BMO Q4 2006 Earnings

The Globe and Mail, 30 November 2006

Bank of Montreal had its profit estimates and price target cut by analyst James Keating at RBC Dominion Securities Inc. yesterday as a result of weakened growth prospects. Mr. Keating reiterated his "underperform" rating on the stock.

Shares of the bank closed yesterday at $68.83 on the S&P/TSX, down 39 cents. Mr. Keating reduced his 12-month share price target to $70 from $73 and lowered his fiscal 2007 cash share profit estimate to $5.20 from $5.35.

"We are concerned about lack of growth in domestic retail banking and the potential for a large U.S. community bank acquisition," Mr. Keating said.

BMO reported a fourth-quarter profit of $1.37 a share this week, but the normalized earnings after adjusting for loan-loss provisions, securitization and securities gains and the tax rate were closer to $1.20 a share, he said.

Operating problems such as sluggish retail revenue and market share losses could cap share profit growth for two years, according to the report.

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Scotia Capital, 29 November 2006

Q4 Results - Underlying Earnings Extremely Weak

• Bank of Montreal recorded a 7% increase in Q4/06 cash operating EPS of $1.33 per share, excluding a $0.04 per share general reserve reversal. Earnings were boosted by an estimated $0.12 per share from a very low tax rate of 17.4% and $0.06 per share from security gains.

• BMO's operating results were disappointing, with weak underlying earnings and market share losses in personal and commercial banking.

• Underlying earnings were weak due to a 3% decline in revenue led by a steep decline in trading revenue (commodities and fixed income) as well as lower retail net interest margin, particularly in the U.S.

• Personal & Commercial (including Harris) earnings were down 11% YOY, with Private Client earnings up 4% and Investment Banking earnings down 11%. Corporate Support earnings contributed significantly to total earnings, increasing to $109 million (including loan loss recoveries) from $9 million a year earlier.

• Cash return on equity was 19.1% versus 19.2% a year earlier. Cash return on risk weighted assets was 1.65% versus 1.66% a year earlier

Dividend Increase 5%

• The bank announced a 5% dividend increase to $2.60 per share from $2.48 per share.

Fiscal 2006 Earnings Growth 13% - Expected to be Below Bank Group

• Cash earnings for fiscal 2006 increased 13% to $5.09 per share versus $4.50 per share in F2005.

• Cash operating ROE improved to 19.0% versus 18.3% in fiscal 2005.

Personal & Commercial Earnings Flat in Fiscal 2006

• Personal and Commercial Client Group (PCCG) earnings declined 11% YOY to $302 million. Earnings were down due to weak contributions from both Canadian and U.S. retail segments.

• Total Personal & Commercial bank earnings were flat in fiscal 2006 at $1,236 million versus $1,239 million in fiscal 2005.

P&C Canada Earnings Weak

• P&C Canada earnings were flat YOY at $273 million versus $274 million as volume growth was offset by lower net interest margin, higher expenses, and higher loan loss provisions. Excluding the customer loyalty charge in Q4/05, Canadian retail earnings declined 9% YOY.

• The bank lost 14 bp YOY in residential mortgage loans market share and 55 bp in personal deposits. Business banking loan market share declined 3 bp from a year earlier.

• P&C Canada revenue was up 5% with expenses increasing 4%.

• Securitization revenues were $55 million, up significantly compared with $21 million in the previous quarter and $34 million a year earlier, due to a $27 million gain or $0.04 per share on $1.5 billion credit card securitization.

• Fiscal 2006 earnings for P&C Canada remained flat at $1,097 million versus $1,095 million in fiscal 2005.

Retail Net Interest Margin Declines

• Canadian retail net interest margin (NIM) declined 3 basis points (bp) QOQ to 2.66% due to lower mortgage refinancing fees and price competition, after increasing 7 bp in the previous quarter.

• U.S. retail NIM was under significant pressure, declining 10 bp QOQ to 3.57%.

P&C U.S. Earnings Decline

• P&C U.S. earnings declined 24% YOY to $29 million from $38 million a year earlier due to a weaker U.S. dollar, and costs of integrating acquisitions and branch technology expenses. Average loans and acceptances increased 6% YOY; however, higher loans were offset by margin compression and mix shift to lower spread deposit products and fixed-rate loans.

• The net interest margin declined 10 bp during the quarter to 3.57%. We expect continued margin pressure at Harris.

• P&C U.S. fiscal 2006 earnings declined 3% to $139 million from $144 million due to the weaker U.S. dollar, lower net interest margin and higher costs associated with new branches and acquisitions.

Private Client Group Earnings Solid

• Private Client Group (PCG) earnings in Q4 increased 4% YOY (excluding the $18 million after-tax gain on sale of Harrisdirect and $16 million after-tax gain on sale of TSX shares in Q4/05) to $85 million.

• Cash earnings for fiscal 2006 increased 13% to $364 million versus $323 million in F2005 due to higher fee-based revenue from increased asset levels, while increased managed-asset levels and positive net sales drove higher mutual fund revenues.

• Mutual fund revenue increased 12% YOY to $130 million. Mutual fund assets under management (as reported by IFIC) increased 20% YOY to $34.4 billion.

• For the fiscal year, mutual fund revenue increased 14% to $499 million.

Investment Banking Group Earnings Down 11%

• Investment Banking Group (IBG) earnings declined 11% to $186 million due to extremely weak trading revenue and a 6% decline in capital markets revenue.

• For the fiscal year, IBG operating earnings were up 12% to $861 million resulting from higher trading revenue.

Trading Revenue Extremely Weak

• Trading revenue declined by half to $83 million from $172 million in the previous quarter and $162 million a year earlier, the lowest level in two years. The bank recorded a trading loss in the other category (mainly commodities, oil and gas). The bank was offside in its natural gas position during the quarter. Interest rate trading revenue was also very low.

Trading Revenue - Commodities and Interest Rates - Steep Decline

• Trading revenue in other (commodities) was a loss of $8 million versus a profit of $41 million in the previous quarter and a profit of $43 million a year earlier.

• Interest rates (fixed income) trading was also particularly weak at $11 million versus $52 million in the previous quarter and $62 million a year earlier. Interest rates trading revenue in Q4/06 was at the lowest level in at least seven years.

• For the fiscal year, trading revenue was $665 million, up 13% from $588 million in fiscal 2005 on higher commodities driven by volatility and foreign exchange trading.

Capital Market Revenue

• Capital market revenue was $351 million versus $352 million in the previous quarter and $373 million a year earlier. Underwriting and advisory fees increased 3% YOY to $104 million, while securities commissions and fees declined 9% to $247 million.

• For the fiscal year, capital market revenue increased a modest 1% to $1,458 million.

Security Gains & Unrealized Security Surplus

• Security gains recorded in the quarter were $46 million or $0.06 per share versus $0.02 per share in the previous quarter and $0.04 per share a year earlier (excluding special gains).

• Unrealized security surplus increased to $41 million from $5 million in the previous quarter, with its equity position in MasterCard accounting for a good portion of this. The bank has one quarter of security gains available based on this quarter's gains.

Corporate Support Earnings - Strong

• Corporate Support earnings increased significantly to $109 million (excluding the general reserve reversal) from $9 million a year earlier due to higher LLP recoveries, lower expenses and lower income taxes. The bank also booked a $27 million gain on $1.5 billion in credit card securitization in the corporate segment.

Total Revenue Down 3%; Expenses Flat

• Operating leverage in Q4/06 was negative 3% with total bank revenue declining 3% and noninterest expenses remaining flat.

• For the fiscal year, revenue increased 3% while non-interest expenses increased 2%.

Productivity Ratio

• Overall, the bank’s cash productivity ratio deteriorated to 64.2% from 62.0% in the previous quarter and 62.6% a year earlier.

• The bank's productivity ratio for fiscal 2006 improved 60 basis points to 62.6% (excluding unusual items), missing its goal of 100 - 150 basis point improvement.

Loan Loss Provisions 13 bp

• Specific loan loss provisions (LLPs) were $51 million or 0.13% of loans, versus $42 million, or 0.11% of loans in the previous quarter. Total LLPs in fiscal 2006 were $176 million, comprised of specific LLPs of $211 million and $35 million of general reserve reversal.

• Specific LLPs in fiscal 2006 were $211 million or 0.13% of loans, compared to $219 million, or 0.15% of loans in fiscal 2005.

• Our 2007 LLP forecast is unchanged at $320 million or 0.20% of loans, with management guidance at $400 million or less. Our 2008 LLP forecast is $400 million or 0.25% of loans.

Tier 1 Capital

• Tier 1 ratio was 10.2% versus 10.1% in the previous quarter and 10.3% a year earlier. Risk weighted assets increased 9% YOY to $163 billion. The total capital ratio was 11.8% at the end of the quarter versus 11.6% in the previous quarter and 11.8% a year earlier.

Acquisition of First National Bank & Trust

• On September 27, BMO announced that its U.S. subsidiary, Harris Financial Corp., agreed to acquire First National Bank & Trust (FNBT) for US$290 million. The transaction is expected to close in January 2007. Excluding one-time items, the transaction is expected to be accretive to BMO's cash EPS in year one. FNBT has 32 branches and 33 ABMs in Indianapolis and the surrounding communities of Kokomo and Terre Haute.

Share Buyback Activity

• During the quarter, BMO repurchased 975,000 shares at an average cost of $65.84 per share for $64 million. Year-to-date, BMO repurchased 5,919,400 shares under its repurchase programs for total consideration of $376 million.

• On September 1, BMO announced a normal course issuer bid to repurchase up to 15 million Bank of Montreal shares, representing approximately 3% of BMO’s public float. This program commenced on September 6, 2006, and will expire on September 5, 2007.

Fiscal 2007 & 2008 Earnings Estimates

• We are reducing slightly our 2007 cash earnings estimate to $5.30 per share from $5.35 per share. We are introducing our 2008 earnings estimate at $5.60 per share.

• Our 12-month share price target is unchanged at $80, representing 15.1x our 2007 earnings estimate and 14.3x our 2008 earnings estimate.

Recommendation

• Maintain 3-Sector Underperform on BMO based on relative weak earnings momentum, low return on equity versus the bank group and weak strategic positioning with no meaningful P/E multiple discount to the bank group.

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newratings, 29 November 2006

Analyst J Bantis of Credit Suisse maintains his "neutral" rating on Bank of Montreal. The target price has been raised from C$68 to C$72.

In a research note published this morning, the analyst mentions that the company has reported its 4Q operating EPS short of the consensus. Bank of Montreal’s performance has been negatively impacted by a reduction in the net interest margins, market share losses in domestic retail, higher operating expenses in US retail, proprietary trading losses and rising market risk, the analyst says. The market share headwinds in domestic retail banking are likely to continue during 1H07, since a turnaround without price competition would need time and execution, Credit Suisse adds.

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newratings, 29 November 2006

Analysts at UBS maintain their "neutral" rating on Bank of Montreal, while reducing their estimates for the company. The target price is set to C$72.

In a research note published this morning, the analysts mention that the company is expected to witness challenges to attaining earnings growth during 2007. Although Bank of Montreal is undertaking initiatives to address operational issues, it is expected to witness market share erosion going forward, the analysts add. The EPS estimate for 2008 has been reduced from $5.75 to $5.70

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The Globe and Mail, Andrew Willis, 29 November 2006

Employees at some of Bank of Montreal's 201 branches in the Chicago area have grown accustomed to seeing a balding 54-year-old pedal up on his way to work, park his bike, check that the ATMs are working, then go to the teller's cage to ask how business is going.

The cyclist in question is Bill Downe, the newly named chief executive officer at Canada's fourth largest bank. As he prepares to take the wheel -- or handlebars -- from 61-year-old Tony Comper at the annual meeting next March, Mr. Downe is bringing a hands-on approach to a bank that faces a formidable challenge in finding new places to grow.

Mr. Downe is taking control of a bank that is losing market share to rivals in its major business lines. One reason the bank's board tapped this 23-year BMO veteran for the top job is no one knows more about how to expand the bank's U.S. operations, which represent its single biggest growth opportunity.

That American retail banking network saw profit fall $11-million to just $23-million in the most recent quarter, compared with last year. The decline reflected small acquisitions -- BMO spent $290-million (U.S.) on a recent 32-branch purchase -- along with the costs of rolling out new technology in branches.

Mr. Comper said the new computers make integrating larger takeovers easier and cheaper, and repeated the bank is targeting 400 U.S. branches, a goal that has been in place throughout the outgoing CEO's seven years in the top job. Colleagues say Mr. Downe "spends his whole day with his sleeves rolled up" and is likely to deliver on long-promised U.S. expansion.

"Bill is growth-oriented. And he's an optimist. He's not going to do a lunatic acquisition, but he's going to be far more willing to pull the trigger than Tony," said one long-time colleague in the bank's Chicago office. BMO has consistently said it can spend up to $2-billion on U.S. purchases, but on Mr. Comper's watch, it didn't step forward with an acquisition that would vault the bank out of the middle of the Midwest pack.

Mr. Downe's great advantage over his predecessors, and domestic rivals, is two decades of U.S. banking experience. He knows the players in a clubby industry. He championed the bank's foray into the U.S. discount brokerage, then engineered a profitable exit from the sector when the economics turned against BMO. Bank of Nova Scotia's Rick Waugh is the only other Canadian bank CEO who has run his institution's U.S. operations.

Long before he was riding his bike around to Chicago branches, Mr. Downe broke into banking as a credit analyst and corporate lender in BMO's energy-focused Houston office, then moved to Denver and Chicago. Armed with an undergraduate degree from Wilfrid Laurier University, and an MBA from University of Toronto in 1978, the Ontario native successfully balanced making loans to clients such as cyclical energy companies with holding the line on credit quality. In recent years, he has run the Canadian wealth management and investment banking teams, in addition to overseeing the U.S. operation.

Success as a travelling corporate banker took a personal toll. Mr. Downe and his wife Robin, who have three adult sons, separated briefly then reconciled last year. One colleague said: "I think that, like many wives, she grew impatient with a husband who spent his entire life on an airplane."

Mr. Downe will still be seeing a fair amount of airports, as he maintains homes in both Chicago and Toronto. But regardless of where he is based, the new CEO is expected to be more plugged into colleagues than the previous generation of bank chiefs.

"Bill will send an e-mail over the weekend, or phone first thing in the morning to discuss a deal. That's a welcome degree of engagement," one of the bank's senior deal makers said. Another colleague said: "The last generation of CEOs said get back to me next month. Bill says get back to me tomorrow." Mr. Downe is known for being BlackBerry-accessible, seven days a week, a sharp departure for a bank with a history of regal CEOs.

In his address to employees following the succession announcement, Mr. Comper said: "Bill has the intellect, the industry knowledge, the leadership acumen and the will to take this enterprise to new heights of growth and success."

Because the new CEO is an insider, and succession was clearly telegraphed, there's unlikely to be a sweeping changing of the guard at BMO's head office. Analyst James Keating at RBC Dominion Securities said yesterday: "Mr. Downe's personnel are already in place at all three divisions, so no management changes should be expected. The change heightens our alertness for acquisitions in U.S. retail and/or [investment banking]."

Jason Bilodeau, an analyst at UBS Securities Canada, said he doesn't expect Mr. Downe to "deviate" from Mr. Comper's U.S. strategy. "There's not going to be a radical shift in direction," Mr. Bilodeau said before the succession announcement. "He has spent a lot of time talking about the domestic retail business and their need to be more effective with their retail customers in Canada."

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The Globe and Mail, Andrew Willis, 29 November 2006

A slowing U.S. economy and strong competition are threatening earnings growth at Bank of Montreal, which announced a record $2.7-billion annual profit yesterday, and named a new chief executive officer.

BMO earned $1.35 a share in the fourth quarter, handily beating the $1.26 forecast by analysts polled by Thomson Financial. For the year, BMO's profit was up 11 per cent, and the bank recorded a return on equity of 19.2 per cent, compared with 18.8 per cent in 2005.

Despite the strong results, BMO chief executive officer Tony Comper noted that "operating momentum slowed in the fourth quarter due to a weaker business environment."

"Market share losses across the board suggest efforts to invigorate the domestic retail operations are ongoing and we suspect will be an issue for the coming quarters," said analyst Jason Bilodeau at UBS Securities in a report to clients titled "Not a Great Start," a reference to the fact that BMO was the first bank to report results for fiscal 2006. Mr. Bilodeau said: "Looking to 2007, rising credit costs, less robust trading activity and a normalization of tax rates all present headwinds."

The bank's fourth-quarter revenue was down 5.9 per cent, though the slide would narrow to 2.3 per cent if BMO's soon-to-be sold U.S. discount brokerage was removed from the mix.

Incoming chief executive officer Bill Downe, who will take the top job at the March 1 annual meeting, said yesterday: "We need to do a better job of translating our good intentions to build lasting customer relationships into tangible business results." In the internal address to employees, he added: "We need to pick up the pace of progress."

Bank stocks have soared in recent months, and analysts feared the rally could end if a softening economy led to slower-than-expected profit growth and higher-than-anticipated credit losses. Right now, Canadian bank stocks command a premium to their global peers, and analyst Martin Roberge at Versant Partners said in a report: "The high and rising relative valuation multiple of the banks is troubling considering relative profitability growth has lagged over the past two years."

BMO shares fell on the earnings news, closing yesterday down $2.29 or 3.2 per cent to $69.22 on the Toronto Stock Exchange.

BMO had no problems with bad loans, setting aside a $16-million provision in the fourth quarter for credit losses, compared with $57-million in the same period last year. The bank is forecasting profit will rise by 5 to 10 per cent in 2007, although specific provisions for credit losses could almost double to $400-million from $211-million this year.

BMO raised its dividend by 3 cents a quarter to 65 cents or $2.60 annually. The bank has the highest target payout range in the country, with up to 55 per cent of profit handed out to shareholders as dividends. Last year, BMO paid out 50 per cent of its profit as dividends.

"Two important themes continue to dominate the banks from a capital perspective; deployment and dividend growth," said a report from analyst Robert Wessel at National Bank Financial. He said all bank CEOs must balance acquisitions with shareholder-friendly dividend boosts. Four of the six big banks are expected to increase their dividends when they report fourth-quarter results. Bank of Nova Scotia, National Bank of Canada and Canadian Imperial Bank of Commerce are expected to follow BMO's lead by boosting payouts.

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Canadian Press, David Friend, 28 November 2006

The Bank of Montreal has booked its highest-ever annual profit — an 11 per cent increase to $2.7 billion — but analysts said the latest quarter was disappointing and could signal turbulent times ahead.

The Toronto-based bank, also known as BMO Financial Group, reported today its revenues were $2.46 billion in its fourth quarter ended Oct. 31, off from $2.62 billion a year ago.

BMO, the first of Canada’s major banks to report year-end results, earned $696 million on the quarter, amounting to $1.35 per diluted share. That was up 4.8 per cent from $664 million or $1.28 per share in the year-ago quarter.

However, “If you peel that back and look at BMO’s underlying core businesses, they actually posted earnings that were lower than the year-ago period,” said Tom Kersting, a financial services analyst with Edward Jones in St. Louis.

Operating profit beat expectations but was driven by unsustainable factors including an unusually low tax rate and a decline in loan loss provisions to a mere $16 million, Kersting said.

He noted that the three weakest divisions were personal and commercial banking, the private client investment group and investment banking — and “the three businesses across the board being weak is pretty unusual from an earnings standpoint.”

Profits from personal and commercial banking dropped $11 million to $294 million, while private client group income was down $22 million at $85 million. Investment banking profit tumbled $40 million to $186 million on lower trading revenues and securities gains.

Kersting noted that the comparisons come against strong year-ago results.

“The last couple of years saw a tremendous period of earnings growth driven by a strong Canadian economy, particularly driven by a strong consumer,” he said, adding that the other banks could feel similar pressure.

UBS Securities analyst Jason Bilodeau commented that the most likely challenges for BMO are less robust trading activity, higher credit costs and a return to normal tax rates.

“Market share losses across the board suggest efforts to invigorate the domestic retail operations are ongoing and we suspect will be an issue for the coming quarters,” Bilodeau wrote in a note.

BMO chief executive officer Tony Comper told a conference call that despite a “more difficult operating environment” in the fourth quarter, the bank’s year overall showed a good performance.

“All three operating groups delivered record net income for the second consecutive year,” said Comper, whose retirement effective March 1 was confirmed by the bank Tuesday. Comper, 61, will be succeeded by chief operating officer Bill Downe, 54.

The full-year earnings of $2.66 billion or $5.15 per share came on a 1.5 per cent increase in revenue to $9.99 billion, helped by a record profit of $710 million in the third quarter.

The bank announced an increase in its quarterly dividend to 65 cents per share, up three cents, representing a payout of about half of the past year’s earnings available to common shareholders.

Comper said BMO has “some gaps in the small business sector and we are losing share at this point in time,” and the new year will also bring a closer look at the mortgage business.

“We have backed off a very aggressive pricing strategy and we’re looking at that participation strategy as we move into the first couple of quarters,” he said.

BMO shares closed down $2.35 or 3.3 per cent to $69.16 on the Toronto Stock Exchange. The stock had hit an all-time high of $72.22 on Monday ahead of the earnings report.

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Bloomberg, Doug Alexander and Sean B. Pasternak, 28 November 2006

Bank of Montreal, Canada's fourth- biggest bank, promoted William Downe to chief executive officer, replacing Anthony Comper, who will step down in March. The stock had its biggest decline in 15 months after profit at the three main business units fell.

Comper, 61, said earlier this year he'd retire by April, ending his tenure as the longest serving chief executive among Canada's six largest banks. That fueled speculation that Downe, the chief operating officer, would be the successor.

Downe's challenges when he becomes CEO on March 1 will be to reverse a slump in the U.S. and to regain market share in Canada from bigger rivals Royal Bank of Canada and Toronto- Dominion Bank, said Tom Kersting, an analyst at Edward Jones. The bank said today that profit from U.S. consumer banking fell to C$23 million ($20 million), the lowest in 10 quarters.

``The U.S. hasn't been a particularly bright spot for BMO, and market conditions are not getting any easier,'' said Kersting in an interview today from St. Louis.

Shares of Toronto-based Bank of Montreal fell C$2.29, or 3.2 percent, to C$69.22 at 4:10 p.m. on the Toronto Stock Exchange, the biggest decline since Aug. 4, 2005. The stock has risen 6.5 percent this year, the worst performer among Canada's five biggest banks. Other bank shares declined, with Canadian Imperial Bank of Commerce dropping 2.3 percent and National Bank of Canada down 2.4 percent.

Bank of Montreal, the first Canadian lender to report fourth-quarter earnings, said in a statement that net income rose 4.8 percent to C$696 million, or C$1.35 a share, from C$664 million, or C$1.28 a year earlier.

Robert Wessel, an analyst at National Bank Financial in Toronto, said the bank earned C$1.33 a share before one-time items, topping his estimate of C$1.24 a share.

The bank benefited from lower taxes and a decline in provisions for bad loans. That helped offset a drop in profit from the investment banking, personal and commercial banking and the private client group units.

``We're clearly not pleased with the softer operating performance in the fourth quarter,'' Downe said today in a conference call with analysts.

Canadian consumer banking profit for the period ended Oct. 31 rose 1.2 percent to C$244 million, and profit from its U.S. operations fell 32 percent. Overall profit for personal and commercial banking declined 3.7 percent to C$294 million. The bank said lending margins narrowed as interest rates rose and competition increased for products such as mortgages. The bank also lost market share for consumer deposits.

The bank said it backed off on ``aggressive pricing'' for its mortgages and high-interest savings accounts, which hurt revenue in these areas. The bank saw stronger growth in consumer loans and credit cards, said Frank Techar, head of Canadian consumer banking.

Profit from investment banking fell 18 percent to C$186 million, as trading revenue from commodities and foreign exchange declined 59 percent to C$69 million. Revenue from underwriting and advisory fees rose 2.9 percent to C$104 million.

``You didn't see any one business unit that shined,'' said Kersting, who rates Bank of Montreal stock a ``hold'' and doesn't own any. ``I think people are starting to get concerned about the sustainability of earnings.''

Revenue fell because of a decline in commodity trading, Genuity Capital Markets analyst Mario Mendonca said today in a note. Genuity said in October that falling natural-gas prices and the collapse of hedge-fund manager Amaranth Advisors LLC, a Bank of Montreal client that lost $6.6 billion betting on the commodity, would hurt the bank's trading businesses.

The bank met four of its five financial targets in Comper's final year as CEO, after he took over the top spot in 1999. Earnings per share rose 12 percent on the year to C$5.15, topping the bank's target of 5 percent to 10 percent growth. Bank of Montreal aims to increase profit by 5 percent to 10 percent again next year, and is targeting the ``low end'' of that range, Chief Financial Officer Karen Maidment said on the conference call.

Lending to small business, increasing mortgages and boosting consumer banking fees will be priorities for 2007, Downe said on the call. He also said he expects ``double-digit'' loan growth in the U.S. next year.

The bank surpassed its earnings growth target ``with the benefit of extremely low taxes that are unlikely to be sustainable, suggesting poor quality,'' said Canadian Imperial Bank of Commerce analyst Darko Mihelic, who added that this was ``an extremely weak result.''

The bank expects a tax rate of 25 percent to 28 percent for 2007, Maidment said in the call.

Bank of Montreal said profit for fiscal 2006 rose to a record C$2.66 billion, up from C$2.4 billion, or C$4.63 a share, in the previous year. Revenue for the year rose 1.5 percent to C$10.1 billion.

Comper, who joined Bank of Montreal in 1967, will remain with the bank as an adviser until April 24, his 62nd birthday, the bank said.

Downe, 54, was promoted to the new position of COO in February. He's been with the bank for about 23 years, starting as a credit analyst. He became head of the BMO Nesbitt Burns investment-banking arm in May 2001 and began overseeing the U.S. operations in September 2002.

Jason Bilodeau, an analyst at UBS Canada, said he doesn't expect Downe to ``deviate'' from Comper's strategy.

``There's not going to be a radical shift in direction,'' Bilodeau said in an interview before the announcement. ``He has spent a lot of time talking about the domestic retail business and their need to be more effective with their retail customers in Canada.''

Downe completed his Bachelor of Arts degree from Wilfrid Laurier University before graduating from the University of Toronto with a Master of Business Administration in 1978, according to Bank of Montreal's Web site. Comper also attended University of Toronto, obtaining a bachelor's degree in English.

Over the last seven years, Bank of Montreal's total shareholder return, including dividends, has been 19 percent a year, the second-worst performer among the six biggest lenders over that period.

Comper indicated in March at the bank's annual meeting of shareholders in Calgary that he could step down within the next year. The next annual meeting is on March 1 in Toronto.

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RBC Capital Markets, 28 November 2006

First Impression

• Underlying EPS Low. BMO’s $1.37 cash EPS included: (i) a $35MM general loan loss release (added 4.5¢ versus our estimate), (ii) 17% effective tax rate (hard to estimate net impact – calculates as a 20¢ helper versus our estimate), (iii) corporate division was high by $42MM (added 8¢ versus our expectation and prior run-rate), and (iv) securities gains added 4¢ versus our estimate. Underlying EPS looks like ~$1.20 (consensus was $1.26, we estimated $1.21). Dividend hiked 3¢ as expected.

• Negligible Revenue Change. Revenue, by our calculation, declined 3% YoY, surprisingly weak given that securities gains and securitization revenue were above estimates. Retail spread was weak.

• Personal & Commercial Missed by 11%. Retail and commercial income of $294MM was below our estimate of $330MM (a 7¢ miss).

• Investment Banking and Wealth In Line. Collectively, $271MM in net income matched our estimate of $272MM. However, securities gains were very high at $46MM (added 4¢ versus our expected level) while trading revenue missed our estimate and the prior run rate by $83MM (12¢).

• Corporate Contributed 18% of Earnings. The centralized, non-core division reported $131MM in earnings this quarter. Excluding our estimate of the general loan loss release already highlighted above, we see another $42MM of positive variance, roughly an 8¢ helper.

• Expenses In Line. Given the revenue miss and expense as expected, operating leverage took a hit, with cost/revenue rising to 65.5%.

• Low Tax Rate. BMO experienced a “perfect storm” in Q4/06 with the favourable resolution of certain tax matters and several small tax initiatives all going the right way. The bank reported a tax rate of 17.4% (teb) – this is not sustainable, as indicated by the bank’s 2007 range of 25% to 28%. We are currently using 28.6% (teb) in our 2007 estimates.

• It’s Official – Tony Comper Retiring March 1st. BMO announced Tony Comper is set to retire and pass the CEO mantle on March 1, 2007, with Bill Downe taking over as expected. Mr. Downe’s personnel are already in place at all 3 divisions, so no management changes should be expected. The change heightens our alertness for acquisitions in US retail and/or wholesale.

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Scotia Capital Upgrades Sun Life

Scotia Capital, 29 November 2006

• We are rolling out our 2008E EPS estimates and increasing our share price targets for the Canadian lifecos - we forecast modest compression in forward multiple (from current 13.3x to 13x, in line with three year average) in part due to declining bond yields. Our share price targets imply an assumed average forward multiple for the group of 13x, down slightly from the current 13.3x, in part due to our expectation that long term bond yields will fall a little further by the end of 2007 (US 10-yr from 4.50% to 4.40%, and 10-year Canadas from 3.92% to 3.70%). Our 13x group average is in-line with the average over the last three years.

• MFC's premium to the group expected to continue to modestly compress, IAG's discount to the group expected to expand. GWO's premium to the group expected to remain constant. We expect modest compression in MFC's premium to the group on a forward P/E basis (from 5% to 4%, and closer to its 2% average) as the company's top-line growth rate, especially in the U.S., continues to decelerate from its exceptional 30%+ range in late 2005/early 2006 (when the premium to the group ran up to 12% peak in early 2006) and returns to levels closer to industry norm. We expect IAG's discount to the group to expand from its current 5% discount to a 7% discount, in part due to its higher sensitivity to low Canadian bond yields, and in part due to its higher sensitivity to volatile Canadian equity markets, and move closer to the 10% discount it has averaged to the group, excluding acquisitions, since 2000. We expect GWO's premium to the group to remain at its current 5%-6% range (still less than its 8% average premium since 2000), in part due to the potential for more bolt-on acquisitions, as well as its diversified earnings base and its strong market share in niche growth businesses with relatively high barriers to entry. Exhibit 1 outlines our targets and rationales.

• We are upgrading Sun Life to a 1-Sector Outperform from a 2-Sector Perform, primarily based on valuation. We believe Sun Life's valuation is especially attractive versus other Canadian lifecos. Trading at 12.4x NTM EPS, the stock is at a 7% discount to the group average (versus an average 2% discount over the last three years). See Exhibit 2.

• SLF's relative growth rate to the group has increased but its relative multiple to the group has decreased, presenting an attractive opportunity. We believe Sun Life's 10.5% estimated annual EPS growth from 2006E-2008E, versus the sector average at 11.8%, should justify something less than a 7% discount, especially given that the average discount was 2% from 2003-2006E, when Sun Life grew EPS 11% annually versus the sector average of 13%.

• SLF valuation and growth rate is particularly attractive versus the Canadian banks. As outlined in Exhibit 3, Sun Life's forward multiple versus the Canadian banks has declined to a 3-year low of 7% discount, versus its 2% average premium over the last three years. This combined with an 11% EPS growth in 2007, versus the banks at 9%, adds to the attractiveness.

• A fresh look to the management team is a positive to the SLF story. The recent hires of CFO Rick McKenney (former CFO of Genworth), Stephan Rajotte as President of SLF Asia (from MetLife International) and Dean Connor, EVP, responsible for UK, Reinsurance and International operations, bring lots of important and necessary outside experience to the company.

• With the unnecessary sense of urgency to do a deal now essentially out of the way, we believe the company can focus on improving fundamentals of the business. We feel the need to do a large transformational deal, and the associated risks thereof, has been a drag on SLF's valuation relative to the group. With this essentially behind us, we believe the company can re-focus on the business, and utilize its exceptional capital base to further enhance EPS through share buybacks, and further increase shareholder value though dividend increases.

• Payout ratio will likely climb to 35% with more and more share buybacks. An attractive 2.5% dividend yield, we look for the payout ratio to increase from its current 30% of 2007E EPS to 35%. In addition, we expect the company will continue to be active in buying back stock, buying back nearly 3% of its shares in 2007.

• We forecast 11.8% average EPS growth for the group through 2008. Exhibits 4, 5 and 6 outline our estimates, as well as the underlying assumptions. The currency assumptions are based on current estimates from Scotia Economics. We see upside in our estimates (1%-2%) should the Canadian dollar remain below US$0.90 through the end of 2008.

• Over the last five months banks have outperformed the lifecos by 10%, almost entirely due to relative multiple appreciation for the bank group, as the lifeco forward P/E premium to the banks fell from 10% to 0%, below its long term average of a 2% premium. We attribute part of the decline to the 60 bp fall in long bond yields in the U.S. and Canada, and the fact that the banks have been primary beneficiaries of a decline in resource based stocks and the income trust fall-out. With only minimal decline in bond yields (20 bp) expected by the end of 2007 we believe the decline in lifeco multiples versus the banks is all but complete. See exhibit 7.

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National Bank's Quebec Discount

The Globe and Mail, Derek DeCloet, 29 November 2006

This is a tale of two banks. For the moment, let's call them Company A and Company B.

Company A is one of best-run banks in Canada, though it wasn't always so. Along with one other player, it dominates the financial services market in one region of the country. Its earnings are diversified and, though its Bay Street securities arm has struggled, the company stands to make a 20-per-cent return on equity this year.

Company B is also a well-managed, regional player with a profitable niche. The CEO is credible, the track record excellent, the growth rate superb. But, unlike most other Canadian banks, it is heavily reliant on the health of the business sector -- only 12 per cent of its loans are to individual customers. It has no presence in some of the biggest growth areas in finance, like mutual funds. Its return on equity, at 14 per cent, lags its larger peers.

Which one would you rather buy? A smart investor would probably answer, "It depends on the price." Company A is Montreal's National Bank, which is getting its usual lack of respect and trading at about 12 times next year's earnings (using BMO Nesbitt Burns estimates). Company B is Edmonton-based Canadian Western Bank, which sells for 17 times. The better bank gets a Quebec discount; the inferior one, an Alberta premium.

That fact alone does not make National a good buy, but the investment case is worth looking at. The knock on the bank is that it's hemmed into Quebec and lacks a solid growth plan for English Canada, particularly since the performance of National Bank Financial is uneven. The skeptics have been winning the argument lately. Despite a great run for big bank stocks, National has been by far the worst one to own over the past year, returning 5.1 per cent, including dividends.

But to focus too much on the recent past is often a mistake with the Canadian banks, which have a habit of rebounding from their problems. Investors who walked away from Toronto-Dominion in 2002, when the bank took billions in loan write-offs, regretted their decision. Ditto those who gave up on Royal Bank in its dark days of 2004. You thought CIBC was doomed after last year's infamous Enron write-off? Guess which bank is virtually tied for top spot this year among the Big Six.

National, which reports its year-end results tomorrow, hasn't stepped in it the way those other banks did. That's a credit to Réal Raymond, the bank's 56-year-old chief executive officer. Yet the Quebec stigma still sticks. The question is, does it justify the discount to the other large banks?

Not if you turn it around and look at this way: National is one half of a Quebec duopoly. Together, the bank and the Caisse Centrale Desjardins own about 60 per cent of the provincial market in personal and commercial banking. None of the larger Canadian banks can claim any such market share, anywhere. In the U.S., where there are dozens of sizable regional banks, investors would see this as an advantage, worth paying extra for. But not here.

What can Mr. Raymond do about it? From a perception point of view, it would help to make an acquisition outside of Quebec, except that there's nothing much to buy, and the last two significant deals -- for mutual fund company Altamira and U.S. investment bank Putnam Lovell -- haven't been stellar.

Mergers among the biggest banks would also help since it would force the sale of branches, which National could be in the best position to buy. You could argue Ottawa's solution to the merger problem, in fact, is to make it a policy to build National into a truly national bank -- good for Quebec, good for competition. But mergers aren't about to happen soon (though, at 12 times earnings, investors aren't paying for the possibility; consider it a free option).

In the short-term, a better answer might to be to ratchet up the dividend. National is one of the best dividend growers in the large-cap S&P/TSX 60, yet its payout ratio is on the low side -- about 37 per cent so far in 2006. But after the income trust debacle, high dividends are something the market seems willing to pay for. If National decided to give back, say, half its earnings, you could see its dividend rise by one-third next year.

Maybe then Mr. Raymond's bank would get the respect it deserves.

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P/E ratio on 2007 earnings*

• Canadian Western Bank 17.0
• Royal Bank 14.4
• Bank of Nova Scotia 13.8
• TD Bank 13.0
• Bank of Montreal 12.9
• CIBC 12.5
• National Bank 11.9

* Cash earnings for fiscal 2007, based on BMO Nesbitt Burns estimates

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Scotiabank Eyes China & India

Canadian Press, David Friend, 28 November 2006

Bank of Nova Scotia is looking to carve out more business and push its brand in India after more than two decades of a marginal banking presence in the world's second most populated country.

A stepping stone to that expansion will be the opening of Scotiabank's latest Chinese commercial branch in Shanghai, executive vice-president Rob Pitfield said yesterday. "Those are two fantastic countries which we're very interested in, so we're continually working with the government to see what they'd be willing to permit us to do."

The move could also help Canada's most international bank establish a strong relationship with regulators in India, a country with more than 1.1 billion people, which could open the door to future expansion opportunities.

"Just by the fact that you're there and you're taking these opportunities, clearly your competitors can't," he said. "In India it's quite regulated so it's difficult for a foreign company to invest, but on the other hand it's a fantastic partner."

The bank already has five branches serving retail and commercial customers in India but Mr. Pitfield said Scotiabank is exploring opportunities to make bigger acquisitions that could include banks or financial service companies in the country.

In China, where regulators have not yet allowed the bank to establish retail locations, Scotiabank is building a relationship with regulators that it hopes will open doors.

"They decide how they want to see their financial services industry expand, and we think it's natural that when you decide to expand you do it with proven entities that have stood the test of time and that you trust," Mr. Pitfield said. "We'll work with the regulators and we'll work with authorities and whatever services they choose to bestow to us we're thankful for."

Most major Canadian banks have been tiptoeing through international expansion, with Bank of Montreal, Royal Bank of Canada and Toronto-Dominion Bank opting to head to the United States to fulfill their global aspirations.

Scotiabank has taken an alternative route, pushing into markets such as Latin America, which it refers to as its main focus outside Canada, and now Asia. With the addition of the Shanghai branch, the bank will have six branches in China.

Each location must be individually approved by the local government, which puts a wrench in the cogs of any plans for vast expansion.

"You're not going to see an announcement where a foreign bank says they're going to open 100 branches," Scotiabank's Robin Hibberd, senior vice-president of corporate development, said in an interview. "They're going to have to be one at a time."

And so the process has stretched on for decades, with Scotiabank first establishing itself in China and India during the early 1980s, and setting up a new operation once every few years.

It isn't the sole Canadian bank sniffing out opportunities in the region. Last month, RBC entered China's market by announcing a joint venture with China Minsheng Banking Corp. Ltd. to launch a fund management company based in Shanghai.

Minsheng Bank is the first major national commercial bank in China without state ownership.

Regulators aren't the only challenge to Canadian banks hoping to carve out a presence in Asia, according to Ian Nakamoto, director of research at MacDougall MacDougall and MacTier Inc. in Toronto.

He says well-known U.S. and European banks are also making headway in the market, buying stakes in well-known local banks and putting themselves at an advantage compared with the smaller Canadian players who haven't built a strong reputation overseas.

"For any Canadian bank to go into places where their brand name is not known, it tends to be different than if you're selling them a shirt," Mr. Nakamoto said. "But you've got to start somewhere."

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RBC CM Analyst's Preview of Bank Q4 2006 Earnings

Report on Business Television, 27 November 2006

Click here for the ROBTv video clip, of Jamie Keating, Senior Bank Analyst, RBC Capital Markets.

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Morningstar on Banks

Morningstar, Ryan Batchelor, CPA, 27 November 2006

After reviewing the newly expanded International Stalwarts list in the October issue of Morningstar StockInvestor you may have asked yourself, "What gives with all of the Canadian banks?" In addition to Royal Bank of Canada, which was one of the original Stalwarts, we added four additional wide-moat Canadian banks to the list last month: Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, and Toronto-Dominion Bank.

I believe these are all very solid banks that would make fine investments if they fell to our 5-star prices. In addition to their strong business models, which we'll highlight below, the Canadian banks are quite shareholder friendly and pay healthy dividends. At our consider buying prices, and based on this year's current dividend, each of the 5 banks would sport a dividend yield near to or above 4%.

It is, however, a little ironic to be talking about Canadian banks--which, quite frankly, can seem a little boring--given the highly publicized recent initial public offering of China's largest bank, Industrial & Commercial Bank of China, or ICBC, in October. While we don't cover this firm yet--it's listed only in Hong Kong and China--the IPO was the world's largest ever, raising more $22 billion, and was received with much fanfare--and a very large opening day price pop--across China and Hong Kong.

To give you a flavor for the demand for ICBC, local media in Hong Kong reported that individual investors in Hong Kong placed orders to buy almost $54 billion of the IPO, while institutional investors wanted $325 billion worth! One Hong Kong newspaper suggested that more than 1 million people, or one in seven Hong Kong residents, placed an order to buy the stock.

Canada's Banking Environment

In contrast to the hype and excitement surrounding China and its 1.3 billion people clamoring for banking, the sleepy Canadian banks just quietly keep plugging along serving a nation that has 40 times fewer people. They do it with little fanfare, quietly creating lasting value for shareholders by virtue of their wide moats.

Unlike the United States, which has a very fragmented banking industry, Canadas top six banks (the five Stalwarts members plus one we don't yet cover) dominate the Canadian market with roughly 90% market share in deposits and assets. Banking is also big business. Even though more than half of Canada's exports are commodity-related, its largest industry, as measured by gross domestic product, is financial services.

When evaluating potential investments, I like to see a dominant firm because thats usually strong evidence that there is some sort of a moat that allowed the firm to attain its position. This assumes, of course, that the firms are earning high returns on capital--which each of the five Stalwart banks do, with an average return on equity of about 17%. Our expert on Canadian banks, Michael Kon, identified three main reasons that the top banks dominate.

First, the banks tout themselves as home-grown Canadian banks, which we believe appeals to Canadians' sense of nationalism. Second, there are rules and regulations in Canada that make it very unattractive to start a new bank there, especially for foreign banks trying to penetrate the market. Third, because the large banks are so entrenched, they have vast networks of branches, automated teller machines, and established brands that act as steep barriers to entry for potential competition. I'll also add on to these three reasons my own belief that while the banks certainly compete against each other, there hasn't been much churn among bank customers, so I think there are some unwritten rules of competition that help ensure that the banks maintain their livelihoods.

While these banks dominate Canada, the country is certainly not China. Growth rates in Canada will make even the most patient investors yawn, thanks primarily to these banks' already-dominant positions. As a result, almost all of the banks use their Canadian operation as a cash cow to fund international expansion. This strategy leads to a big risk: The risk of a great business throwing cash at marginal ideas because it doesn't have anything better to do with the money. We've accordingly given each of these businesses average, rather than below-average, risk ratings.

The Bright Side of Lower Margins

Surprisingly, the financial metrics of Canadian banks are relatively underwhelming, with margins noticeably lower than their U.S. counterparts. This may seem counterintuitive, given their dominant market positions. However, high margins in banking attract not only competition, but also regulatory and political scrutiny. (Who wants the big bad dominant banks to be plundering society?) So theres an incentive to post good, but not great, margins if you hold a dominant market position. The key point is that despite so-so margins, they earn returns on capital well above their cost of capital. This is the linchpin of a wide moat, and these banks do it consistently.

My Favorite Canadian Bank

While all five Stalwarts are excellent banks, I'm particularly fond of Bank of Nova Scotia. In Canada, this bank has posted an impressive 31% return on equity over the past five years, a testament to its wide moat. Unlike most of its peers, which expanded to the United States in search of growth, BNS attacked Latin America. It has worked well so far. The firm's foreign operations have generated a very healthy 17% return on equity over the last five years.

The bank's expense efficiency and business diversification isn't as good as some of its peers, but the firm manages its balance sheet very well. Its net interest margins--a key measure of banking that measures the spread between what it earns on its assets and what it pays for its liabilities expressed as a percentage of assets--are higher than its peers, thanks to careful management of interest-rate risk. Unfortunately this bank's not trading for a very cheap price right now--that's true of the other Canadian banks as well--but it's certainly worth keeping them on a watch list and patiently waiting for a fat pitch opportunity to present itself.

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Banks Q4 Profits Seen Strong

Financial Post, Don Vialoux, 27 November 2006

The Canadian financial services index has a history of moving higher in late November/early December prior to release of final earnings reports for the year by Canada's top six banks.

Chief executives of the banks like to offer encouraging news to shareholders when they release fiscal fourth-quarter results for the period ended Oct 31. The chart shows performance of the TSX financial services index in late November/early December during the past five years.

Technicals

Technicals for the TSX financial services index are encouraging. Late last week, the index closed at a record high.

The index remains in a three-year uptrend. Recent changes in Canada's tax laws have contributed to recent strength. Income-oriented investors have been encouraged to prefer high-yielding, dividend-paying bank stocks rather than income trusts.

Fundamentals

Chief executives from the banks have lots of good news to give their shareholders when they release fourth-quarter results this year.

- Fourth-quarter earnings per share for the top six banks are expected to improve by 10.6% on a year-over-year basis. Gains will come from strong loan demand, rising fee income (thanks partly to strong equity markets and a robust new-issue calendar) and a growing contribution from international operations.

- Dividends are expected to rise. Banks likely to raise their quarterly dividend when fourth-quarter reports are released include CIBC, Scotia Bank, National Bank and Bank of Montreal.

- The quality of bank loans is expected to remain high. Loan loss provisions are expected to remain relatively stable.

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The Globe and Mail, Andrew Willis & Roma Luciw, 26 November 2006

The financial forecast calls for the banks to rain dividends on investors over the next two weeks, as Bank of Montreal kicks off the annual earnings season on Tuesday with the first in a series of projected double-digit increases in dividend payouts.

Bank of Montreal is expected to bump up its annual dividend by up to 12 per cent to $2.78, a move that's expected to continue the market's recent love affair with the sector. Yield-hungry investors have embraced banks this month as they search for new sources of income in the wake of the federal government's Oct. 31 decision to tax income trusts.

With banks enjoying a near-perfect combination of solid economic growth and minimal loan losses, analyst Darko Mihelic at CIBC World Markets Inc. expects four of the big six banks will raise their dividends, with an average increase of 11 per cent. The two banks unlikely to move — Royal Bank of Canada and Toronto-Dominion Bank — are only constrained by the fact they recently raised dividends.

Banks have been star performers, with the S&P/TSX capped financial subindex up 14 per cent this year, outperforming a 12.2-per-cent gain by the S&P/TSX composite index. The question of just how much higher the sector can soar now preoccupies analysts.

Robert Wessel of National Bank Financial Inc. said in a report: “The banks continue to report strong EPS growth. This fact, combined with (still) attractive valuations, low risk, and most importantly, our expectation of another two years of double-digit EPS growth, supports our continued bullish stance, although a short-term correction is possible.” He forecasts bank profits will increase 9.8 per cent in 2007 and 10.9 per cent in 2008.

However, this year's rising prices mean the bank stocks are now relatively expensive, compared with historic valuations. The price-to-earnings ratio of the group is 13.3 times forecast earnings, near the 10-year high of 14 times earnings that was seen at the height of bank-merger mania in 1998.

A number of analysts are warning that with bank stocks commanding premium prices, there is the potential for unpleasant surprises in annual earnings over the next two weeks. Mr. Mihelic said: “While banks may trade at high multiples due to dividend yields, the stocks are at risk should earnings or outlook disappoint.”

While the banks are expected to report higher year-over-year profit, with 13-per-cent annual growth in earnings per share — results from the fourth quarter of fiscal 2006 are expected to show profit growth slowing as the credit cycle darkens.

“We believe credit quality and equity markets are unlikely to be as good for the banks in upcoming years as in the last five years,” said Merrill Lynch analyst Andre-Philippe Hardy. While year-over-year growth will be impressive, Mr. Hardy says fourth-quarter numbers will likely be weaker than what was seen in the third quarter, with share profit dropping 2 per cent on a 25-per-cent projected rise in provisions for credit losses.

Merrill Lynch's forecast has Royal Bank of Canada leading the way on profit growth, while Canadian Imperial Bank of Commerce is likely to come in at the back of the pack, “mainly driven by lower merchant banking gains,” Mr. Hardy said.

However, CIBC is expected to restart dividend increases, with Mr. Mihelic calling for a rise of up to 17 per cent on what's currently a $2.80 annual dividend. CIBC has rebuilt its balance sheet after taking a $2.4-billion (U.S.) hit to settle Enron-related lawsuits early last year.

Bank of Montreal will be the first of the big six to report earnings, followed by RBC and National Bank of Canada on Nov. 30, CIBC on Dec. 7, and TD Bank and Bank of Nova Scotia on Dec. 8.

Bank of Montreal earned $1.30 (Canadian) a share in the third quarter of fiscal 2006, when capital markets revenues hit record highs. The consensus forecast from analysts calls for earnings of $1.25 a share in the fourth quarter.

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Canadian Press, David Friend, 26 November 2006

Canada's big banks are certain to ring up strong year-over-year net profit growth as they begin to report fourth quarter earnings this week — mainly because the fallout from the Enron scandal won't drag down their books as it did in fiscal 2005.

Overall, the six biggest banks — the Royal, CIBC, Bank of Montreal, TD, Scotiabank and National — earned a net profit of $10.4 billion last year, a figure already surpassed in the first nine months of fiscal 2006, when the banks earned cumulative profits of $13.6 billion.

Analysts are forecasting the banks as a group will complete the fiscal fourth quarter, which runs from August until October, with median earnings per share growth of around 10 per cent.

"These are not rocketship returns in terms of EPS. It's more a matter of steady as she goes and no potholes on the horizon," said Ian Nakamoto, director of research at MacDougall, MacDougall and Weir.

RBC Capital Markets analyst James Keating said the Bank of Montreal is the only big bank he expects to report lower earnings than a year ago.

"It's not so much that they had a weak quarter, but more that some of their prior quarters have been unsustainably strong," he said, citing past gains on securities and tax credits.

Other analysts are more optimistic about BMO, on average predicting a three per cent rise in its earnings per share.

Earnings this year will look especially good, considering some of the banks were pummelled by billions of dollars in charges last year for liabilities in lawsuits connection with the Enron scandal.

Retail banking "has been pretty friendly," according to Keating who equates it with abuot 50 to 60 per cent of the banks' profits. Capital markets have also seen good results, though "the arrows are pointing down a bit."

He noted that bank shares, with their steadily increasing dividends, have benefited from investors' flight from income trusts since Finance Minister Jim Flaherty's Oct. 31 announcement that trust distributions will be taxed at corporate rates in 2011.

"Some of the money that was in income trusts has found its way over to banks. We were predicting a five or six per cent lift as a result of that, and I'd argue that's what we've seen."

Caldwell Securities portfolio manager John Kinsey said low interest rates have helped sustain bank profits.

"The bank earnings have been slowing from two or three years ago, when they were gangbusters, but they're still going to be in the high single-digit or low double-digits," he said.

Kinsey predicted four banks will increase their dividends this quarter, in line with Keating's expectation that Scotiabank will lead by boosting its payout by eight per cent.

Keating also targets dividend increases of five per cent at BMO, four per cent at National Bank and three per cent at CIBC.

Royal Bank and TD boosted their dividends in the third quarter and are unlikely to do so in this period, analysts said.

The fourth-quarter earnings season begins Monday and runs until Dec. 8, with BMO the first to report.

It will be followed by the Royal and National Bank on Thursay, then CIBC on Dec. 7 and both TD and Scotiabank on Dec. 8.

The Royal and TD have been putting their increased cash to use as they attempt to boost their U.S. presence.

RBC, aiming to "re-accelerate" its U.S. presence in 2007, paid US$456 million in August for Flag Financial Corp. and Flag Bank in Georgia.

Last week, TD announced plans to acquire the rest of its majority-owned Portland, Me.-based TD Banknorth Inc. for C$3.6 billion.

But more generally the Canadian banks have been hesitant to expand stateside, given high bank-share valuations, a slumping housing market and indications of a slowing American economy.

Looking into the new financial year, RBC's Keating says earnings estimates "may prove conservative again . . . as the benign credit and interest rate conditions prevail, and stability in the U.S. dollar and Canadian dollar stabilizes non-domestic earnings contribution."

He said the main risks would be credit problems related to unemployment, a sharp drop in the Canadian dollar, or surprise inflation and interest rate increases. None of these is particularly likely, he added.

Nakamoto said next year's loan losses will put the banks to the test after a healthy five-year showing.

"People are going to focus more on the credit quality because the general sense is that the economy is softening," he said.

"Let's see if there are any sins of the past, loans that were made in 2003 and 2004, that will haunt them in 2007."

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NBF on Banks

National Bank Financial, 24 November 2006

Excerpt from the report titled 'Canadian Banks - Q4 2006 Quarterly: New '08 EPS Estimates; Still Very Bullish," 21 November 2006

• Still very bullish: F2006 has been a solid year for the banks. Benefiting from a favourable operating environment, and with lending NII, very promisingly, showing signs of improvement, the banks continue to report strong EPS growth. This fact, combined with (still) attractive valuations, low risk, and most importantly, our expectation of another 2 years of double-digit EPS growth, supports our continued bullish stance (although a short-term correction is possible).

• Introducing F2008 estimates (and updating F2007): We are revising our F2007 estimates and introducing F2008 forecasts, which assume Y/Y growth of 9.8% and 10.9% respectively. Our investment thesis for the next 2 years incorporates (i) increases in PCLs of over 20% per year, (ii) a modest recovery in net CMRR from lower F2006 levels, (iii) good loan growth & modestly improving margins, and (iv) a large decline in securities gains.

• A powerful earnings driver reawakens: Last quarter, much higher lending NII, supported by solid loan growth and margin expansion, helped drive the excellent 14% Y/Y EPS growth. Over the next 2 years, we expect lending NII to take over from provisions as the primary driver of double-digit earnings growth.

• Will tax on Income Trusts drive higher payout ratios? Although capital deployment continues to be the most important secular trend facing the banks, dividend growth also remains important. In our view, the tax on income trusts and investors' heightened demand for yield may cause the three banks (BNS, NA, TD) with the lowest payout ratios (35% to 45%) to increase their target ranges, supporting already solid dividend growth for the sector.

• Conclusion - solid growth prospects support bullish stance: The group's fundamentals remains robust, with high ROEs, strong capital, and double-digit EPS growth expected. As of November 17th, the group traded at 13.0x and 11.7x our F2007 and F2008 estimates respectively, levels we believe to be attractive given the sector's (higher) growth and (low) risk profile. Our top pick is CM.

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The Globe and Mail, Roma Luciw, 24 November 2006

Canada's biggest banks are expected to report higher year-over-year profit when they start releasing results next week, but earnings growth could slow from the previous quarter as the credit cycle darkens.

“We believe credit quality and equity markets are unlikely to be as good for the banks in upcoming years as in the last five years,” said Merrill Lynch analyst Andre-Philippe Hardy.

Fourth-quarter core profit among the six largest Canadian banks is expected to rise 12 per cent from last year. Merrill is looking for Royal Bank of Canada to lead the way on “easy reinsurance comparisons” while CIBC is likely to come in at the low end, “mainly driven by lower merchant banking gains,” Mr. Hardy said.

Compared with the third quarter, he expects per share profit will drop 2 per cent on a 25 per cent projected rise in provisions for credit losses. “We believe new provision levels remained low in both personal and corporate lending as credit conditions remain benign,” Mr. Hardy said.

Strong capital markets were stronger-than-expected in October, he said. Strong debt underwriting, mergers and acquisition advisory fees and wealth management sales will be partially be offset by lower equity underwriting revenues and flat to lower trading revenues.

Bank of Montreal will be the first of the big six to report earnings on Nov. 28, followed by Royal Bank of Canada and National Bank on Nov. 30, Canadian Imperial Bank of Commerce on Dec. 7, Toronto-Dominion Bank and Bank of Nova Scotia on Dec. 8.

The S&P/TSX capped financial sub-index has risen 14 per cent so far this year, outperforming a 12.2 per cent gain by the S&P/TSX composite index.

Although lower bond yields, higher capitalization levels, decreased exposure to credit risk, and lower personal dividend tax rates have boosted the bank's multiples, Mr. Hardy does not believe the credit or equity market environment will be as positive for the big banks in the coming years.

“We do not believe further expansion is likely given our outlook for slowing earnings growth,” he said.

Robert Wessel, the banking analyst for National Bank Financial Inc., forecasts bank profits will increase 9.8 per cent in 2007 and 10.9 per cent in 2008 and trade at 13 times and 11.7 times, respectively, his profit estimates.

James Keating, an analyst with RBC Dominion Securities Inc. is looking for about a 13-per-cent return, including dividends, from the banks.

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The Globe and Mail, Allan Robinson, 24 November 2006

The banks begin reporting their fourth-quarter results next week, led by Bank of Montreal on Tuesday, and the group will need to play a pivotal role if the S&P/TSX composite index is to continue to climb next year.

"I will point out that while the S&P/TSX return will be fairly good, you are looking at a polarized stock market, with most of the return expected from two sectors, energy and financials," said Jeff Rubin, chief strategist for CIBC World Markets Inc.

That could be good news. "The TSX seems made to order for an environment of rising energy prices and falling interest rates," Mr. Rubin said. Two-thirds of the market capitalization of companies comprising the index are in interest-sensitive and energy stocks.

CIBC has a 12-month target for the index of S&P/TSX of 13,500, which implies the market could move up another 7 per cent from its close yesterday at 12,644.9. Since Nov. 1, the index has surged 4.9 per cent.

Investors in bonds and stocks are anticipating the U.S. Federal Reserve Board and the Bank of Canada could begin cutting interest rates next year, strategists say.

"The banks have historically been the major beneficiaries of interest rate decline," Mr. Rubin said. Relatively high-yielding utilities and telecom stocks also benefit, he said. The banking sector currently yields about 3.1 per cent.

CIBC estimates that for every 100 basis points cut in 10-year yields, the share price of banks increase on average by about 9.5 per cent. The yield on 10-year Canadian government bonds is currently 3.97 per cent and CIBC forecasts the yield could drop 55 basis points to 60 points next year, which implies more than a 5-per-cent gain in the bank shares from that alone. (A basis point is 1/100th of a percentage point.) The bank shares could also get a boost from rising profits, which CIBC estimates will increase 14 per cent in the fourth quarter and 12 per cent during 2007, Mr. Rubin said. Lower interest rates boost profit margins and lower default rates.

James Keating, an analyst with RBC Dominion Securities Inc. is looking for about a 13-per-cent return, including dividends, from the banks. On a year-to-date basis, the banks have outperformed the S&P/TSX by 3.3 percentage points after rising 14 per cent during the past four months, he said. Robert Wessel, the banking analyst for National Bank Financial Inc., forecasts bank profits will increase 9.8 per cent in 2007 and 10.9 per cent in 2008 and trade at 13 times and 11.7 times, respectively, his profit estimates. He remains bullish.

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The Globe and Mail, 24 November 2006

James Keating, an analyst with RBC Dominion Securities Inc., rates the Toronto-Dominion Bank as an "outperform" and says the decision to take 40-per-cent-owned TD Banknorth private is a turning point.

Yesterday, he raised his share profit forecasts on a cash basis by 4 cents in 2007 and 5 cents in 2008 to $5.40 and $6.05, respectively. Mr. Keating describes his profit increase as a "tweak," but he says RBC's cash estimate is the highest on the Street.

"In our view, investors are too bearish on TD's earnings-per-share outlook, meaning the discounted price-to-earnings multiple is doubly attractive."

The latest deal simplifies the corporate structure, adds to future profit and increases the incremental leverage to any rise in the U.S.-Canadian dollar exchange rate, he said.

The shares of the bank closed yesterday at $67.96, up 55 cents. RBC's 12-month share price target is $84.

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Strong Quarter Predicted for Banks

Reuters, Nicole Mordant, 23 November 2006

Analysts expect Canada's big six banks to show handsome earnings growth of around 10 per cent for their fourth quarters, and forecast that four of the banks will bump up their dividends as the sector benefits from an unusually long period of health.

Reporting season for the August-to-October period kicks off Tuesday with Bank of Montreal's results.

"We're looking for high single-digit earnings or low double-digit," said John Kinsey, portfolio manager at Caldwell Securities in Toronto.

"It's going to be more of the same. The banks are still doing well. The focus has been for the past five years on dividend increases and on share buybacks," he said.

Canadian banks, stuffed with cash and with few places to park it lately, have been returning some of that cash to shareholders. Several have announced share repurchase programs, and in the last quarter Royal Bank of Canada and Toronto-Dominion Bank boosted their dividends.

Analysts now expect their four big peers — Bank of Montreal, Bank of Nova Scotia , Canadian Imperial Bank of Commerce and National Bank of Canada — to announce higher quarterly dividends.

Scotiabank and National Bank could also increase their target ranges for dividend payouts, said Mario Mendonca, an analyst at Genuity Capital Markets in Toronto.

That should hearten income-hungry investors who flocked into the banking sector this month in the wake of Ottawa's Halloween announcement that it will start taxing income trusts, which pay out nearly all of their profits to unitholders.

"With the income trust tax changes, people are looking at large blue chips as a source of income and therefore there is going to be a real desire for those target payout ratios to move up," said Ohad Lederer, an analyst with Veritas Investment Research in Toronto.

Although profits are expected to be strong — return on equity for the sector is seen at between 18 and 24 per cent — analysts fret that the best times may be over.

They note, for example, that banks will need to set aside more money in future to cover bad loans.

"Provisioning levels need to move higher as the credit environment has the potential to deteriorate," RBC Capital Markets analyst James Keating said in a research note. "It may not be evident in Q4 results, but we are watching for higher loan losses in 2007 and 2008."

On top of a solid performance from their personal and commercial banking operations, the banks' wealth management operations should show "modestly higher" fourth-quarter earnings from increased trading volumes on the Toronto Stock Exchange, said Susan Cohen of Dundee Securities.

Investors will also look for bank executives to outline their business expectations and goals for the new fiscal year.

Here are the mean analyst estimates for earnings per share, before unusual items, as compiled by Reuters Estimates:

• Bank of Montreal: $1.25
• Royal Bank: 90 cents
• National Bank: $1.25
• CIBC: $1.65
• TD Bank: $1.19
• Scotiabank: 88 cents

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RBC to Acquire Daniels & Associates

Financial Post, Duncan Mavin, 22 November 2006

RBC Capital Markets yesterday beefed up its strength in the communications, media and entertainment industries in the United States in anticipation of a wave of activity set to sweep through the sector.

"There's going to be a tremendous amount of activity in this sector," said Peter de Vos, RBC Capital Markets U.S. chief.

The investment banking division of Canada's largest bank will acquire Daniels & Associates, LP, a Denver, Colorado-based mergers and acquisitions advisor that specializes in the cable, telecom and broadcast industries.

"We feel that it's going to be an incredibly active area and one that's going to require a lot of capital," said Mr. de Vos.

The impact of the Internet on TV and print advertising sales, as well as new technologies in video, data and audio, are creating opportunities for growth and consolidation.

For instance, last week radio and television operator Clear Channel Communications Inc. was sold to a private equity group in a deal worth US$26.7-billion. On the same day, investors led by Ripplewood Holdings bought Reader's Digest Association Inc. for about US$2.4-billion.

RBC said Daniels has completed more M&A transactions in the CME sector than than any other investment bank in the past six years. The firm has about 30 professionals dedicated to the communications, media and entertainment industries, a significant increase from RBC's current headcount of eight staff covering the sector.

The joint operations will be renamed RBC Daniels and current Daniels head Brian Deevy will remain as chief executive.

"We are very excited about joining forces with RBC Capital Markets," said Mr. Deevy. "This transaction will allow us to provide a much broader range of services to our clients."

RBC's Mr. de Vos said the business of the new RBC Daniels unit will be predominantly in the U.S. although it will also provide advice to RBC Capital Markets units in Canada and in other international markets.

RBC did not disclosed the financial details of the transaction, which is the latest in a series of U.S. acquisitions for the bank.

In October, RBC Capital Markets agreed to buy the broker-dealer business of New York-based Carlin Financial Group. The bank's RBC Centura retail banking business has also recently agreed to buy Atlanta-based Flag Financial Corp. as well as 39 branches in Alabama from AmSouth Bancorporation.

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Desjardins Securities on Banks

Financial Post, Grant Surridge, 22 November 2006

The good times continue to roll in the Canadian banking sector. Earnings and dividends will keep rising in the fourth quarter, in what Desjardins Securities analyst Michael Goldberg predicts will be another "golden quarter."

Canadian banking stocks were up 9.4% in the period from August to October, versus 4.3% for the TSX Composite, and 2.6% for banks south of the border.

Canadian Imperial Bank of Commerce led the charge, up 13.4% over last quarter, with TD close on its heels with 12.7% growth.

Mr. Goldberg notes that this performance doesn't even reflect the positive impact from the federal government's income trust announcement at the end of October.

Many of the positives enjoyed by banks in the third quarter should propel double-digit operating profit growth in the fourth, despite pressure on net interest margins, according to Mr. Goldberg. A robust economy likely drove strong loan growth, with takeover activity seemingly becoming more prevalent.

While Mr. Goldberg sees this as an indication of continuing upward momentum in loans, it also probably means a maturing of the credit cycle. This will mark the eighth consecutive quarter of strong growth for Canadian banks.

The fourth quarter should also see four of the six major banks post higher dividends, with increases ranging from 7% at CIBC to 3% at Bank of Montreal.

Toronto-Dominion remains Mr. Goldberg's top pick among banks, with a target price of $76.50. BMO, Scotia Bank, CIBC and Royal Bank are all rated "buy," while National Bank is a "hold."

He sees banking shares rising four to 16% over the coming year, with TD and BMO near the top of that range and Royal Bank at the bottom.

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Banks to Add 250+ Branches Over 5 Years

Bloomberg, Sean B. Pasternak & Doug Alexander, 21 November 2006

A month before Royal Bank of Canada opened a new branch in Toronto's King West Village, manager Neil Joshi donned a hockey jersey bearing his bank's logo and hit the streets and cafes to drum up business.

His efforts paid off: 79 people and 19 companies signed accounts in the first month after the branch opened in September in an old industrial area where condominiums have sprung up.

"This is a hot neighborhood," Joshi, 35, said. "The bank has made the right choice coming here."

For the first time this decade, Canada's five biggest banks are adding branches. Barred from pursuing domestic mergers and unwilling to make costly acquisitions abroad, lenders such as Royal Bank are turning to their domestic branch network for predictable earnings growth. Combined, the banks plan to add at least 250 branches over five years, an increase of 5 percent, after six years of closings.

"Retail branch banking in Canada is about one of the most boring things, but also one of the safest, most profitable," said Gavin Graham, chief investment officer at Guardian Group of Funds in Toronto, which owns banks among the equivalent of $5.1 billion it manages. "Boring is good."

With profits rising and their stocks near record highs, the banks need somewhere to put their excess cash, which National Bank Financial analyst Robert Wessel estimates at about C$9 billion ($7.9 billion). The 39-member Standard & Poor's/Toronto Stock Exchange Financials Index has risen 13 percent this year, compared with a 10 percent gain in the S&P/TSX Composite Index.

Investing in consumer trade has proven more lucrative than investment banking for companies such as Toronto-Dominion Bank, which relied on retail banking and asset management for 76 percent of profit in the fiscal third quarter. At Canadian Imperial Bank of Commerce, the two areas accounted for 74 percent of net income, up from 59 percent two years ago.

Canadian banks, which begin reporting fourth-quarter results Nov. 28, may increase profits by an average 10 percent from a year earlier, led by consumer lending and capital markets fees, according to UBS Canada analyst Jason Bilodeau.

"For a while there was a big focus on expansion outside Canada," said Lindsay Gordon, chief executive officer of HSBC Holdings Plc's Canadian unit. "Many of the Canadian banks have retracted from that and are focusing in-market."

The Vancouver-based bank, with 127 branches, says it plans to open 20 new outlets in the Toronto area by the end of 2008 and 10 in the western province of Alberta.

Royal Bank, the biggest lender, may build as many as 112 outlets in the next four years to add to its 1,117 branches, Chief Operating Officer Barbara Stymiest said at an Oct. 4 investor conference. Bank of Nova Scotia, the third-largest bank by assets, plans to open 30 branches next year. CIBC aims to open or expand 70 in the next five years. Toronto-Dominion, the No. 2 bank, opened 19 branches in October alone and says it expects to open 30 more each year. Bank of Montreal plans to add 16. All five banks are based in Toronto.

Incentives are emerging along with new branches. Toronto-Dominion began offering Apple Computer Inc.'s iPod music players last year to clients who opened new checking accounts, and its latest promotion is a free portable DVD player. Next year, Scotiabank will start a loyalty program that will include movie tickets. The bank offered free North American flights for new accounts opened in September and October.

"Some customers still like to have a premium for bringing their business over,'' said Tim Hockey, co-chairman of personal banking for Toronto-Dominion.

Some bankers said the expansion isn't needed. Canada ranks seventh in the world with 46 offices for every 100,000 people, according to a 2005 World Bank study. Spain ranked first with 96, followed by Austria, Belgium, Italy, Portugal and Germany. The U.S. had 31 per 100,000.

Michel Tremblay, senior vice president of personal banking and wealth management at Montreal-based National Bank of Canada, said that, outside of Quebec, Canada is "over-branched and over-banked'' most of the time. National Bank plans to open no more than a few new branches.

Earlier this decade, Canadian banks focused on expansion abroad. Royal Bank and Bank of Montreal bought lenders in North Carolina and Chicago, while Toronto-Dominion and CIBC increased lending to U.S. telecommunication and technology companies through their investment banks. CIBC retreated from its U.S. retail strategy four years ago, while Royal Bank last year sold its unprofitable U.S. mortgage unit.

Today, banks are betting on growing demand for investment advice and mutual funds from an aging population, especially in expanding suburbs.

"There's a lot of new and high-growth areas, particularly in cities like Toronto, Vancouver, Calgary, Edmonton, and that's where you're seeing most of the banks focus," Royal Bank CEO Gordon Nixon said in an interview.

The banks are also targeting areas of increased immigration. Last year, Bank of Nova Scotia bought the Canadian unit of National Bank of Greece SA, while Bank of Montreal has agreed to buy the local arm of Banco Comercial Portugues SA for about C$41 million.

Banks closed branches this decade because of a rise in Internet banking. Still, most Canadians will visit a branch for some needs.

"People will go shopping on the Internet for a mortgage, but they want to deal with a person," said Raymond McManus, CEO of Montreal-based Laurentian Bank of Canada. "I would say you've got to have both, and that's what the banks have discovered."

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Veritas Investment on Life Insurance Cos

Financial Post, Jonathan Ratner, 21 November 2006

It comes as little surprise that the Conservative government's Halloween decision to tax income trust distributions drove more investors into quality blue-chip financials.

While the announcement may have trust-holders feeling tricked, it appears to have been a treat for dividend-paying stocks such as some of Canada's largest insurance companies.

Ohad Lederer at Veritas Investment Research thinks quality financial services companies Manulife Financial Corp. and Sun Life Financial, both near their 52-week highs, stand to make further gains. His price targets are $44.50 for Manulife and $51.35 for Sun Life. Both company's shares jumped on the Federal government's announcement and have continued to move up since.

In a research note, Mr. Lederer also points out some relevant facts for these companies: As the first Baby Boomers turn 60, these life insurers-turned-wealth managers continue to be in the midst of a growth period. And "over the long-run, we're also all dead."

Mr. Lederer expects both companies will continue to increase earnings and dividends by complementing their core businesses with further investment in more complex wealth management offerings in North America and basic financial products in rapidly developing Asian markets.

Veritas expects Manulife to trade at a premium to Sun Life, and as a result, suggests investors who own both insurers overweight Manulife due to its superior prospects for new business growth.

While Manulife did rise following the government's announcement, "these levels are not 'expensive' given the robust growth and experience gains the company delivers on a regular basis," Mr. Lederer wrote.

Nevertheless, he doesn't consider Manulife invincible, citing the potential of possible blips such as a slowdown in sales or increased competition.

Veritas is also clear about Sun Life shares: they are not cheap. But nor are they considered excessively expensive, since dividend increases are expected to come "at a measured pace" and investment in developing markets could emerge as something significant in the future.

The only other financial institutions with equally-compelling international strategies for Mr. Lederer are Scotiabank and Great West Lifeco.

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TD Bank to Take TD Banknorth Private

Scotia Capital, 21 November 2006

TD Bank to Acquire Remaining 41% of TD Banknorth - Shift in Strategy

• TD Bank announced that it will buy the remaining 41% stake in TD Banknorth for US$32.33 per BNK share or US$3.2 Billion (C$3.6 billion) in an all cash offer. The purchase price represents 15.8x 2007 EPS of US$2.05 per share and 6.5% premium to the closing price on November 17, 2006.

• Closing of the transaction is expected for March or April 2007. This transaction is expected to be accretive to TD by C$0.05 per share in 2007 and C$0.16 per share in 2008.

• TD's Tier 1 capital will decline to 9.8% from 12.1% and tangible common equity ratio will decline to 7.0% from 9.1%. The transaction will be financed by C$3.0 billion primarily of subordinated debt.

Shift in Strategy

• The 100% ownership of TD Banknorth we believe increases TD's strategic flexibility in terms of restructuring, sale, or vending it into a larger entity in the U.S. This buy-in represents a major shift in strategy as TD Banknorth was not the currency for U.S. expansion that the bank had initially anticipated. This step we view as necessary in an attempt to maximize returns from this investment over the next two to three years.

Shareholder Approval

• TD indicated that two large shareholders with discretion over 26 million of the total 99 million shares to be bought in have indicated that they view the transaction favourably.

• Private Capital Management (PCM), which owns 18.2 million BNK shares, and Aerial Capital Management (ACM) which owns approximately 8 million BNK shares, have indicated that they will vote in favour of the transaction.

Total Investment in TD Banknorth US$8.5 Billion

• Upon privatization of BNK, TD will have spent a total of US$8.5 billion or an average of US$35.21 per BNK share for 100% ownership in TD Banknorth. TD paid US$40 per share for its original 51% ownership in BNK.

• Pro-forma, BNK earnings will represent 13% of TD's earnings, versus the current 7% (YTD as at Q3/06).

Recommendation

• We view the transaction from a financial perspective as positive given the weak share price performance of TD Banknorth, small premium and accretive nature of the transaction (increased leverage). However, operational challenges at TD Banknorth remain, including competition, earnings pressure and low shareholder returns.

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

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Financial Post, Theresa Tedesco, 21 November 2006

'The key is admitting what you don't know."

That's how Ed Clark, president and chief executive of Toronto-Dominion Bank, explained his decision not to tamper with the existing management team at Banknorth Group Inc. just after his bank bought a majority stake in Maine's largest retail bank in 2004.

Two years -- and dismal returns on investment capital -- later, Clark has clearly decided he knows better.

The chief pinstripe most likely to win the award for best executive micro-manager on Bay Street announced that TD, Canada's second-largest by assets, plans to spend US$3.2-billion to buy out the 43% of TD Banknorth it doesn't already own.

The plan is to privatize the U.S. consumer bank, one of the largest in the northeastern United States. And to smooth that along, Clark shoved over William Ryan, TD Banknorth's current CEO and president, and installed his trusted lieutenant, Bharat Masrani, to be his eyes and ears in Portland, Me.

In fact, all of TD Banknorth's existing senior team but Ryan will likely be gone by March, 2008, while Ryan is committed to stay at least until 2010.

"Two years ago we didn't know them and they didn't know us, so certainly I thought it would take a few years [before TD bought 100%]," Ryan said yesterday in an interview. "Working with them in the last couple of years, both parties have gained a lot of respect for each other. We like each other."

With TD's U.S. partnership experiment now officially dead -- and Ryan relegated to wistfully eyeing potential acquisitions he admits he can't buy -- what else could a demoted executive say?

"You have to really be blowing smoke to believe that," said a Bay Street denizen.

Intellectually driven to know how everything works -- just ask his senior executive team about the number of calls they get from the corner office -- Clark's DNA is about control.

"There was no chance that he was ever going to let TD Banknorth do what it wanted. That was never going to happen because it's not in it for Ed to do anything without his approval," said a senior banker familiar with TD's chief executive.

Even so, Clark's Type-A personality aside, TD has discovered that the balance of maintaining local expertise and transplanting the culture and ideas from head office is tricky to achieve.

Perhaps TD's head honcho has figured it's better for the bank's balance sheet for it to be the sole shareholder of TD Banknorth and accrue all the appreciation and earnings flow that go with it, than merely collecting dividends as majority shareholder.

More importantly, TD's decision to maintain a wholly owned subsidiary in the U.S. represents an important strategic statement about the Canadian bank's long-term strategy south of the border.

Its partnership experiment with TD Banknorth is officially dead. In its place, TD has decided to maintain a beachhead in the United States -- TD Banknorth is the largest consumer bank in Maine, New Hampshire and Vermont, and has 600 branches in Massachusetts, Connecticut and New Jersey -- to develop a growth strategy similar to Royal Bank and Bank of Montreal.

So far, TD has found the massive U.S. market a difficult beast to tame. Return on investment capital from TD Banknorth is 4.8% for the first three quarters of 2006, compared with 24.3% for TD Canada Trust and Domestic Wealth Management.

That drag is expected to continue. "It's fair to say we are facing a challenging environment in the U.S.," Clark said yesterday. "We are well aware it may get worse before it gets better."

By privatizing TD Banknorth, Clark can shield the worsening results and alleviate the incessant pressure of delivering quarterly results demanded by the marketplace. That breathing space should provide TD the freedom to pursue a long-term vision even though the short-term prospects are not good.

For now, it looks as if Clark is throwing good money after bad when some say it would be easier to cut and run. That's not Clark's style. He's betting TD's future prosperity is in the United States - and the returns be damned.

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The Globe and Mail, Derek DeCloet, 21 November 2006

Ed Clark's brilliant. Really, he is.

It's not that Ed Clark's deal to double his bet in the United States is a great move; it is far too early to know that. But the way he gets the Street to buy his rationale without a lot of skepticism -- that's the brilliant part. Maybe he is the smartest banker in Canada, maybe not, but he is unquestionably a damn fine salesman.

That's why he can do a part-reversal of his most important strategy, weaken the balance sheet, yet investors implicitly trust him, and Toronto-Dominion's stock price barely moves.

Trivia question: Who said the following? "The reality is, in America today, I would still say TD Bank stock is not their stock of choice. They tend to want to use local currency." If you said, "Ed Clark," give yourself 10 bonus points. He said it in July, 2005 -- all of 16 months ago.

The "local currency" angle was supposedly the bit of genius in TD's U.S. banking play. By controlling TD Banknorth, but leaving it a New York-traded public company, Mr. Clark could enjoy the best of both worlds. He could get a sizable piece of profits from a U.S. retail bank, something that's been extremely tough for a Canadian bank to do. Yet he could also use Banknorth shares in acquisitions. Local management, local stock, local bank, all steered via remote control by a benevolent owner in Toronto: Like we said, it looked brilliant.

And now? Last month, TD effectively gave Banknorth chief Bill Ryan, who'd just turned 63, the early boot upstairs and installed Bharat Masrani, a Toronto-educated TD veteran, as the new boss in Maine. And yesterday, it offered to buy out Banknorth's minority owners for about $3.2-billion (U.S.) and get rid of the NYSE listing.

Perhaps all that local stuff wasn't so important after all. Or at least, it became less important than some other factors, like price. Yesterday's offer for the 43 per cent of Banknorth that TD doesn't already own values the U.S. bank at roughly $7.4-billion. In effect, TD is paying less now than it did to acquire its majority stake in the summer of 2004, a creeping takeover without a big premium attached. Not bad.

But the real insight of this deal is that when it comes to U.S. banking, you are either in or you are out, and there is not much point in going halfway. And Mr. Clark has decided he is absolutely, positively in, with both feet. Banknorth's financial performance under TD's ownership has been uninspired. Return on equity (ROE), a key measure in banking, is south of 5 per cent for Banknorth, and the prospects for profit growth next year are minimal. Large U.S. regionals like M&T Bank, Fifth Third and SunTrust tend to have ROEs in the low to mid-teens.

The safe thing for Mr. Clark to do would be to stop putting money in, stop funding Mr. Ryan's endless acquisition schemes -- just hold everything, as Royal Bank did when it encountered some trouble at its own U.S. regional bank in North Carolina. Perhaps that's the route he would have chosen, too, if not for the restless Banknorth minority asking to be bought out. That he stepped up and wrote a cheque is a signal that he's willing to be more contrarian than a lot of other bankers (and that's probably wise -- why, after all, wait for a turnaround that makes Banknorth more expensive to privatize?).

And yet, it is probably more of a gamble than you'd think if you looked only at the market's blasé reaction (TD fell 0.44 per cent to $67.45). Even for a bank of its size, a $3.2-billion, all-cash deal is a lot to swallow. The bank entered this deal with well more than $1-billion in excess common equity; now it will lose all of that cushion and then some.

That means no more big deals for at least a year, and dividend increases will likely be modest, too, as the bank rebuilds its capital. Mr. Clark knows this, knows that Banknorth's numbers won't look so great in 2007, and knows that if he's wrong in the long run, it's going to harm his legacy at TD. Somehow, he manages to not let any of that bother him. When you've got the aura, why worry?

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The Globe and Mail, Andrew Willis, 21 November 2006

Toronto-Dominion Bank put further U.S. expansion on ice yesterday by offering to take its TD Banknorth Inc. subsidiary private for $3.6-billion, a takeover that would eliminate the Canadian bank's best currency for American acquisitions.

TD is offering to buy the 43-per-cent of TD Banknorth it doesn't own at the request of directors and major shareholders in the Portland, Me.-based bank, which is struggling in the face of intense competition and a slowing economy in the northeastern United States.

The Canadian bank is offering $32.33 (U.S.) for each TD Banknorth share, after buying its initial stake back in 2004 for $40 a share. The offer is a thin 6.5-per-cent premium to TD Banknorth's closing price on Friday. Two U.S. money managers that together hold 11 per cent of TD Banknorth have already agreed to sell.

"It has been and will continue to be a very difficult banking environment," said Bill Ryan, chief executive officer at TD Banknorth. He said: "Our investors were asking when TD would buy the rest of Banknorth, and saying they would like to see it sooner rather than later."

TD Bank CEO Ed Clark said the decision to buy 100 per cent of the U.S. unit now, rather than wait in hopes of a cheaper deal, reflects motivated sellers with short-term outlooks and a deep-pocketed buyer that takes a long-term view of its U.S. operations.

"These privatizations are difficult to do, and we found ourselves with the support of directors and two of the biggest shareholders," said Mr. Clark, pointing to the troubles that companies such as Sears Holdings Corp. have encountered when trying to buy out minority shareholders.

He added: "We were setting aside capital to buy TD Banknorth anyway, so from our point of view, there's no extra cost to buying now."

But Mr. Clark agreed that there is no quick turnaround in sight at TD Banknorth, which has seen profit decline in five of the past six quarters. The outlook for U.S. retail banking is bleak, with the housing market in freefall and a recession possible in 2007.

TD Banknorth used its shares to buy two New Jersey banks in the two years since TD bought in. But Mr. Clark said further U.S. branch acquisitions are on hold until TD Banknorth's profitability improves.

TD rivals such Royal Bank of Canada and Bank of Montreal have also struggled to bring profit levels at U.S. retail operations to anything close to those of their Canadian parents, and both these banks own 100 per cent of the American subsidiaries.

TD's turnaround plans are focused on grassroots marketing and in-branch initiatives aimed at attracting more clients to basic services such as chequing accounts. Owning all of the U.S. bank will make it easier to blend operations between the U.S. bank and its Canadian parent. "It makes sense. Accounting-wise, you can then consolidate it into the overall operation, as opposed to having it hanging out there," said David Rea, chairman of Toronto-based Davis-Rea Ltd., which owns TD shares.

While Mr. Clark expects the offer to be accepted -- it needs the approval of TD Banknorth shareholders and state regulators -- Mr. Clark said: "It's not the end of the world if [TD Banknorth] shareholders say no to this transaction."

If accepted, the deal is expected to close by April, 2007. Not all TD Banknorth shareholders were thrilled with the terms. Bloomberg News reported shareholder Helene Hutt sued the bank yesterday, claiming the $32.33 a share offer is "grossly unfair."

Analysts agreed that TD appears to be offering a discount price. Mario Mendonca of Genuity Capital Markets said he was "positively predisposed" to a buyout that will play out at 16 times TD Banknorth's forecast earnings, compared with multiples of up to 21 times earnings paid for similar-sized U.S. regional banks. "While we thought this move would be several years off, the deal appears to be struck at a reasonable valuation and reduces some potential near-term uncertainty," said analyst Jason Bilodeau at UBS Securities Canada.

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Bloomberg, Sophia Pearson, 20 November 2006

TD Banknorth Inc., Maine's biggest bank, was sued by shareholders over a $3.2 billion buyout agreement with parent company Toronto-Dominion Bank.

Toronto-Dominion, Canada's second-biggest lender, today disclosed plans to buy the 43 percent of TD Banknorth it doesn't already own to boost earnings from U.S. consumer banking. The price of $32.33 a share is ``grossly unfair,'' shareholder Helene Hutt said in a lawsuit filed in Delaware Chancery Court.

``The intrinsic value of TD Banknorth's common stock is materially in excess of the amount offered,'' Hutt said in the suit, one of at least three filed in the court today that seek to block the transaction. The bid is 6.5 percent higher than TD Banknorth's Nov. 17 closing price.

Independent directors of TD Banknorth invited Toronto- Dominion to bid for the shares. Toronto-Dominion intends to turn around TD Banknorth's declining profits in three or four years by making fewer acquisitions and focusing on internal growth, Toronto-Dominion Chief Executive Officer Edmund Clark said on a conference call with investors.

More than a dozen TD Banknorth board members are named in Hutt's lawsuit, including Chairman and CEO William Ryan. Board members breached their duties to stockholders by forcing the sale at an ``unfair'' price and are obligated to ``explore all alternatives to maximize shareholder value,'' the suit said.

Ryan said in a telephone interview that he hadn't seen Hutt's suit and couldn't comment. Hutt's attorney is former Milberg Weiss partner Seth Rigrodsky, who left the firm this year to start his own practice.

Albert Goldstein, who owns 8,000 shares of TD Banknorth, claimed in a separate suit that board members ``misleadingly'' portrayed the offer price as a premium.

The market price of Banknorth's stock has been ``artificially depressed'' in recent months by restructuring charges and other impairments, Goldstein said in his suit.

TD Banknorth shares rose $1.83 to $32.18 in New York Stock Exchange composite trading at 4:16 p.m., giving the Portland, Maine-based company a market value of $7.35 billion.

Hutt's suit is Helene Hutt v. TD Banknorth Inc. et al, 2556-N, Delaware Chancery Court (Wilmington).

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Bloomberg, Sean B. Pasternak, 20 November 2006

Toronto-Dominion Bank, Canada's second-biggest lender, agreed to buy the 43 percent of TD Banknorth Inc. it doesn't already own for $3.2 billion as it tries to revive earnings at its slumping U.S. consumer bank.

Toronto-Dominion offered $32.33 per share in cash for TD Banknorth stock, the Toronto-based company said in a statement today. That's 6.5 percent higher than TD Banknorth's closing price on Nov. 17.

Toronto-Dominion Chief Executive Officer Edmund Clark is trying to turn around TD Banknorth, whose profit has declined in five of the last six quarters. He said that Maine's biggest bank will make fewer acquisitions and focus on internal growth.

``There's simply no question that owning 100 percent will facilitate us driving even harder to do the things you have to do in Banknorth for it to be competitive three or four years from now,'' Clark said on a conference call with investors.

The transaction will add 2 cents to Toronto-Dominion's earnings per share in the year that began Nov. 1, and 12 cents a share in fiscal 2008, Chief Financial Officer Colleen Johnston said. Although TD Banknorth's earnings have declined, Clark said Toronto-Dominion earnings growth this year may top 10 percent. He said TD Banknorth's rate of return of about 6.5 percent is ``not acceptable.''

Toronto-Dominion is taking advantage of a slumping TD Banknorth stock price to buy out remaining shareholders. TD Banknorth shares had risen just 1 percent since March 2005, when Toronto-Dominion completed the purchase of a 51 percent stake. The offer today is 19 percent below Toronto-Dominion's original purchase price of $40 a share in stock and cash.

``TD Banknorth is an average bank that hasn't done anything at all clever,'' said Christopher Lowe, who helps manage the equivalent of $7.4 billion at Burlington, Ontario-based AIC Ltd., including 7.5 million Toronto-Dominion Bank shares. ``That's given TD an opportunity to buy it at a fair price.''

TD Banknorth profit has declined on rising costs for acquisitions and advertising, and as demand for loans slows. The Portland, Maine-based bank said last week that earnings in 2007 will be little changed from this year, or between $2.05 and $2.15 a share.

``This has been, and will continue to be, a very difficult banking environment,'' said TD Banknorth CEO William Ryan. ``We think it's a very fair price, knowing that this market is not going to get better in the near future.''

The bank said independent directors of TD Banknorth invited Toronto-Dominion to make a bid for the shares it doesn't own. The bid was backed by the TD Banknorth board, and the purchase is expected to close in March or April, the banks said in the statement. Private Capital Management and Ariel Capital Management, which own a combined 26.2 million shares, are expected to support the bid, the bank said.

TD Banknorth shareholders saw ``more downside risk than upside potential,'' Clark said on the call.

Shares of Toronto-Dominion fell 30 cents to C$67.45 at 4:10 p.m. trading on the Toronto Stock Exchange. TD Banknorth shares rose $1.83, or 6 percent, to $32.18 in New York Stock Exchange composite trading, for a market value of $7.35 billion.

TD Banknorth has about 600 branches in states including Connecticut, Massachusetts and New Jersey. Since Toronto- Dominion took control of TD Banknorth, the firm has purchased Hudson United Bancorp and agreed to buy Interchange Financial Services Corp., both based in New Jersey.

Toronto-Dominion bought a 51 percent stake of TD Banknorth in March 2005 for about $3.51 billion as its first entry into U.S. consumer banking. The total investment in the bank will be $8.5 billion if this bid is approved. TD Banknorth may be taken private after the purchase.

Standard & Poor's credit analyst Lidia Parfeniuk said TD Banknorth's earnings trends and the erosion of capital sparked by this purchase will delay a possible debt upgrade for Toronto- Dominion.

``The acquisition of TD Banknorth is proving to be somewhat of a disappointment,'' Parfeniuk said in a statement.

The bank may also delay its planned share buyback to later this fiscal year as a result of the investment, Johnston said.

Toronto-Dominion's investment trumps its Canadian rivals. Royal Bank of Canada, the biggest lender, has spent more than $6 billion since 2000 on U.S. banks and brokerages such as RBC Centura, while Bank of Montreal has spent about $2.8 billion since 1984, mostly to expand Harris Bank in the Chicago area.

In the fiscal third quarter, TD Banknorth's contribution to Toronto-Dominion's earnings was C$68 million, or 8.5 percent of overall profit. The bank expects the U.S. unit to contribute about 13 percent of earnings once the deal is completed. Toronto-Dominion reports fourth-quarter results on Dec. 8.

Separately, TD Banknorth shareholder Helene Hutt sued the bank today, saying the $32.33 a share offer is ``grossly unfair.''

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Financial Post, Duncan Mavin, 20 November 2006

Dominion Bank agreed Monday to buy the 43% of Portland, Maine-based TD Banknorth it does not already own for US$32.33 a share, in a move that was widely praised by banking industry analysts.

But the US$3.2-billion acquisition was not popular with some TD Banknorth shareholders and one investor has launched a lawsuit claiming the Canadian bank’s offer is "grossly unfair."

"The intrinsic value of TD Banknorth’s common stock is materially in excess of the amount offered," said lawyers for a TD Banknorth shareholder who filed a suit in Delaware Chancery Court.

The lawyers said they are seeking to block the transaction.

A U.S.-based institutional investor who holds TD Banknorth stocks also said the price is "a little bit low.

"You could argue that its a fair price, but its at the low end of the range of fair," he said.

TD’s offer is 6.5% higher than the closing price of TD Banknorth stock on Friday.

TD chief executive Ed Clark said the offer represented a "fair" price for the remaining shares. Also, TD was invited to bid for the shares by independent directors of TD Banknorth.

The current valuation of Banknorth’s outstanding shares is a reflection of several quarters of weak performance, said Theodore Kovaleff an analyst at New York-based Sky Capital LLC.

"The problems may well have made the price what it is," Mr. Kovaleff said.

TD is taking advantage of a slumping TD Banknorth stock price. TD Banknorth shares had risen just 1% since TD acquired a majority stake. The latest offer is 19% below TD’s original purchase price of $40 a share in stock and cash.

TD Banknorth has seen its margins squeezed by intense competition in the banking sector in the U.S. northeast. The bank has also been unable to integrate acquisitions as smoothly as some observers had hoped; TD Banknorth spent US$2.5-billion to buy two banks this year, including US$1.9-billion on Hudson United Bancorp, described by Mr. Clark as "a fixer upper."

TD Banknorth delivered a return on capital of only 4.8% in the first three quarters of 2006. During that same period, TD’s domestic retail banking and wealth management businesses had return on capital of 24.3%.

Most bank analysts agreed that the deal is positive for TD.

Genuity Capital Markets analyst Mario Mendonca said the transaction simplifies the reporting structure at TD and signals that U.S. acquisitions are on hold for now.

UBS Investment Research analyst Jason Bilodeau called the deal "a reasonable move" that reduces "near-term uncertainty."

TD’s Mr. Clark said Canada’s second-largest lender will focus on improving customer service at TD Banknorth. "There’s simply no question that owning 100% will facilitate us driving even harder to do the things you have to do in Banknorth for it to be competitive three or four years from now," said Mr. Clark.

He said the sought-after improvements will rolled out in the next 18 months and will include "a lot [of measures] that are not that costly."

Mr. Clark also said further acquisitions at TD Banknorth will be on hold until the end of 2007.

Mr. Clark reaffirmed that TD Banknorth chief executive Bill Ryan will be staying with the bank until 2010. Mr. Ryan is stepping down as CEO in March, 2007, and will be replaced by TD veteran Bharat Masrani.

Mr. Clark said Mr. Ryan will focus on potential acquisitions and dealing with the bank’s commercial clients.

Shareholders still have to approve TD’s purchase of the remaining TD Banknorth shares in a vote.

However, it is unlikely shareholders will oppose the deal or that TD will sweeten their offer given the low potential for a rival bidder when TD already owns 53% of the shares.

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