

For Sun Life as a whole, "it was solid growth across all divisions," said Edward Jones' Mr. Kersting.

Sun Life produced record earnings of $541-million, or 94 cents a share, up 26% from $430-million, or 74 cents, a year earlier.

Net income growth came from across Sun Life's geographic markets, Mr. Stewart said. There was particularly strong growth in the group benefits division in Canada and at operations in China and India. Results were also helped by stronger equity markets.

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Bloomberg, Sean B. Pasternak, 26 October 2006

Sun Life Financial Inc., Canada's second-largest insurer, said third-quarter profit increased 26 percent to a record, led by its U.S. money manager MFS Investment Management.

Net income climbed to C$541 million ($482 million), or 94 cents a share, from C$430 million, or 74 cents, a year earlier, the Toronto-based company said today in a statement. The shares rose as profit beat analysts' estimates.

Higher institutional fund sales and a rally in stocks boosted earnings at Boston-based MFS by 26 percent to C$58 million. Sun Life said Oct. 23 it plans to keep MFS after hiring investment bankers last month to find a partner for the unit, which manages the oldest U.S. mutual fund.

"Our strategic review did not include the possibility of an outright sale," Sun Life Chief Executive Officer Donald Stewart told investors today. He said there are no plans to change the MFS ownership structure.

A rise in equity markets increased MFS's assets under management 11 percent to $175 billion. That offset $100 million in redemptions during the quarter, compared to $1.4 billion in net sales in the year-earlier period. Redemptions slowed from $400 million in the second quarter. MFS's revenue fell 4.1 percent to C$395 million as the Canadian dollar gained against the U.S. currency.

Shares of Sun Life rose 79 cents, or 1.7 percent, to C$46.26 at 4:10 p.m. in trading on the Toronto Stock Exchange. They've fallen 1 percent this year, compared with an 8.2 percent increase for the 38-member S&P/TSX Financials Index.

MFS has started to rebound after four years of withdrawals from its mutual funds. Individual investors began pulling money because of poor growth-fund performance during the 2000-2002 bear market and continued after the company's involvement in a mutual-fund trading scandal and undisclosed sales payments to brokers.

Stewart said this week there was a "high degree of interest" in MFS. Analysts including Robert Wessel at National Bank Financial said the insurer may instead sell a stake in MFS through an initial public offering.

"If they manage to spin that off that would be quite positive," said David Cockfield, who holds Sun Life shares among the $1.1 billion he helps manage at Leon Frazer & Associates Inc. in Toronto. "The mutual fund business is not a great place to be."

Sun Life said profit from Canada rose 5.3 percent to C$240 million on gains in the group benefits business. Earnings from the U.S. insurance arm increased 2.3 percent to C$136 million, while profit from Asia rose 30 percent to C$13 million. Overall revenue rose 20 percent to C$6.6 billion.

Earnings in the year-ago quarter were reduced by C$51 million because of the sale of its investment in Chilean pension fund Administradora de Fondos de Pensiones Cuprum SA. Excluding one-time items, Sun Life said profit was 94 cents a share.

Wessel was expecting 87 cents a share. The company was expected to earn 88 cents a share, according to the average estimate of six analysts surveyed by Bloomberg.

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TD Banknorth Q3 2006 Earnings

BMO Capital Markets reduced estimates for TD Banknorth by about 5%, on the back of third quarter results. It noted that TD Banknorth continues to grapple with competitive deposit pricing and mediocre loan growth. The reduced estimates amount to a negative impact of $0.02 per share to TD Bank’s earnings for 2007.

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Analysts at Cohen Bros reiterate their "hold" rating on TD Banknorth. The target price has been reduced from $31 to $30.

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Scotia Capital, 26 October 2006

TD Banknorth Q3/06 Earnings - Low End of Management Guidance

• TD Banknorth reported Q3/06 cash earnings of US$0.51 per share versus US$0.56 per share in the previous quarter and US$0.63 per share a year earlier, the low end of management guidance. Consensus was US$0.52 per share.

• On September 12, 2006 BNK had warned that third quarter earnings would be in the range of US$0.51-US$0.54 per share, versus the previous average estimate of US$0.58 per share.

• Reported earnings were US$0.38 per share and included the following after-tax items: US$0.10 per share for the amortization of intangible assets, US$0.04 per share for merger and restructuring costs, and US$0.01 per share related to the gain from discontinued operations.

• Operating EPS continues to be negatively impacted by earnings dilution from the acquisition of HU. The bank issued 62 million shares in conjunction with the HU acquisition (partly offset by the repurchase of 8.5 million shares) with weighted average diluted shares increasing 31% YOY to 229.1 million in Q3/06 compared to 174.4 million a year earlier and 228.8 million in the previous quarter.

• Also impacting earnings this quarter were higher loan loss provisions of US$13.8 million versus US$8.7 million in the previous quarter (after tax impact of US$0.01 per share), higher advertising and marketing expenses of US$12.7 million versus US$10.0 million in the previous quarter (after tax impact of US$0.01 per share) and a litigation reserve of US$3 million (after tax impact of US$0.01 per share).

• BNK continues to suffer from margin compression due to competitive deposit pricing, inverted yield curve and intense competition for high quality loans.

• TD Bank indicated that BNK's contribution this quarter would be C$63 million or C$0.09 per share versus C$68 million or C$0.09 per share in the previous quarter and C$69 million or C$0.10 per share a year earlier.

Net Interest Margin Declines

• Net interest margin (NIM) for the quarter declined to 4.01% from 4.07% in the previous quarter and from 4.09% a year earlier. The decline in NIM was primarily due to competitive deposit pricing, inverted yield curve and intense competition for high quality loans.

• The bank expects margin compression to remain a challenge and indicated that net interest margin might not hold at the 4.00% level in the fourth quarter, and potentially deteriorate in 2007.

Loan & Deposit Growth

• Average loans increased 28% YOY mainly due mainly to the HU acquisition. Organic loan growth was approximately 5.5% YOY with commercial loan growth stronger than consumer loan growth. On a QOQ basis, loan growth was 0.5%, slow due to competitive pressures. Management indicated that loan growth for the year would more likely be in the range of 4.5% to 5.5%.

• Average deposits increased 34% YOY due to the HU acquisition. However, organic deposit growth was flat YOY primarily due to continued competitive deposit pricing, and increased only 0.8% QOQ.

Revenues Decline Sequentially

• Total operating revenues (excluding securities gains/losses, and losses on derivatives) increased 22% YOY to US$429.4 million versus US$352.3 million a year earlier. However, operating revenues declined 1% QOQ with net interest income declining 2% QOQ and noninterest revenues increasing 1% QOQ.

• Non-interest revenues (excluding securities gains/losses, and losses on derivatives) increased to US$128.3 million from US$127.0 million in the previous quarter and from US$103.3 million a year earlier, primarily due to the HU acquisition.

Operating Expenses Increase 4% Sequentially

• Non-interest expenses increased 34% YOY (excluding amortization of intangibles and merger and restructuring costs) to US$240.5 million from US$179.5 million due to increased Hudson United-related operating expenses.

• Organic non-interest expense (excluding amortization of intangibles and merger and restructuring costs) increased 4% or US$8.5 billion from the previous quarter.

• Cost saves from Hudson United were offset by higher advertising and marketing expenses which increased $2.7 million or 27% QOQ. The bank mentioned that third quarter expenses also included a litigation reserve of $3 million related to a pending suit, and also indicated that they would not expect this litigation reserve to be there in the fourth quarter.

Loan Loss Provisions

• Loan Loss provisions (LLPs) were US$13.8 million or 0.21% of loans compared to US$8.7 million or 0.14% of loans in the previous quarter and US$5.5 million or 0.11% of loans a year earlier. Management indicated that loan loss provisions would mostly likely be at the same level in the fourth quarter.

• Total non-performing loans (NPLs) in the third quarter were US$91.8 million or 0.36% of total loans compared to US$89.0 million or 0.34% of total loans in the previous quarter and US$64.0 million or 0.32% of total loans a year earlier.

• Non-performing assets (NPAs) were US$93.8 million or 0.24% of total assets versus US$91.2 million or 0.23% in the previous quarter and US$66.9 million or 0.21% a year earlier.

Tier 1 Capital Ratio at 8.2%

• Tier 1 risk-based capital ratio was 8.2% versus 7.9% in the previous quarter and 8.5% a year earlier. Total risk-based capital ratio was 11.4%, versus 11.2% in the previous quarter and 11.7% a year earlier.

Fourth Quarter Earnings Guidance

• Management indicated on the conference call that they expect fourth quarter earnings to be in the range of US$0.51 - US$0.54 per share. IBES estimates are currently US$0.53 per share. Bharat Masrani to Take on Greater Role at TD Banknorth

• On October 23rd, BNK announced that Bharat Masrani will assume the role of Chief Executive Officer effective March 1, 2007 in addition to his role as President to which he was appointed on June 23, 2006.

Recommendation

• Our 2006 and 2007 earnings estimates for TD are C$4.67 per share and C$5.15 per share, respectively.

• Our 12-month share price target on TD is $78 representing 15.1x our 2007 cash earnings estimate.

• Maintain 2-Sector Perform rating on shares of TD Bank.

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RBC Capital Markets, 26 October 2006

Event

3Q06 Operating Cash EPS of $0.51 Per Share, $0.02 Below Our Estimate, $0.01 Below Consensus

Investment Opinion

• Earnings Summary: 3Q06 operating cash earnings declined by 19% year-over-year and 8.9% sequentially.

• Modest Margin Pressure: BNK's margin decreased 6 basis points sequentially to 4.01% due to higher deposit and borrowing costs. Modest margin pressure is expected to persist over the next couple of quarters.

• Loan Growth Trends: Commercial business loans increased by 0.3% sequentially, while consumer and residential loan balances contracted by 0.6% and 2.6% respectively during the quarter. We expect only moderate loan growth over the next several quarters due to extremely competitive pricing for high quality lending opportunities.

• Core Fee Revenue Pressure: Core fee income declined 4.4% sequentially, driven mostly by contracting insurance fees and merchant banking fees. Only moderate overall fee revenue growth is expected in upcoming quarters due to slowing deposit and loan growth, which is expected to result in slower growth in deposit and loan fee revenue.

• Asset Quality Held Steady: Non-performing assets increased by 2.8% sequentially to $93.8 million, and held relatively steady sequentially at 0.24% of total assets. Reserves remained healthy at 1.10% of total loans vs. 1.07% at the end of the prior quarter. We expect asset quality to remain stable for the remainder of 2006, though modest deterioration is expected in 2007.

• Adjustments: We lowered 2006E/2007E operating cash EPS estimates to $2.13 and $2.12 per share from $2.18/$2.34 per share to reflect reduced loan and fee revenue growth and ongoing margin pressure.

• Thoughts On The Stock: The operating environment is likely to remain challenging for BNK for the next couple of quarters. We are now forecasting a 14% contraction in cash EPS in 2006 and essentially flat cash EPS in 2007. At 14x our current 2007 cash EPS estimate, we view the stock as fairly to fully valued, and we view the company as an ongoing acquirer. Therefore, we would continue to avoid the stock.

• Rating: The stock trades at a modest premium to our price target of $28 per share, justifying our Sector Perform rating with Average risk, in our opinion.

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Financial Post, Duncan Mavin, 26 October 2006

Toronto-Dominion Bank's stuttering U.S. growth plans ground to a halt yesterday as TD Banknorth revealed slipping quarterly earnings and a grim outlook for 2007.

TD Banknorth chief executive Bill Ryan said tough competition and unfavourable interest rates are forcing the bank to reduce prices and "aggressively" cut costs.

He also said the bank's acquisitive growth strategy is "pretty much shut down." TD Banknorth has spent US$2.5-billion to buy two banks this year and had targeted up to two more major purchases each year.

However, those plans now look to have been put on hold in the face of a dearth of acquisition targets and weak results.

The Portland, Maine-based bank's third-quarter profit fell to US$86.1-million, down from US$88.7-million last year.

TD, which owns 56% of TD Banknorth, will see its share of the U.S. bank's earnings this quarter slashed to $63-million from $69-million last year.

Looking to 2007, Mr. Ryan said management has not yet calculated the amount it plans to squeeze out of the banks costs. He said savings will come partly through automating some processes, such as credit approval.

"When you are under the price pressures that banks are under right now, you better be watching the little things and making sure they are in order," he said.

The bank will also close between 10 and 20 branches, and reduce prices on loans and other products to compete with local banks in the fragmented U.S. banking sector, said Mr. Ryan.

The belt-tightening forecast did not offer much hope to investors looking for improvements from TD's U.S. retail banking, which has now seen declining earnings in five of the past six quarters.

Genuity Capital Markets analyst Mario Mendonca called the outlook for TD Banknorth "dour" with management signaling a tough year ahead.

"Both interest rate conditions and the competitive environment for balance sheet growth are not showing signs of improving," said Mr. Mendonca.

Morgan Stanley analyst Paul Delaney forecast a "tepid" 2007 with "poor organic growth prospects."

Earlier this week, TD Banknorth also announced that TD's Bharat Masrani will take over from Mr. Ryan as chief executive in March 2007. The bank said Mr. Masrani will take over running the day-to-day operations at the bank, freeing up Mr. Ryan to look for acquisitions.

The move surprised many analysts because TD has previously trumpeted the strength of the local management team, and because Mr. Masrani does not have a retail banking background.

However, Mr. Ryan said Mr. Masrani is the best person available for the CEO position. He also said Mr. Masrani's appointment was "not forced down our throat by our parent in Canada," and cited health concerns for his own stepping aside.

TD Banknorth's results followed disappointing earnings reported by TD's other U.S. venture, TD Ameritrade.

The discount brokerage in which TD has a 39.5% stake reported adjusted earnings per share of 20 cents a share compared to analysts' expectations of 22 cents a share, with competition a significant factor. The Omaha, Nebraska-based brokerage has cut the price it charges for trades to keep up with similar cuts at rival brokerages.

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Bloomberg, Sean B. Pasternak, 25 October 2006

TD Banknorth Inc., the U.S. consumer-banking unit of Toronto-Dominion Bank, said quarterly profit fell for the fifth time in six quarters after it set aside more money for bad loans and advertising costs rose.

Profit fell to $86.1 million, or 38 cents a share, from $88.7 million, or 51 cents, the Portland, Maine-based bank said today in a statement. Earnings met the bank's revised estimate.

Non-interest expenses increased 39 percent to $294 million, mostly because of higher salaries and advertising costs following the $1.9 billion acquisition of Mahwah, New Jersey- based Hudson United Bancorp. The bank plans to reduce costs and halt acquisitions, after making 27 purchases in 13 years.

"Our strategy of buying banks in the near future is pretty much shut down," Chief Executive Officer William Ryan said on a conference call.

TD Banknorth shares fell 29 cents to $29.53 at 4:01 p.m. in New York composite trading. Toronto-Dominion rose 54 cents to C$64.43 on the Toronto Stock Exchange.

Before one-time items such as acquisition costs, profit was 51 cents a share. The bank said on Sept. 12 that higher costs for deposits and marketing would lead to earnings of 51 cents to 54 cents on that basis. That was below the average analyst estimate of 58 cents, according to Thomson Financial.

Profit will be between 51 cents and 54 cents a share in the fourth quarter as well, said Ryan, who plans to step down as CEO in March, and stay on as chairman until 2010.

The bank's net interest margin "is suffering under increased competition on both the deposit and loan side," he said.

TD Banknorth, which operates in the New England states, as well as New York and New Jersey, said revenue rose 22 percent to $429.4 million as loans and deposits rose from the Hudson United purchase. The bank set aside $13.8 million for bad loans, more than twice as much as the year-earlier quarter.

Merger and restructuring costs soared to $14.1 million, from $1.1 million.

TD Banknorth President Bharat Masrani was appointed this week to replace Ryan, 62, who said "health issues," contributed to the change.

Toronto-Dominion, which bought a controlling stake of TD Banknorth last year, has said it will buy up to two-thirds of the bank over an unspecified period. Toronto-Dominion, Canada's second-biggest bank by assets, said that TD Banknorth will add C$63 million ($56 million) to profit when the bank reports earnings on Dec. 8.

The bank said yesterday that TD Ameritrade Holding Corp., the third-largest online broker, will add C$53 million to profit. Toronto-Dominion is the largest shareholder of TD Ameritrade.

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RBC to Acquire Carlin Financial Group

The Globe and Mail, Boyd Erman, 26 October 2006

With brokerages increasingly focused on providing fast trading services to hedge funds, Royal Bank of Canada's securities arm is bulking up by buying a New York-based firm that specializes in helping small funds make big trades.

With the purchase of Carlin Financial Group, RBC Dominion Securities Inc. increases the number of shares it trades on U.S. markets by 40 per cent, or almost one billion a month. About half of that addition is on the New York Stock Exchange.

Traders at hedge funds, seeking lower costs and more control, are increasingly doing business via firms like Carlin that offer computer systems with direct access to order books at exchanges rather than placing orders through brokerages where human beings handle purchases and sales. Banks, and brokerages they own, risk being cut out of the loop unless they can buy or build systems giving the direct market access that hedge funds want.

With Carlin, RBC gains a business focused on small hedge funds of less than $1-billion (U.S.) in assets, as well as professional traders.

"What Carlin presented us with was the opportunity to cover a client segment that to a large extent we don't cover in any sort of depth, and that is the emerging hedge fund manager community -- the smaller hedge fund managers -- as well as the professional trader community," said Greg Mills, RBC head of global equity sales and trading.

RBC also plans to tie the U.S. trading platform to its Canadian market-access systems in a bid to attract business from U.S. managers who want to trade in Canadian securities, Mr. Mills said.

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TD Ameritrade Q4 2006 Earnings

In a research note published yesterday, analysts at Friedman Billings reiterate their 'outperform' rating on Ameritrade. The target price has been reduced from $21 to $19.50.

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Bloomberg, Sybil Chahbandour, 25 October 2006

TD Ameritrade Holding Corp. was downgraded from 'outperform' to 'in-line' by analyst David Trone at Fox-Pitt, Kelton.

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MarketWatch, Greg Morcroft, 25 October 2006

Sandler O'Neill analyst Rich Repetto Wednesday trimmed his earnings estimate and price target for online financial services firm TD Ameritrade, but left his buy rating on the share after it reported earnings a penny below estimates yesterday. Repetto trimmed his full year earnings estimate to $1.16 from $1.2 and cut his target price to $21, from $23.75.

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Scotia Capital, 25 October 2006

Event

• TD Ameritrade reported Q4/06 cash earnings of US$0.21 per share versus US$0.24 per share in the previous year, slightly below IBES estimates of US$0.23 per share (GAAP US$0.22 per share). Fiscal 2006 cash earnings were US$0.91 per share versus US$0.83 per share in F2005.

• AMTD's updated earnings guidance for fiscal 2007 was essentially unchanged with a range of US$0.98 per share to US$1.22 per share from US$0.99 - US$1.21 per share.

What It Means

• TD Bank indicated AMTD (TD owns 39.5%) earnings contribution this quarter would be C$53 million or C$0.07 per share versus C$55 million or C$0.08 per share in the previous quarter.

• AMTD shares were down 4.8% at market close. Every 5% change in AMTD's share price impacts TD's value by $0.30 per TD share.

• TD Bank - 2-Sector Perform

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BMO Capital Markets, 24 October 2006

For the fourth quarter ending September, TD Ameritrade reported net earnings of US$0.21 inclusive of US$0.01 of one time gains. This compared to street estimates of US$0.22. The variation reflects slightly higher expenses. AMTD has widened its guidance for 2007 slightly from US$0.99-1.21 to US$0.98-1.22. TD Bank subsequently announced that that this would translate into a contribution to TD of $53mm in the fourth quarter, marginally behind our estimate of $55mm. The variation is about one quarter of one cent per TD share. Though the impact of these results is minor on TD, the outlook statement by AMTD seems to be less robust; it is assuming somewhat higher trading volumes offset by slower reduction in costs. AMTD management has indicated that the decision to delay some cost reductions is intended to ensure a better client experience. As we look at it, AMTD is broadly on track to deliver the upside potential from the Waterhouse merger

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Bloomberg, Bradley Keoun, 24 October 2006

TD Ameritrade Holding Corp., the third-largest online broker, reported profit and revenue for the fiscal fourth quarter that missed analysts' estimates as the company slashed commissions to keep up with rivals' price cuts. TD Ameritrade shares fell 4.8 percent to a three-month low.

Net income in the three months ended Sept. 29 rose 36 percent to $128.1 million, or 21 cents a share, the Omaha, Nebraska-based company said in a statement today. Excluding the impact of investment gains and losses, earnings per share were 20 cents. The average estimate in an analyst survey by Thomson Financial was for profit of 22 cents a share.

Chief Executive Officer Joseph Moglia cut TD Ameritrade's base price for trades to $9.99 in April from $10.99 after Charles Schwab Corp., the No. 1 discount broker by assets, reduced its rates by more than 60 percent in three years. While TD Ameritrade is anticipating that customers will generate more profit by paying fees for premium services, the company made less per transaction last quarter than many analysts expected.

"It's no secret that this is a pretty competitive business," said Richard Herr, an analyst at Keefe Bruyette & Woods Inc. in New York who rates the stock "outperform" and doesn't own the shares. "They're opening themselves to a new segment of clients -- those that want to put their money with TD Ameritrade for long-term investing."

Revenue rose 78 percent to $488.7 million because the quarter included results for TD Waterhouse USA, the rival brokerage that Ameritrade Holding Corp. bought for $1.3 billion in January to create TD Ameritrade. Analysts' revenue estimates ranged from $493 million to $517 million.

While the TD Waterhouse purchase also helped boost net income from $94.4 million, earnings per share declined from 23 cents because Ameritrade paid for the acquisition by issuing new stock. For the full fiscal year, TD Ameritrade earned $526.8 million, or 95 cents a share, up from $339.8 million, or 82 cents, the prior year.

During the quarter, TD Ameritrade had a $4 million cost to compensate clients whose accounts were infiltrated by computer criminals, Chief Financial Officer Bill Gerber disclosed on a conference call with analysts today. Katrina Becker, a spokeswoman for the company, said some customers suffered losses because of bogus trading by unauthorized users from Eastern Europe and Asia.

Moglia told the analysts that the cyber-criminals mostly targeted TD Ameritrade customers who used public computers outside the U.S. The company may be able to recoup some of the losses through an insurance policy, Gerber said.

E*Trade last week disclosed losses of at least $18 million because of similar fraud. The Federal Bureau of Investigation, the Securities and Exchange Commission and the NASD are investigating the losses, TD Ameritrade and E*Trade said.

TD Ameritrade said today it expects to earn 98 cents to $1.22 a share in the fiscal year ending September 2007, a change from its previous forecast of 99 cents to $1.21. The average estimate in the Thomson survey currently is for profit of $1.20 a share.

It's taking longer than the company predicted to convert TD Waterhouse customers to TD Ameritrade's trading system, Moglia said in an interview today. The conversion, originally scheduled for December, won't be completed until March, resulting in additional costs, Moglia said.

"The key to whether or not the TD Waterhouse acquisition is going to be successful will be determined at the end of 2007," when the company is fully integrated with TD Ameritrade, Moglia said on the conference call. "It's not going to be by us having a great blowout quarter prior to that integration."

Shares of TD Ameritrade fell 79 cents, or 4.8 percent, to $15.84 in Nasdaq Stock Market composite trading.

Customers made an average of 204,480 trades per day in the quarter, TD Ameritrade reported, down 19 percent from the previous three months. Herr, the Keefe Bruyette analyst, expected 205,000 to 206,000 trades a day.

"The environment in the equity markets was not nearly as good" as it was last year, Herr said. "You had that huge drop- off in the May and June timeframe, and even though the markets got better, by then people were disengaged."

Schwab and E*Trade also reported declines in trading from the quarter that ended in June.

On the conference call, Moglia said daily trades have improved since the end of the quarter, averaging 225,000 so far this month.

The company reported an average commission of $12.76 per trade in the fourth quarter, down from $13.01 a year earlier. Excluding one-time payments related to the TD Waterhouse acquisition, the rate would have been $13.11, Gerber said on the conference call. With the adjustment, the rate fell below Lehman Brothers Holdings Inc. analyst Roger Freeman's estimate of $13.25.

Earlier this month, Bank of America Corp., the nation's No. 2 bank by assets, began offering 30 free trades a month to customers who maintain balances of $25,000. That day, TD Ameritrade shares dropped 12 percent on concern that the move might ignite a price war among online brokers.

In the interview, Moglia said he doesn't expect TD Ameritrade's average commissions to decline by more than $1 in the coming year.

"There's always pressure on pricing, but for most of the participants in the online brokerage business, they have already gone through changing their prices," he said. "I don't think there will be any significant price changes as far as 2007 goes. But, you know, we'll see."

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Online Trading Account Thefts

Hackers Cost TD Ameritrade $4 million in Q4

MarketWatch, Robert Schroeder, 24 October 2006

Leading online financial services firm TD Ameritrade said Tuesday it took a $4 million charge the fourth quarter because of identity theft-fraud, highlighting the financial cost of a growing problem plaguing online businesses.

While no clients lost assets thanks to the company's reimbursement policy, the loss underscored a thorny issue for online brokers and retailers: how to safeguard the identities of their clients, especially from suspects overseas.

TD Ameritrade is not alone: Last week E-Trade reported that thieves in Eastern Europe and Thailand cost their customers $18 million in losses in the third quarter.

"This seems to be something happening overseas. People are traveling and allowing their log-ins and their user IDs to be obtained. It mostly seems to be through wireless systems," Chief Operating Officer Randy MacDonald said on a conference call Tuesday.

Omaha, Neb.-based TD Ameritrade made the disclosure as part of its fourth quarter earnings report.

The online broker, which is the country's third-largest, said fourth-quarter profit rose 36%, driven by a large acquisition made earlier in the year. Trading results, commissions and net income were a bit weaker than expected.

Ameritrade executives said they and other firms are working as an industry to protect people's passwords and log-ins.

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The Toronto Star, Tara Perkins, 24 October 2006

The Investment Dealers Association of Canada plans to meet with brokerages and security experts in the next month as regulators and law enforcement agencies in Canada and the United States try to tackle growing losses caused by identity-theft scams that target individual investors' online trading accounts.

The association also plans to issue a notice to members, asking them to review their insurance coverage. These scams are often not covered under fraud provisions, which generally apply only to fraud committed by employees.

The issue has been gaining attention as incidents have increased. Last week, ETrade Financial Corp. revealed it spent $18 million (U.S.) on fraud losses in the third quarter. The company said that, "like a number of our competitors, (ETrade) experienced a significant increase in losses resulting from fraud relating to identity theft."

John Stark, chief of the United States Securities and Exchange Committee's office of Internet enforcement, said in an interview that "it is a growing concern of ours, and we have seen more complaints about it and more incidents of it in recent months, and we currently have a slew of investigations concerning unauthorized intrusions into online brokerage accounts.

"It's so nascent, it's hard to know exactly how much there is in losses," he added.

Canadian industry sources said the problem doesn't appear to have snowballed as quickly here.

In late August, the Canadian investment dealers association issued a warning to online traders after two accounts were broken into and wiped out. The hijackers reinvested the money in penny stocks. Authorities suspected the aim was to manipulate the price of the penny stocks. It appeared the hijackers had learned the clients' passwords.

Yesterday, Alex Popovic, vice-president of enforcement at the dealers association, said he's now aware of 10 cases.

"We're just in the process of setting up a meeting with the members to discuss this issue," he said.

"We're looking at bringing in some consultants to talk about security and provide some expertise and knowledge on how to beef up security."

JoAnne Hayes, spokeswoman for the Bank of Montreal, said its BMO InvestorLine has had "less than a handful of instances."

"We did reimburse clients," she said.

Lisa Hodgins, spokeswoman for TD Bank Financial Group, which runs TD Waterhouse, said "around August, we were investigating a few reports of unusual activity... but we're not currently investigating any claims."

The brokerage, like many, now has a security guarantee for customers who lose money due to fraud.

TD Waterhouse has not had any proven incidents, Hodgins said.

Popovic said the frauds are happening in numerous ways.

"We've seen all of it. We've seen the viruses, where somebody downloads it onto your home computer.... We have seen situations where people have been asked in an email to go to a website and put in their login.

"We have also tracked some of the false webpages.

"We saw them go as far as Germany, and then we hit a wall," he said.

The investment dealers association refers the incidents to law enforcement agencies.

The perpetrators are becoming more sophisticated, experts said.

"I looked at one of the bank-owned examples, and everything looks exactly the same," Popovic said. "You'd have to be really familiar with the original website to notice that there is a difference."

The international origins of many of the operations make them very difficult to shut down.

The U.S. regulator's Stark said arrangements with various countries allow U.S. authorities to obtain information, "but it involves a lot of co-operation.

"It's not going to move as quickly as it would if the wrongful conduct occurred here in the United States. But, having said that, we're not precluded. We can work with foreign countries to try to do what we can, and we are."

The commission has been warning about fraud directed at online brokerages for more than a year. Originally, the regulator was seeing the criminals liquidate investors' securities and wire the money out to a bank, Stark said.

"Lately, we've been seeing more of these manipulation intrusion kind of schemes — what the IDA is describing — which is when the hacker owns a bunch of some microcap stock, and then goes into an account, liquidates the securities and then buys up enough of that microcap stock to pump up its price," he said.

The hacker then sells, or dumps, previously obtained shares into an artificially inflated market.

TD Ameritrade spokeswoman Katrina Becker said the problem has been increasing, but declined to give figures.

"This is a widespread issue. It's not just online brokerages. It's financial services."

Dean Turner, senior manager for Symantec Security Response, said more than 80 per cent of all "phishing" attacks target financial services.

"The financial-services sector is the Number 2 targeted sector globally in terms of targeted attacks. The only reason they are Number 2 is because the Number 1 target are home users," he said in an interview.

"We certainly don't want to go out saying the sky is falling; that's not the case," Turner said. "I don't think we have accurate numbers on the amounts of dollar losses," he added. "I think it's probably much higher than what's reported."

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Sun Life Takes MFS Off the Auction Block

The Globe and Mail, Sinclair Stewart, 24 October 2006

It's the word that haunts Don Stewart: "Credibility." Too many investors think he lacks it, which is part of the reason Sun Life Financial trades at a discount to Manulife.

Credibility is what CEOs get when they say they're going to do something, then do it. Mr. Stewart, a hard-working Scot who has been Sun Life's top executive since 1998, has a monster problem in MFS Investment Management, its U.S. mutual fund division. He vowed to fix it, hired bankers to shop it, and came away with dust. The failure, says National Bank Financial's Rob Wessel, "will have a negative impact on" -- here's that word again -- "management credibility."

So the new company line is that Sun Life is going to keep MFS and manage it better. That's fine, but don't count on that as the long-term solution, because so far, Boston-based MFS appears unmanageable, at least by a remote shareholder in Toronto. Mr. Stewart may have decided that the cost of divorce is too high right now, but let's be clear: This is not a healthy marriage, and Sun Life is not done trying to get out of it.

Why can't these two just get along? Because any happy couple has to want the same things, and Sun Life management and MFS brass don't. Sun Life, as the 98-per-cent shareholder of MFS, wants profitability to be as high as possible. MFS's well-fed managers, as owners of the other 2 per cent, may care less about earnings and more about other things. Compensation, for instance. By some accounts, the pay scale is very rich at MFS, even by the usual grotesque standards of the money management business.

This is more than a matter of opinion. In a business where pay is by far the biggest expense, MFS's profit margins, to use the technical term, stink. Yesterday, Sun Life said MFS made about 30 cents in profit, excluding taxes for every dollar of revenue in the third quarter, a dandy improvement from previous quarters. But that's still weak compared with most of the competition. T. Rowe Price made 46 cents (U.S.) per dollar of revenue over the past 12 months, according to data from Standard & Poor's Capital IQ. Nuveen Investments, one of the companies that looked at MFS, makes a similar margin.

But fat paycheques are just one element of the MFS managers' sweetheart deal; they also hold a hammer in any takeover. On a change of control, they are entitled to a 20-per-cent cut of the value (Sun Life has not formally disclosed this arrangement). Plus, there's the usual fear about how the money managers will leave and take assets with them -- though given the mediocre performance of MFS funds, perhaps Sun Life should let them try.

You can see the conflicting priorities here. Sun Life, having failed (for whatever reason) to grab a firmer hand on the operation, needs to outsource its MFS problem to someone else. That means it wants to sell to a strong partner -- a U.S. player with the guts to walk into Boston and start firing people. Sun Life would ride along as a significant shareholder, replicating the formula it has used in Canada with CI Financial.

But if you are an MFS manager, your interests are the opposite. You'd prefer that nothing disrupts your comfortable existence. But if the firm must be sold, you'd rather it went to someone who's weak in asset management -- a player who would need your expertise. Wachovia, a rumoured buyer last week, likely fit the bill from MFS's point of view, but not Sun Life's.

What you've got here is an untenable situation. Mr. Stewart may have been right to walk away from a bad deal, but he has merely deferred the problem. He'll still have to sell a chunk of MFS -- if not to another fund company, then to the public. It will give him better earnings, a better stock price and something else, too. It's called credibility.

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Financial Post, Duncan Mavin, 24 October 2006

Sun Life Financial Inc. will have to come up with a new plan for MFS Investment Management after ruling out any potential deal to sell all or part of the Boston-based asset manager yesterday.

Canada's second-largest life insurer had been considering "strategic alternatives" for the under-performing unit, with a host of big name U.S. financial institutions linked to a deal that potentially would have seen MFS rolled into a new entity in which Sun Life was a shareholder.

Observers valued the asset manager at between $4.5-billion and $5.5-billion.

But chief executive Don Stewart admitted the search for a "third-party transaction" is over, despite a "thorough and disciplined assessment [and] ... a high degree of interest in partnering with MFS."

The news was viewed harshly by some investors as Sun Life's stock fell $1.11 to $44.74 on the day.

"We were disappointed to hear that MFS will neither be sold nor be part of a joint venture," said RBC Capital Markets analyst Jamie Keating in a note.

"MFS still lacks scale for investment in technology, marketing, and overhead relative to larger competitors."

National Bank Financial analyst Rob Wessel said "there is no question the impact [of yesterday's announcement] on the company will be very clearly negative." The failure to find a partnership damages management credibility, he added.

Mr. Wessel said the insurer should now look to "plan B" -- taking the company public. Sun Life currently owns about 98% of MFS and could "unlock value" by selling some of its stake, he said.

However, Len Racioppo, president of money manager Jarislowsky Fraser Ltd., said he has a less negative view of management's plan to improve performance without a transaction.

Indeed, Sun Life revealed yesterday that MFS' revenue rose 8.7% in the first six months of the year and third-quarter profit rose 37% to $52-million.

"The value's still there," said Mr. Racioppo.

Nevertheless, the process of looking for ways of improving results at MFS has been ongoing for several months and was made public in September when Sun Life announced it had engaged investment bankers to look at various options.

Most of Sun Life's businesses have been firing on all cylinders of late but MFS has largely stood still. MFS's net income has declined from US$173-million in 2000 to US$148-million in 2005. MFS's assets under management barely budged from US$149-billion in 2000 to US$162-billion last year. The company now manages about US$175-billion of assets.

Sun Life spokesman Michel Leduc said that the company considered partnering with "a variety of organizations," but he would not name names. Speculation in recent weeks has particularly focused on Wachovia Corp. and Mellon Financial Corp but yesterday's announcement would appear to suggest they were not able to offer a suitable transaction.

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The Globe and Mail, Andrew Willis, 24 October 2006

Sun Life Financial Inc. decided yesterday to fix its troubled U.S. money management division, rather than sell MFS Investment Management to a rival.

Toronto-based Sun Life put MFS on the block this summer, hoping to exchange its stake for a minority position in a much larger asset manager. The move was meant to boost MFS's profit, jump-start its funds and give Sun Life a larger presence in U.S. money management. A number of U.S. money managers and banks looked at the Boston-based company, which has $175-billion (U.S.) in assets under management. "There was a high degree of interest in partnering with MFS," Sun Life CEO Donald Stewart said. But the right deal, at the right price, was not forthcoming, so Mr. Stewart said in a release: "We will focus on improving performance and profit margins and expanding its global investment and distribution platforms."

A number of industry executives and investment bankers said the amount of influence that Sun Life would have in the merged company, and the roles that MFS executives would play going forward, also stood in the way of a deal. Analyst Robert Wessel of National Bank Financial Inc. said in a note: "Not achieving this objective will have a negative impact on management credibility."

Analysts have pointed out that MFS can improve margins that lag rivals by outsourcing administrative functions and shifting its head office from downtown Boston to cheaper real estate. Mr. Wessel estimates these moves could cut costs by $67-million a year. A Sun Life spokesman declined to comment on specific plans for MFS.

At the same time it took down the For Sale sign at MFS, Sun Life announced that the company's results were improving, with profit up 11 per cent to $52-million in the third quarter from the previous three months. International fund assets are expanding and MFS executives have said a priority is improving performance in U.S. funds. Sun Life will officially announce third-quarter results on Thursday. Founded in 1924, MFS ranks as the No. 45 U.S. money manager by assets.

Companies interested in MFS included money managers Nuveen Investments Inc. and Federated Investors Inc., and two banks, Wachovia Corp. and Mellon Financial Corp., investment bankers who worked with potential buyers said. Analyst Jason Bilodeau at UBS Securities said: "While we believe there were a number of interested parties, the combination of price and management's desire to remain invested in the asset management business in the U.S. prevented a deal from coming together."

Mr. Wessel said in a note: "We continue to believe there is a value to be unlocked with respect to this operating subsidiary, which will be realized eventually." He suggested Sun Life show what MFS is worth by selling a portion of the subsidiary in an initial public offering.

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BMO Capital Markets, 23 October 2006

Sun Life announced this morning that it has concluded its strategic review process of MFS with no transaction at this time. While we believe there was significant interest in acquiring MFS, the challenge was finding the right partner. It is clearly disappointing that the strategic review concluded in this manner. However, no deal is better than a bad deal. Moreover, the company did announce that MFS Q3/06 earnings would be US$52 million versus our estimate of US$47 million, which translates into an additional $0.01 per share. Pre-tax margins improved to 30% from the low 20%-range last year. We suspect that net inflows remain modestly negative. We believe that the improved margins reflect better cost controls and there should be some more room to improve margins into the 35% range over the next 12-24 months. Nevertheless, we believe that MFS remains at risk of becoming marginalized in the U.S. mutual fund business in the absence of a strategic partner as net flows remain negative in the mutual fund segment. While disappointed, investors should note that SLF shares traded at $40 at the end of 2000 and currently trade at $45.85 despite compound annual growth rate in earnings and dividends of 11% and 46%, respectively.

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RBC Capital Markets, 23 October 2006

Back to Basics – With the MFS Strategic Review Over, Our Focus Shifts Back to the Upcoming Quarter

Investors’ will now shift their focus back to Sun Life’s management execution, in our view, aimed at upgrading weak sales. In our view, sales growth lags the industry norms across the following platforms: (i) domestic individual insurance and wealth, (ii) U.S. annuities; (iii) U.S. mutual funds. Further, last quarter’s spike in sales of U.S individual life insurance was not based on market pricing, so as pricing is increased to market levels, we believe even the U.S. life sales may revert lower again.

We have a Below-Consensus Earnings Outlook for the Upcoming Q3/06

We are expecting EPS of $0.85 for Q3, 3¢ below consensus, up 4% YoY, and down 1% QoQ. On a constant currency basis, we are expecting 7% (7¢) YoY earnings growth. We are particularly cautious after what we interpreted as weak EPS quality in Q2/06. We are also wary of acceleration in mutual fund and/or annuity net redemptions after potential disruption from the MFS strategic review. Our Q3 estimates are based on the following divisional constant currency YoY growth rates: (i) Canada 10%; (ii) US -25%; (iii) MFS 20%; (iv) Asia 300% and; (v) Corporate -15%.

Underlying EPS Quality a Little Suspect in Q2/06

Sun reported Q2/06 EPS at $0.88 although underlying EPS we estimated as arguably as low as $0.80. Sun recorded a one-time tax benefit of 8¢ - this should not repeat in the current quarter. There were three mitigating features in the Q2 results, each of which may improve again this quarter. First, the U.S. life division recorded unusually high sales strain last quarter, which cost an estimated -7¢ in EPS. We expect the sales strain will repeat, but in a -6¢ magnitude in Q3/06. Second, weak equity markets cost an estimated -5¢ in Q2/06, and this we believe may still be a -4¢ factor in Q3/06. Last, foreign exchange translation cost - 5¢ in YoY EPS performance – for Q3/06 we estimate the F/X cost at -4¢. Collectively, we estimate 3-5¢ benefit from these three factors, roughly building to our $0.85 Q3/06 estimate.

Factoring Market-Like Domestic Life Sales Growth

We estimate that domestic life insurance sales for Q3 will be $38 million, up 6% YoY from $36 million in Q3/05, for an industry-neutral growth rate. SLF’s sales growth through newly-reopened independent channels has been strong from a small base, while growth from the Clarica sales force has looked stagnant, declining 5% YoY last quarter. Part of Sun’s domestic sales challenge may be that they do not offer a participating insurance policy, unlike the other 3 lifecos, and industry sales for this category grew 21% YoY in Q2/06, triple the industry average including term and universal life (Sun’s key products). Also, we continue to expect aggressive pricing pressure in Sun’s core universal life product, this quarter as Manulife dropped prices mid-quarter on its popular UL product and service offering.

We Believe Sun’s U.S. Life Insurance Sales Are Not Sustainable

We estimate that U.S. insurance sales will come in at US$70 million, indicated up 94% YoY from $36 million in Q3/05. However, management confirmed last quarter that the recent leap in U.S. insurance sales is owing to a decision to sustain below-market life insurance rates that Sun has left in place longer than would be normal to support significant new marketing agreements signed up in Q1/06. The higher market rates reflect recent increases in reinsurance costs that most competitors have passed onto insureds with price increases. With competitors priced higher, Sun Life is getting a higher-than-normal proportion of business until they too follow with higher rates of their own. SLF confirmed that their below-market pricing would positively impact a portion of Q3 sales, but it would seem not thereafter. Accordingly, we are wary that SLF will not be able to sustain sales at their current levels once pricing is raised in-line with the other insurance companies.

Also, we caution investors to be careful to also break out the lower quality, institutionally-driven single premium COLI/BOLI sales. Roughly 25% of Sun’s U.S. life insurance sales in the past four quarters have been of this nature, which we consider lower-quality and lower margin. We have included an estimate that US$15 million of our estimated US$70 million in U.S. insurance sales will be COLI/BOLI sales, implying an estimate of US$55 million in core life sales.

Valuation

Our $49 price target is set at 14x our 12-month-forward EPS estimate of $3.50 (Q3/06-Q2/07). Our Sun Life target P/E is set a multiple below our 15x sector target P/E. We believe the discount is warranted based on Sun’s growth challenges in domestic insurance and U.S. annuities. We also believe Sun’s financial performance is more reliant on favourable interest rates and equity markets, than for the peer group.

Price Target Impediments

Impediments to achievement of our target price include: (i) another round of extra-low interest rates; (ii) an equity market correction; (iii) poor execution on the U.S. Annuities sales turnaround and/or domestic independent retail insurance platform rebuild.

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Bloomberg, Sean B. Pasternak, 23 October 2006

Sun Life Financial Inc., Canada's second-largest insurer, decided not to sell its MFS Investment Management unit after the company failed to find a suitable partner for the U.S. money manager, investors said.

Sun Life said last month it hired investment bankers to consider a sale or asset swap for Boston-based MFS, which manages the oldest U.S. mutual fund. Wachovia Corp. and Mellon Financial Corp. were bidding for the unit, in a sale that would have raised about $3 billion, the people said.

"They probably didn't like the bids they were getting," said Len Racioppo, president of Montreal-based money manager Jarislowsky Fraser Ltd., which has about 8.4 million Sun Life shares among its $54 billion in assets. "In asset management, it's very important how you structure the deal, what partner you get."

Toronto-based Sun Life said in a statement today it will keep MFS, after the money manager increased profit following four years of withdrawals from its mutual funds. Revenue rose 8.7 percent in the first six months of the year and third- quarter profit rose 37 percent to $52 million. Assets increased to a record $175 billion.

"We never believed that an outright sale of MFS was in the cards," Desjardins Securities analyst Michael Goldberg said in a note to investors, adding that Sun Life wanted to keep a minority stake in a rival firm in exchange for MFS. "The termination of the process reflects the inability of Sun and its bankers to put together the ideal transaction."

Goldberg said that the "ideal" transaction would have been similar to Sun Life's one-third stake in CI Financial Income Fund, Canada's second-biggest mutual fund company. In 2002, Sun Life exchanged its Spectrum Investment Management and Clarica Diversico businesses for 30 percent of CI of Toronto.

Shares of Sun Life fell C$1.11, or 2.4 percent, to C$44.74 at the 4 p.m. close of trading on the Toronto Stock Exchange, the biggest decline in three months.

Sun Life may now look at an initial public offering for MFS, said Robert Wessel, an analyst at National Bank Financial.

"We continue to believe that there is value to be unlocked with respect to this operating subsidiary, which will be realized eventually," Wessel wrote today in a note to investors.

Michel Leduc, a Sun Life spokesman, declined to comment on whether Sun Life would consider an IPO.

Leduc declined to say which companies were interested in MFS or whether any bids were submitted. Chief Executive Officer Donald Stewart said in the statement there was a "high degree of interest in partnering with MFS."

MFS's assets are split almost evenly between mutual funds and institutional accounts. The firm had $6.8 billion in net inflows since the start of 2005, as institutional sales offset redemptions from stock and bond funds, according to MFS spokesman John Reilly.

Individual investors began withdrawing money because of poor growth-fund performance during the 2000-2002 bear market and continued after the company's involvement in a mutual-fund trading scandal and undisclosed sales payments to brokers.

MFS agreed in 2004 to pay $351 million in penalties for allowing some investors to make improper trades in its funds. The settlement was made with the U.S. Securities and Exchange Commission, New York Attorney General Eliot Spitzer and New Hampshire securities officials.

"The very fact that they were putting it up for sale signaled to me that, at least in the U.S., they were pulling back from the mutual fund/asset-management business," said Ian Nakamoto, director of investments at MacDougall, MacDougall & MacTier Inc. in Toronto, which manages the equivalent of about $3.2 billion, including Sun Life shares.

U.S. banks were considering a purchase of MFS to expand their money management businesses, analysts said. Mellon Financial, the Pittsburgh-based owner of Dreyfus mutual funds, purchased Edinburgh-based Walter Scott & Partners Ltd. this month. Charlotte, North Carolina-based Wachovia, the No. 4 U.S. bank, bought Metropolitan West Capital Management LLC of Newport Beach, California, in June.

MFS was being shopped at the same time Marsh & McLennan Cos., the world's largest insurance broker, was soliciting offers for Putnam Investments, its mutual-fund unit. Marsh & McLennan spokeswoman Robin Liebowitz had no immediate comment on the status of Putnam, which oversees $180 billion.

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