29 December 2006

% Returns, as at 29 December 2006

Globe Investor, 29 December 2006

21 December 2006

BMO CM on Life Insurance Cos

BMO Capital Markets, 20 December 2006

Consolidation Paying Dividends - Three Years After Consolidation: Market Shares Concentrated & Higher Operating Margins

Executive Summary:

Harvesting Earnings from Canada

The Canadian life insurers are by and large global companies. Nevertheless, earnings from Canada represent 25-100% of each company’s profits and for all, except Manulife, Canada is the biggest geographic contributor (Table 1). At the high end, Industrial Alliance generates substantially all of its earnings in Canada, followed by Sun Life at 48%, Great-West at 47%, and Manulife at 25%. System-wide, Canada contributes 38% of total earnings from the four publicly traded life insurers, which is down from 41% in 2004.

While there are numerous businesses within the Canadian operations, three areas comprise the bulk of earnings and revenue. These areas include individual life, group benefits, and group and individual wealth management. Given the diversity of the businesses, we will review each separately.

Since 2000, the Canadian life insurance industry underwent significant changes including de-mutualization and consolidation. Currently, the top three operators - Great-West Life, Manulife, and Sun Life - dominate the domestic market with aggregate market shares ranging from 62% to 71% of every major segment of the Canadian life market.

Two years ago, we released a report titled 'Post Consolidation - Harvest Time in Canada' that detailed the consolidation in the Canadian marketplace and that this consolidation would enable the Canadian lifecos to harvest earnings from their Canadian operations. Fortunately, the industry has reported very good margin improvements over the last couple of years and appears to be using excess earnings generated in Canada to fund growth.

Higher margins can be driven by better pricing or lower costs. Since markets for life insurance products are opaque, it is difficult to determine if pricing has improved, or deteriorated. However, anecdotal evidence suggests that pricing remains competitive. As such, we believe that most of the gains in the operating margins have come from the benefits of consolidation: increased scale and lower unit costs. Moreover, since pricing trends can be unpredictable because of competition, lower unit costs represent more sustainable improvements in margins. ROEs in Canada remain attractive in the mid to high teens, on average.

Consolidation is by no means the only reason for higher margins over the last couple of years. Rising equity markets and a benign credit environment have contributed to the good margins, offset somewhat by the low level of long term interest rates. While acknowledging the importance of the good equity and credit markets on current operating margins, we do believe that consolidation has led to higher 'trough' margins and higher 'peak' margins over a cycle.

We estimate that the four publicly traded lifecos will generate roughly $3 billion in earnings in Canada in 2006 and rise 10% annually for the next two years. In addition, we conservatively estimated that $300 million of these earnings will be reinvested in the domestic businesses in 2006 and rise by 10% per year over the next two years (Table 2). As a result, the domestic operations are expected to generate 'excess' earnings (earnings available to use outside of Canada, increase the dividend, or buyback stock) of $2.8 billion in 2006, rising to $3.4 billion in 2008 for a cumulative total of $9.2 billion in excess earnings over the 2006-2008 time frame. To put this in perspective, just the Canadian operations alone should be able to double the current estimated level of 'excess earnings' among the four publicly traded Canadian lifecos over the next 24 months.

In effect, Canadian insurers should be able to continue to expand internationally, comfortable in the knowledge that profitability on the home front is secure. In particular, Manulife’s ability to use excess earnings generated in Canada and reinvest in Asia is attractive for long-term shareholders.

The Big Picture:
Demographic Trends Remain Supportive

Over the last 45 years, general fund assets grew at a compound annual rate of 8%, 9% if segregated fund assets are included, and at a rate of 6% over the last five years (see table inside front cover of this report). We believe that general fund growth should range from 3-5% over the next few years, which is close to nominal GDP growth. Inclusion of segregated fund assets could add an additional 2-3% in annual growth rate. We believe that growth in general and segregated funds represent a 'floor' of earnings growth expected in Canada. Including some operating leverage, the combined 5-8% growth in segregated and general fund AUM should translate into roughly 10% earnings growth.

Conceptually, there are four phases in the financial life cycle of Canadians pertaining to insurance: protection, wealth creation, retirement and wealth transfer (a nice way of discussing death).

In the early stages of an individual’s life cycle, expenses generally exceed income and the primary attraction of insurance is to protect dependents in the event of premature death. As individuals age, the focus shifts to wealth creation, where numerous other financial intermediaries compete for financial assets. The third stage focuses on the need to fund retirement from accumulated assets, and lastly consumers need to distribute their estates in a tax efficient manner.

Life insurers are substantial participants in all stages of the lifecycle, offering protection products in the early years (term and whole life), accumulation products in the middle years (segregated funds, mutual funds and universal life), retirement products in later years (payout annuities and RRIFs), and ensuring efficient wealth transfer through death benefits on life insurance or segregated fund products.

The main attraction of insurance over the last 30 years has been to provide protection to the baby boomers, the single largest demographic group. As this demographic group aged, insurers have had to compete with banks and other financial intermediaries in the wealth management space. Accordingly, the dominant selling proposition of insurance has changed as this large demographic group aged.

The main selling proposition today focuses on the real possibility that aging boomers outlive their savings. Moreover, low interest rates do not provide the relatively high risk free rate of return that many boomers had become accustomed to prior to 2000. Insurers are particularly well positioned to serve this need through annuities and new features of segregated funds. In addition, the tax advantage benefits of life insurance are ideally suited for wealth transfer.

In reality, the stages are far less clear than we have detailed and, in fact, many insurance products have crossover appeal. Furthermore, there are two enduring characteristics of insurance that should sustain growth: tax efficiency and protection. Protection from market volatility and outliving your savings in retirement, and the tax efficient nature of death benefits as well as wealth accumulation within an individual life policy or a tax deferred capital accumulation plan. Overall, we believe that historical data plus unfolding demographics trends support industry growth projections of 5-8% in total AUM.

The most basic measure of market share would analyze the percentage of AUM - general and segregated AUM only - at the big 3 insurers. In 2000, these big three insurers had a 41% market share (Table 3). Over the course of the next four years, this market share rose to 63% due to consolidation. Results in Table 3 are supported by market share statistics presented on the front cover of this report, where the big three insurers in aggregate control 62-71% of the industry’s premium-driven business (individual insurance, group insurance, and annuities) and 65-70% of the industry’s asset-driven businesses (segregated funds and DC Plans). These formidable market shares act as a barrier to entry and represent a significant long term competitive advantage.

Individual Life - Mature with Modest Growth Prospects

Canadians currently have $1.5 trillion of individual life insurance in force (i.e., face value) and there are 13 million individual life policies in the country. The face value of all individual in-force life insurance grew at a compound annual rate of 7% over the last five years, which is at the low end of its historical growth rate. Premiums grew at a compound annual rate of just under 3% over the same time period. Premium growth rates have declined over the last 30 years as the aging population focused more on wealth creation and retirement planning than protection (see discussion in previous section).

While growth in individual life premiums has not been spectacular over the last five years, there are a number of positive trends that could help offset the slower premium growth. First, approximately 78% of all individual life premium income comes from renewals, which provides the business with some immunity to economic cycles. New policies sold in any one year represent roughly 10-12% of total premium income, a figure that is more sensitive to the economy and equity markets.

Second, the in-force block of business should continue to support steady stream of earnings, particularly as mortality continues to improve and cost efficiencies are realized due to consolidation and technology.

Third, benefits paid on life insurance contracts are not taxable and as such remain an attractive form of estate planning. It is estimated that approximately $1.2 trillion in wealth will be transferred to the baby boomers from their parents over the next 20 years. Despite these positive trends, the relatively low level of interest rates has increased pricing for traditional permanent insurance and demographics support the thesis that the core individual life business will remain a slow growth business.

New individual life sales have remained relatively flat over the last five years. Despite negligible growth in terms of new industry sales, the mix of business has changed significantly over the last decade. In the early 1990s, over 70% of the new policies sold were term or whole life policies. However, Universal Life has become the most popular form of individual life, accounting for over 50% of industry sales in 2005 and year to date in 2006.

The popularity of Universal Life tends to mirror the equity markets. Universal Life, or UL, was developed to deal with he trend among consumers to 'buy Term and invest the difference.' UL policies are comprised of a basic term insurance policy with a side fund, where premium payments above the basic cost of insurance are invested. Unlike whole policies, where the insurer takes the investment risk, UL sees the policyholder take some risk as individuals are allowed to invest in equity funds or other investment vehicles. Longer term, this product can function both as a protection vehicle and as an investment vehicle. This product has sold particularly well in the broker dealer channels.

More volatile equity markets in 2001-2003 reduced demand for UL and increased demand for whole life and term insurance. Despite improvements in the equity markets over the last couple of years, the market share of new sales in UL versus non-UL individual life insurance has remained relatively stable.

Over the last 15 years, there has been a steady decline in the number of new policies sold. The decline in new policies sold reflects the aging demographics referred to above. Despite fewer new policies, higher face value policies more than offset the impact of fewer new policies and led to modest gains in new annualized premiums. Higher face value policies can no longer fully compensate for the decline in the number of policies as new annualized premium growth has stagnated. While it appears the number of new policies sold has 'troughed,' the outlook for new business growth in individual life looks modest, 1-2%. Combined with in-force premiums, individual life could grow at 2%+ over the next few years.

Market share in individual life can be measured in a number of ways but the best measure(s) includes the market shares of in-force premiums and market share of new annualized premiums. In terms of in-force premiums, industry concentration among the top three competitors grew from 31% in 1998 to 63% in 2003 and 66% in 2005. This is very important since growth in individual life is expected to remain modest; the big three insurers are expected to generate approximately two-thirds of in-force industry profits given that they control large existing blocks of business. Unlike other financial products such as banking or mutual funds, individual insurance policies can be very sticky.

It is also interesting to note the product mix of the in-force business. In the first half of 2006, UL accounted for only 19% of the policies in force, but 33% of in-force premiums. This reflects the fact that UL policies tend to be larger and targeted to a higher income bracket. Whole life accounted for 49% of all in-force policies and 49% of all in-force premiums, while term insurance accounted for 32% of in-force policies and 18% of in-force premiums.

The concentration of new sales for the top three competitors has been less pronounced than of in-force premiums. In 2000, the top three operators accounted for 43% of new annualized premiums and rose to 55% of new annualized premiums in 2005. Similar trends exist during the first half of 2006 where weaker sales from Manulife have been offset by strong individual life sales at Great-West.

New sales concentration has been less pronounced than in-force concentration for two reasons: changes in distribution and meaningful foreign competition. The percentage of new sales accounted for by 'owned' distribution channels has declined from roughly 70% 15 years ago to under one-third today. Concurrent with the consolidation of 'owned' distribution is the emergence of national accounts, or broker dealers, as a major distribution channel for certain products, particularly UL. According to Investment Executive, roughly 70% of retail stock brokers in Canada now have an insurance license.

There are a large number, over 40, of insurers that remain active in Canada. Many of these competitors are subsidiaries of large global operators, including Standard Life, Aegon, and AIG. This should keep a certain level of competitiveness in the sales process.

Individual Life Industry Outlook

As indicated above, we project the core individual life business to grow at a modest pace of 2%+ per annum. However, if growth were to exceed these projections, sales of Living Benefit products, like critical illness (CI) and perhaps long term care (LTC), are likely to be the driving force.

CI provides policyholders with some additional financial protection in the event of illness. For example, if a policyholder is diagnosed with one of a number of diseases outlined in the insurance contract, the policyholder is paid the benefit amount and can use that money to pay for medical care. If the policyholder does not become ill and survives the length of the contract, he or she will retrieve 75-100% of premiums paid over the life of the contract. Whereas traditional life insurance provides financial protection for mortality and disability provides for supplemental income and/or assistance with health care costs, CI is specifically targeted to insure against unexpected health care costs associated with a list of different diseases.

Overall, we would expect the number of new policies sold to demonstrate very marginal growth as new Living Benefit policies offset lower sales of individual life policies. In addition, we would expect premiums per policy to rise modestly assuming that equity markets rise in a relatively predictable pattern. We believe that the individual in-force blocks at Great-West, Sun Life and Manulife provide these three companies with a significant competitive advantage in terms of scale, costs, and pricing. Accordingly, the big three should maintain, and possibly grow, their existing market shares.

Comparing and contrasting reported individual life margins among the Canadian life insurers is, to say the least, challenging given the different levels of disclosure and corporate structures. Results from Sun Life’s individual life business are commingled with results from individual wealth management and its earnings from CI. Margins at Great-West’s life segment are significantly higher than industry averages as its par block of policies absorbs its share (and the heaviest burden) of costs. Despite these obstacles, observing trends in pre-tax and after-tax margins should be useful in gauging the beneficial/detrimental impact of consolidation.

On a rolling 12-month basis, individual life operating margins for this group have risen sharply since Q1/05. The four quarters ending Q1/05 was chosen as the starting date given that most of the industry consolidation was completed by early 2004 and disclosure from the four publicly traded life companies has remained relatively consistent since that time. Industry pre-tax margins rose from 12% to the 15-16% range. Net income margins rose from 8.5% to 12%.

There are a number of factors that contributed to higher margins including favourable equity markets and a benign credit environment offset somewhat by the dampening effect of low long term interest rates. In a more adverse economic environment, the recently achieved operating margins could come under some pressure; however, we believe that consolidation has permanently increased operating margins (i.e. higher trough margins in difficult times and higher peak margins in robust environments).

The major drawback from the results is that Sun Life does not separate individual life from its individual wealth management results. To address this comparability issue, we added together the individual life and individual wealth mangement financial results for GWO, IAG and MFC. A similar trend in pre-tax and after-tax margins can be observed in this analysis as well. The major pitfall in combining these two different units together is that individual life is a premium-driven business while individual wealth management is an asset-driven business.

Group Benefits - Consolidated with Good Growth Outlook
The Economics of the Group Business

The economics of group life and health are different than in individual insurance. This contrast is most evident in two broad numbers: premiums and reserves. In Canada, total reserves for group businesses are approximately $20 billion on $16 billion in industry premiums. However, individual life has roughly $60 billion in reserves in Canada on $12 billion in annual premiums. Lower reserve requirements mean less capital intensiveness relative to individual life and as such ROEs in group business tend to be higher; however, earnings can be more volatile.

Reserve requirements are relatively low because of the structure of group plans with limited guarantee periods (i.e., one year) and the ability to reprice after guarantee periods. However, group plans can vary dramatically depending on the situation and there are a number of mechanisms for risk sharing between the plan sponsor and the insurer. In addition, insurers do not incur significant commission expenses to sell group plans and the effect of branding is minimal- both different from individual insurance.

Even with the ability to reprice frequently, there is still risk in offering certain products, particularly long-term disability (LTD). Once a LTD claim starts, it will often run for a long period and termination of a relationship with a plan sponsor will not alleviate the responsibility the insurance company has to pay the benefits. Roughly one-third of those disabled at the end of six months will be disabled at the end of five years.

From an investor’s perspective though, the risk on these products is tangible. Since the profitability of the product can be established every year, there is less likelihood of long hidden problems which can dramatically affect previously booked profits. Unfortunately, this does mean more short-term volatility in earnings.

Against a backdrop of annual repricing, little branding, minimal investment income and large individual customers, it is not surprising that low costs- achieved through technology or scale- are key competitive advantages. In addition to more rational pricing of group policies since de-mutualization, consolidation has been a dominant theme in group insurance as competitors built scale. In 1999, the top three operators accounted for 41% of industry premiums, including ASO. The top three players controlled 47% of the group life premiums, 40% of group health, and 40% of ASO fees.

In 2003, the top three operators accounted for 64% of total industry premiums, including ASO. The top three players controlled 79% of the group life premiums, 63% of group health, and 62% of ASO fees.

In 2005, the top three operators accounted for 62% of total industry premiums, including ASO. The top three players controlled 79% of the group life premiums, 64% of group health, and 57% of ASO fees. It is interesting to note how market shares have not moved materially over the last couple of years and preliminary 2006 data suggest that this trend continued.

Group Benefit Margin Trends and Industry Outlook

An analysis of margin trends in the group benefits industry is complicated by the fact that Manulife does not disclose results from Canadian group benefits, rather disclosure focuses on combined results from group benefits and group pensions. Despite the inconsistency in disclosure across the companies (just like individual life insurance discussion above) we still believe that it is useful to look at the trend in margins.

In many respects, group profitability has benefited the most from de-mutualization and consolidation. Prior to de-mutualization, group operations were often run as loss leaders. In the run-up to de-mutualization and post de-mutualization, profits in group rose at significant rates mainly driven by re-pricing strategies. As the industry entered the consolidation phase, margin improvements driven by re-pricing had mostly run its course. Since consolidation, the industry has experienced further margin improvement from 10.5% to 12.0% on a pre-tax basis and from 8.0% to 8.6% on an after-tax basis. Consistent with our margin analysis for individual life, our starting date was the four quarters ending Q1/05, which coincides with the last wave of consolidation that ended in early 2004, and ends with year-to-date results.

Including Manulife and combining group benefits and group wealth management at the other players generates a similar trend in margins as observed in group benefits. The major pitfall in combining these two group businesses is that one is primarily driven by premiums, group benefits, and the other is mainly an asset driven business, group wealth management (also known as group pensions).

The growth outlook for group benefits looks good in our view given expectations of continued growth in employment of 2-3% over a cycle combined with increased focus by employees on benefit plans offered by employers. An ageing workforce is likely to work longer into life and potentially demand incrementally more benefits. ROEs should remain attractive in the mid to high teens and new competition is likely to be limited to some existing players like IAG and Empire Life. The major trend in group is investment in technology to deliver solutions and services in a more electronic format. Anecdotal evidence suggests that Sun Life sets the technology standards within the industry. If margins do come under some pressure, we suspect that this pressure will result from either a less favourable economic environment and/or spending on technology to be competitive with the industry leader.

Individual and Group Wealth Management: Growth Segment

The third area in which insurers generally compete in Canada is the wealth management and retirement savings market. We highlight that this area involves both individual and group markets. The group and individual wealth management segments are analyzed together because we believe the consumer views both types of products as integrated elements of savings and retirement plans. Furthermore, the asset liability management requirements are quite similar.

As opposed to the other segments of the insurance businesses where premiums are key, the focus in this segment is on asset accumulation. Part of this distinction is the difficulty in determining what can be defined as a premium (discussed in greater detail later) but more importantly, this is because the business is either spread-based or driven by fees (both assessed against the asset base). The dominant products in this category are annuities and segregated funds. Annuities, which are spread-based products, tend to be fixed and are obligations of the insurance company (i.e., on-balance sheet obligations). Segregated funds, which are fee-based products, are off-balance sheet obligations (i.e., where the holder of a segregated fund takes an investment risk) and as a result are less capital intensive.

Profitability & Outlook for the Wealth Management Businesses

We estimate that the savings businesses in 2006 will generate $1.1 billion in earnings versus $1.1 billion in individual insurance and $0.8 billion in group. ROEs in the savings businesses are among the highest in the insurance business at 15%+. The above average ROE reflect the fact that an increasing proportion of assets are 'off balance sheet' business, segregated funds, versus 'on balance sheet' or general fund products like annuities.

While the ROEs are higher than individual insurance, earnings are more volatile given sensitivity to equity markets. Earnings from seg funds are sensitive to equity markets in two ways. First, higher (or lower) markets increase (or decrease), fee income as fees are assessed on the level of assets under management. Second, since seg funds have some guarantees, such as guaranteeing the return of 75-100% of premium, there are minimum reserve requirements to back these guarantees. The amount of capital is sensitive to the level of equity markets. In rising markets, reserves required to back seg fund guarantees can decline, but the reverse is also true.

Margin trends in the wealth management segment are less obvious than in the previous two segments discussed in this report. In individual wealth management, profits relative to revenue (premium and fee income) appear to have improved modestly over the last couple of years. Readers should recall that this analysis excludes Sun Life, which does not separate individual wealth management results from its individual insurance segment.

However, since individual wealth management is an asset-driven business, it may be more appropriate to analyze margin trends relative to average assets under management. On this basis, margins have been flat to down over the last two years. The difference in margin trends between earnings relative to revenue and earnings relative to AUM is noteworthy and is mainly driven by results at Great-West and is similar to some trends that have appeared in the mutual fund business. These trends may also reflect the low level of interest rates as individual annuities are unlikely to generate the level of earnings per dollar of assets as in the past. The interest rates argument breaks down in further analysis. GWO, which has experienced the most compression, has the least exposure to annuities relative to segregated funds. Similar to the margin trends in individual wealth management, group wealth experienced rising margins relative to revenue (premiums & fees) and decline margins relative to assets under management.

As indicated previously, growth in wealth management, group and individual, should be driven by segregated funds and capital accumulation plans. Combined these two segments are projected to grow AUM by 5-10% annually, which should generate earnings growth of 7-15% per annum with attractive ROEs. With respect to margins, we would be surprised to see a significant rise in the margins and are obviously dependent on events in the equity markets.

Accounting for Annuities and Segregated Funds

The method of accounting for annuities creates confusion for investors (as if investors needed more confusion at looking at the financial statements of insurers). This is because the actuarial liabilities held to support fixed products are large and changes in the amount of new annuities written (or a reduction in the amount of annuities on the books) dramatically affects several different lines in the income statement.

Annuities are purchased either by a single deposit or a series of payments, with the single premium being much more common. Life insurance companies account for the full deposit as premium income (different from the way a bank handles a GIC). Once this occurs, the company sets up a liability, within actuarial liabilities, for future policy benefits to be paid to the annuitant. The change in actuarial liability is expensed to the income statement as a provision for future benefits. The net effect is zero on earnings but does inflate revenue and costs.

Interest earned from the investment of these deposits is recorded as investment income of the life company. If the annuity is in the accumulation phase, the interest serves to increase the actuarial liabilities and therefore results in a provision expense. On the other hand, in the payout phase, the insurance company pays out the benefits, which are expensed immediately. If the annuity is surrendered, the cash is disbursed and paid out to the individual as a benefit expense on the income statement while the actuarial liability is reduced, effectively a negative cost.

Conclusion and Recommendations

Significant change has occurred in the Canadian life industry over the last three years and we believe that most of this change is benefiting shareholders. In general, margins are rising and the Canadian operations are a source of funds to invest in the Canadian lifecos already significant international platforms. Industry market shares remain concentrated albeit down slightly from the highs reached in 2003. Our analysis of market shares in 2003 calculated the pro forma market shares of all the combined entities: GWO/Canada Life and Manulife/Maritime Life.

These entities have been run on a combined basis since late 2003 early 2004 and as such, some natural attrition in market shares was inevitable. Overall, the Canadian market place should grow at 5-8% over the next few years and provide reasonably reliable earnings growth of approximately 10%. All three of the big insurers are extremely well-positioned in Canada but Sun Life and Great-West Life have the added benefit of stronger market positions in group wealth management.

Great-West and Sun Life remain Outperform rated. Our Great- West recommendation rests with a higher conviction that Europe represents an attractive and sustainable growth opportunity, earnings in Canada may be higher than expected given better-than-expected business growth over the last 12 months, the U.S. Financial Services operations continue to perform well (the Met Life and U.S. Bank 401(k) acquisitions should help earnings growth in 2007), and the U.S. healthcare segment is diminishing in relevance for GWO. In 2003, GWO generated 24% of earnings from the U.S. healthcare and is expected to generate 11% of earnings in 2006 from US healthcare. GWO is actively looking at continued expansion in the U.S. and transaction sizes may increase through 2007.

The Sun Life recommendation reflects the company’s attractive valuation, improving ROE, and expectations of some improvements in margins and earnings from MFS and U.S. annuities. Sales results should improve in U.S. life and group businesses over the next 12 months due to some new distribution arrangements announced in 2006.

Manulife is Market Perform rated. Manulife remains an exceptional franchise with the greatest long-term growth potential in our view given its Asian platform and competitive position in the U.S. Manulife should remain a core holding in any equity portfolio and we expect strong dividend growth. The shares have performed extremely well since the acquisition of John Hancock. The declining Canadian dollar and strong equity markets should help drive earnings over the next few quarters somewhat offset by continued low interest rates and a flat yield curve. The company did report unsustainably strong results from its U.S. spread-based businesses in 2006 and comparisons with 2006 results in 2007 may be challenging.

We recently lowered our recommendation on IAG to Market Perform from Outperform due to strong share price appreciation over the last 12-15 months. IAG indicated that it intends to raise its dividend payout ratio to the high 20s over the next 18 months, which translates into a 30% growth rate in the dividend over the next 18 months. This report has mainly focused on the big 3 insurers; however, investors should note that despite their incumbent position, IAG has consistently grown faster than the overall market. This trend continued in 2006. We continue to believe that the pricing umbrella provided by the big 3 in Canada offers some interesting growth prospects for IAG to grow, particularly in wealth management and group. While the shares are Market Perform rated, small to mid-cap managers should consider this a core position in their portfolios.

BMO's Downe to Split Time Between Chicago & Toronto

Bloomberg, Doug Alexander, 21 December 2006

William Downe, Bank of Montreal's next chief executive officer, will split his time between Chicago and Toronto, becoming the first Canadian bank head in about 65 years to have a base on both sides of the U.S. border.

``Bill will spend his time where the business requires him to be,'' bank spokesman Paul Deegan said in an interview. ``Having lived and worked in the U.S. for many years, Bill had gained a first-hand perspective, which is obviously helpful.''

The base in two cities may signal Downe will focus on reviving U.S. profit when he takes over from Anthony Comper in March. Downe, currently the chief operating officer, has said he plans to expand Chicago-based Harris Bank by opening new branches and pursuing acquisitions in the U.S. Midwest.

Toronto-based Bank of Montreal had a C$115 million ($100 million) profit from its U.S. consumer bank in fiscal 2006. Profit from the U.S. unit has risen 4.5 percent over the past three years, lagging behind the 24 percent rise in profit from Canadian banking. Bank of Montreal's personal and commercial banking unit in Canada earned C$1 billion in 2006.

Downe, 54, was appointed on Nov. 28 to succeed Comper, 61, who is retiring as head of Canada's fourth-largest lender. Downe, a Montreal native, has divided his time between Chicago and Toronto since 1998, when he was named vice chairman of the bank. He was promoted to chief operating officer in February.

``The truth of the matter is he's sort of out of a suitcase quite a bit of the time,'' Deegan said. ``Even when he's in Canada he's traveling around the country. A typical week might be four days in Toronto, one day in Chicago.''

Downe, who joined Bank of Montreal in 1983 as a credit analyst, has lived and worked in Chicago for at least 14 years, after assignments in Houston and Denver. In 2001, he became head of the BMO Nesbitt Burns investment-banking arm. He assumed responsibility for all U.S. operations, including the Chicago- based Harris Bank unit, in September 2002.

Deegan said the dual residency is in keeping with banking rules. A Canadian bank CEO ``must be ordinarily resident in Canada,'' according to the Canadian Bank Act.

``Obviously, that does not preclude one from having more than one residence,'' Deegan said.

Downe is probably the first top executive of a Canadian bank to be based in both countries since World War II. In 1941, Royal Bank of Canada President Morris Wilson became chairman of the British Council in North America, responsible for the flow of war supplies to Britain. As a result, Wilson spent Mondays and Tuesdays at Royal Bank's former Montreal headquarters and the rest of the week in Washington or New York.

Downe's dual base isn't a concern for John Kinsey, who helps manage $800 million at Caldwell Securities Ltd. in Toronto, including Bank of Montreal shares.

``It would obviously be his choice to do what he's going to do, though I don't think it's easy living in two cities,'' Kinsey said.

The shares have risen 5.4 percent this year, the worst performance among Canada's six biggest banks.

19 December 2006

NBF Upgrades Manulife & Scotiabank

National Bank Financial, 19 December 2006

With the lifeco & bank earnings seasons now complete, we are making several changes to our ratings. In general, the changes are related to valuation. Given we employ sector ratings, and as a result, rate our companies (both banks & lifecos) against one another, changes in relative valuation are frequently the most significant reason for our valuation changes.

In this note, we are making the following changes to our recommendations:

• Bank of Nova Scotia: Upgrading to Outperform on valuation, potential deployment accretions.

• Manulife Financial: Upgrading to Outperform on valuation (and new F2008 estimates).

• Sun Life Financial: Downgrading to Sector Perform on completed recovery.

• Great-West Lifeco: Downgrading to Underperform on valuation and rising acquisition risk.

Overall, our investment thesis for the companies in our universe has not changed materially. Furthermore, notwithstanding our two downgrades, we continue to favour the lifecos compared to the banks over the long-term (i.e. 3 to 5 years), in light of their capital deployment advantages.

In addition to the above rating changes, we have adjusted the targets for some of the other companies in our universe.

Canadian Banks are Absent in the World Stage

Financial Post, Duncan Mavin, 19 December 2006

Global banking chiefs hungry for growth and armed with cash to burn are set to make 2007 the international year of the bank merger. The trend will lead to further concentration of international banking power, dwarfing those banks -- such as Canada's domestic banks -- that don't participate in the biggest mergers.

Transactions will be driven by healthy balance sheets and surging profits at many of the biggest banks in the world, says Tom Kersting, an analyst at Edward Jones in St. Louis.

"Put those two things together and that's a very ripe environment for very strong merger activity," he says.

In fact, hundreds of billions of dollars were spent on bank mergers and acquisitions in 2006, including the US$37-billion merger of Intesa and Sanpaolo banks in Italy, BNP Paribas of France's US$11-billion takeover of Italy's BPI and the US$14.8-billion deal that saw Capital One pick up North Fork in the United States. Next year could see even more deals.

Take, for instance, last week's rumours of transatlantic deals ranging from Bank of America's interest in a US$90-billion plus takeover of Barclays Bank PLC. in the United Kingdom, to Citigroup Inc.'s US$2-billion bid for U.K. Internet bank Egg Financial. The Barclays rumours have since been quelled by Bank of America's executives, but shares in the U.K. retail bank surged last week on the speculation.

"In-market [or domestic] consolidation is likely to take place in the United States, Germany, Japan, Australia, Korea, Taiwan and Brazil," UBS Investment Research analyst Philip Finch said in a report on international banking this month.

"We could also see transatlantic deals, driven by European expansion among certain U.S. banks, while other cross-border merger activity is likely in Greece, China, Russia and Hong Kong."

Absent, of course, from the lists of potential merger hotspots is Canada. Domestic mergers are not permitted here, while foreign ownership rules mean the Canadian banks are protected from external rivals -- otherwise the Canadian banks could become targets, given they turned in a record year, combining for profits of almost $20-billion.

Of course, Canada's banks do have international growth stories of their own that include acquisitions. Bank of Montreal, Toronto- Dominion Bank and Royal Bank of Canada all purchased additional banks to add to their strength in different regions of the United States last year. They have all said there's cash in the coffers to buy more banks in 2007, if the right target becomes available at the right price. Bank of Nova Scotia and Canadian Imperial Bank of Commerce were also active on the international acquisition trail in 2006.

Scotiabank, which now earns more than 30% of its annual profits outside of Canada, added to its holdings in Central and South America during the year, while CIBC is spending US$1.1- billion to double its current 44% stake in First Caribbean bank.

But all those deals are just pieces of quite specific regional plays, says Dominion Bond Rating Service analyst Brenda Lum.

"If you look at the strategic growth opportunities for several of the Canadian banks it's not really playing in the global arena," Ms. Lum says.

"The Canadians haven't really been standing still, but, at the same time, I think they are more conservative when it comes to large acquisitions."

In total, the Canadians combined to spend a little more than US$5-billion on overseas acquisitions in fiscal 2006, which is about the same size as the 10th single biggest deal in global banking this year -- Danske Bk of Denmark's acquisition of Sampo Bank of Finland.

If, as predicted, the biggest global banks become even bigger, the Canadian banks will become relatively smaller.

A report from international financial services firm Price Waterhouse Coopers use Coopers this year pointed out that not a single Canadian bank made the top 20 banks in the world listed by market capitalization.

"Canadian banks fail to register on the world stage, with the largest Canadian bank ranking 32nd in the world," the report said.

RBC's market capitalization stands at about US$50-billion, compared with more than US$200-million each for Citigroup Inc. and Bank of America Corp. That may not sound like a problem when you can churn out record profits from your domestic business.

But many observers contend that size really does matter when it comes to banking. In a report this week, international management consultancy firm Bearing- Point said Canadian retail banks "will need to embrace globalization" in the next decade or face competition from external banks that will use new technology and their relative size advantage to infringe on the domestic market.

"If we don't take this into account," Mr. Dodge warned, "then when we look back on 2006 from the perspective of 2020, we will wish we had."

Furthermore, the ever-widening shadow of the global giants could have a direct impact on the Canadian banks, especially when it comes to international corporate and investment banking.

"If you're becoming a relatively smaller and smaller player on a global basis, it's going to be difficult to compete globally," says Edward Jones' Mr. Kersting.

Scotiabank has started to leverage its international network to offer better corporate treasury services recently. RBC Capital Markets, meanwhile, is perhaps alone among Canadian investment banks in terms of expanding its international capacity, especially in North America where the ambitions of hedge funds and private equity players are not limited by borders. But the Canadians, in general, have only limited global networks, say analysts.

"None of the Canadian banks has ever stated that their intention is to be a global player," says DBRS's Ms. Lum. "But I think they have to be cognizant of what's happening globally as it pertains to their niche businesses."

In the long term, says Ms. Lum, the Canadians will have to consider joining in the global merger frenzy.

"If the Canadian banks have ambitions to compete globally, they're going to have be bigger than they are today," Ms. Lum says.

CIBC Sees No Significant Revenue Hit from Trust Ruling

Financial Post, Peter Koven, 19 December 2006

Canadian Imperial Bank of Commerce does not expect a "significant" revenue hit due to the federal government's crackdown on income trusts, the company revealed yesterday.

The announcement came in the bank's accountability report for 2006, which was filed with regulators as part of its Annual Information Form.

The decision to tax income trust distributions, which came on Oct. 31, raised concerns that underwriting activity at the banks would dry up, particularly since most Canadian IPOs in recent years have been trusts.

CIBC World Markets, the company's investment banking arm, was particularly active in the trust market. It participated in 31 income trust transactions worth approximately $4.3-billion in the first 11 months of 2006, according to data collected by FP Datagroup. That's more than any other underwriter in Canada.

But Mario Mendonca, analyst at Genuity Capital Markets, said none of the banks appear to be worried about the chill on trusts.

"In the context of their total revenue, they don't see [trusts] as a big deal. And they feel content there will be enough M&A-type business going the other way as these companies convert back to corporations or seek some kind of exit strategy or merger," he said.

Elsewhere in the report, CIBC said the outlook for its businesses "remains positive" going into 2007, despite forecasts of slower economic growth.

On the retail banking side, the company expects to keep profiting from low interest rates and low unemployment, which should support its lending and deposit growth. And CIBC World Markets should benefit from steady M&A activity, "but with a less active mining market and the potential for a moderation in energy prices," the report noted.

On the down side, CIBC expects its merchant banking portfolio, which includes corporate debt transactions, to decrease because of fewer revenue opportunities.

The company did not offer an earnings forecast for fiscal 2007. In 2006, it reported a record profit of $2.6-billion. That compared to a loss of $32-million in 2005 when it agreed to pay out US$2.4- billion to settle Enron litigation.;

14 December 2006

Merrill Lynch on Banks

Merrill Lynch, 14 December 2006; The following is the first 2 pages from the report

Economic growth likely to slow

Our forecast of a marked slowing in US consumer spending growth dominantly accounts for our projected decline in Canadian overall GDP growth from the 3.0% average over the past three years to 2.1% in 2007. The channel through which that weaker US demand is likely to hit Canadian growth is the auto-heavy, export oriented manufacturing sector.

Bank earnings growth likely to slow

We expect 8% earnings growth next year. We do not believe that 2007 will be as accommodating for the banks’ earnings as the last five years, for two main reasons. Banks’ provisions for credit losses as a percentage of loans have declined 79% over that period, and are at the very least likely to flat line. Equity markets have appreciated by 18% per year in Canada in the last four years and 15% in the US. Those growth rates are clearly unsustainable over extended periods.

Valuations are high by historical standards

Canadian banks are trading at valuations that exceed their five year average. Banks have garnered this valuation as they appear much less exposed to the expected slowdown in the US consumer than US financials or the energy and materials sectors, which make up 44.3% of the S&P/TSX Composite Index, versus 31.7% for financials.

TD is our only Buy-rated bank

We rate TD a Buy and have a 12-month price objective of $74. TD trades at 12.6 times 2007 estimated earnings per share, compared to 13.1 times for the other Big 6 banks, in spite of having the highest outlook for earnings growth in 2007 and 2008, in our view, and lessened acquisition risk. We believe TD can achieve above-average earnings growth on TD Ameritrade synergies, increased TD Banknorth and TD Ameritrade ownership, better retail banking momentum in Canada and lesser credit risk. Our $74 price objective assumes a stable P/E multiple, which is in contrast to the multiple compression we expect for the rest of the industry.

Q4/06 earnings above expectations

Canadian bank earnings were ahead of our expectations, driven by strong loan growth, relatively stable margins and core tax rates that were well below sustainable levels. CIBC and Royal Bank were most ahead of our estimates, and consensus, while Scotiabank and TD Bank fell short of expectations.

• CIBC beat via better results from retail banking and wealth management as well as a lower than expected tax rate compared to our overly high estimate. (Exhibit 2) Lower retail PCLs – which were 25% below the average of the last four quarters – drove the good results, as revenue growth was the lowest of the group. The bank’s initiatives to reduce unsecured consumer loan losses are paying off more rapidly than we had anticipated.

• Royal Bank experienced broad-based revenue growth during the quarter which, combined with a low tax rate, led to the earnings beat. The higher earnings came in spite of an increase in the bank’s PCLs – which were 49% above the average of the last four quarters. Capital markets revenue were well ahead of our estimate as higher M&A revenue in Canada, higher private equity gains and stronger US debt origination offset the (expected) decline in trading revenue and lower securities gains.

• Bank of Montreal surpassed expectations on what we believe to be lower quality sources of earnings – namely a low tax rate and continued low PCLs. The tax rate of 18% compared to an average of 28% in the previous four quarters, while annualized specific PCLs were 71% below the average rate of last 15 years. Trading revenues were 55% below the average of the last four quarters and should provide a partial offset going into 2007 versus the other, lower quality, earnings sources.

• National Bank also exceeded our expectations on relatively low quality sources of earnings. The financial markets division accounted for all the difference as both trading revenues and securities gains were high versus normalized levels. On a consolidated basis, securities gains were 47% ahead of the 4-quarter average while trading revenues were 39% ahead. Wealth management was below our estimates on higher expenses.

• TD Bank’s fourth quarter earnings met our expectations, but the quality was low, in our view, as the tax rate of 18% was 6% below our forecast. Domestic retail banking earnings were light by 5%, mainly due to surprisingly high PCLs, but also higher expenses. PCLs grew to $132 million versus $104 million in Q3/06 and $78 million in Q2/06 on rapid credit card growth and lower commercial reversals and recoveries.

• Scotiabank’s results were most-below our expectations, as the bank’s low tax rate was not enough to offset weakness in its core divisions. On an aggregate basis, revenues were light versus our expectations (because of the Other division), expenses were higher (Domestic and International) and the tax rate was low (18% versus the 20-23% expected range, driven by the Other division). Higher PCLs in Scotia Capital more than offset lower PCLs in Domestic Banking and International, and led to an overall level of PCLs 39% above the average of the last four quarters.

13 December 2006

UBS Says Banks & Life Insurance Cos Fully Valued

Financial Post, David Berman, 13 December 2006

Canadian financial stocks have been on a tear in 2006, especially after the downfall of income trusts sent money flowing into the high-yielding sector. Now, Jason Bilodeau, an analyst at UBS, is less enthusiastic.

In a note to clients this week, he lowered his recommendation on Industrial Alliance and Sun Life Financial (once his top pick) to "neutral" from "buy," because of the strong rallies both stocks have experienced.

"Sun Life has recovered from its summer doldrums, breaking through new all-time highs," Mr. Bilodeau said. "We continue to see upside in operational improvements, and capital deployment, but the valuation discount relative to Manulife Financial Corp. has narrowed considerably."

However, he raised his 12-month price targets on the two insurance companies slightly. His target on Sun Life is now $56, up from $55 previously. It closed yesterday in Toronto at $50.10. He also raised his target on Industrial Alliance to $39 from $38. It closed at $36.10. (He is maintaining a "buy" recommendation on Manulife, with a target of $44.)

At the same time, he is staying "neutral" on most bank stocks because of lower growth prospects in 2007.

"It is hard not to like the banks as they continue to post record profits with few obvious concerns looming for the immediate term," Mr. Bilodeau said. "However, the group has made a strong recovery from its late spring/early summer lows and valuations have returned to full levels."

Toronto-Dominion Bank, which he expects will continue to deliver strong earnings growth because of its strong domestic operations, is his lone "buy" among Canadian banks, with a target price of $77. It closed yesterday at $67.85.

12 December 2006

Fund Managers on Cdn Banks

The Globe and Mail, Dale Jackson, 12 December 2006

Peter O'Reilly isn't waiting for the market to tell him Canadian banks can no longer live up to investor expectations. The Dublin-based manager of the Investors Global Financial Services fund has been trimming his Canadian bank stock holdings for the past few weeks.

The fund's exposure to the Canadian financial services sector -- which includes banks, insurance companies and wealth management services -- has been cut over the past few months to less than 5 per cent of the total portfolio. "The multiple that has been ascribed to the Canadian banking sector has led it to a valuation that would suggest there are more interesting opportunities on a global level," Mr. O'Reilly said.

It's not that he doesn't like Canadian banks. His decision has more to do with bank stocks in other parts of the world that perform just as well and trade for less. "You can buy more Bank of America with your Canadian bank stocks" he said.

His global focus has paid off this year. The Investors Global Financial Services fund has returned more than 24 per cent thanks to heavy weightings in U.S. and European financials.

Here at home, investors were lining the streets for the earnings parade that ended Friday with the big six Canadian banks posting a record combined annual profit of $19-billion. Since Canada Day, the average bank share has gained 20 per cent.

But parades always look a little different from behind. Canadian banks shares now trade at close to 14 times their 2007 expected earnings -- that's good compared with other sectors, but higher than typical Canadian bank multiples of 10 to 12 times. Banks such as ING in the Netherlands and HBOS PLC in Britain trade closer to 10 times earnings.

Some Canada-based global financial services fund managers also believe domestic banks have gotten pricey. "We see Canadian banks as fully valued" said Chris Lowe, who has trimmed Canadian bank holdings in his AIC Global Advantage fund to less than 2 per cent from close to 9 per cent two years ago. "A pretty attractive valuation gap has opened up between Canadian banks and global banks."

Mr. Lowe said that unlike Canadian banks that function in a commodity-based economy, many of the big foreign banks don't carry as much single-country risk. On average, Canadian banks rely on the domestic market for 80 per cent of their business. Foreign banks including Barclays, Royal Bank of Scotland, BNP Paribas and Spain's BBVA generate half their revenue from home markets. Much of their operations are in developing markets with surplus economies such as Asia.

The AIC Global Advantage fund has returned 18 per cent so far this year.

Selling Canadian bank stocks is more difficult for Bernard Gauthier at CIBC Asset Management Inc. His CIBC Financial Companies fund is required to hold at least 60 per cent of its total assets in Canadian banks -- and he's not going a shade over. He expects earnings growth to slow in the coming years but unlike many bank fund managers, he believes generous dividend payouts make them well priced. His favourite is Toronto-Dominion Bank because he considers its growth prospects better, and valuations lower, than those of its peers.

The remaining 40 per cent of the fund is in international stocks including Barclays, UBS AG and Royal Bank of Scotland.

So far this year the CIBC Financial Companies fund has returned 14 per cent.

One true believer in the Canadian banks is Peter Gibson of Desjardins Securities. In a recent interview on Report on Business Television, he suggested the Canadian bank party may have just begun.

"This is part of a 10-year economic expansion, which means it's still early in that expansion" Mr. Gibson said.

He points to "exceptional fundamentals" and return on equity growth of up to 15 per cent as a sign the Canadian banking sector remains "extremely cheap. . . .

"They may look expensive relative to their own history but you've never seen a period like this before when you've had such a high ROE level," he said.

11 December 2006

Banks Q4 2006 Summary

Report on Business Television, 11 December 2006

Click here for the ROBTv video clip, of Jamie Keating (Senior Bank Analyst, RBC Capital Markets) speaking about the Banks' Q4 2006 Earnings.
RBC Capital Markets, 11 December 2006

Banks Beat Consensus, But Quality a Concern for Some. The banks delivered 17% EPS growth YoY, led by CIBC up 40% and RY up 22%. BMO lagged, up only 7%. Earnings quality was weakest for BMO and BNS where retail operating leverage declined. TD also benefited from non-core items such as a low tax rate, but generated strong retail revenue growth and operating leverage, indicating high-potential sustainability.

Actions on CIBC, RY and BMO. We raised estimates and price targets by 10% for CIBC (upgraded to Outperform) and by 2% for RY (already rated O/P). We held our NA and TD estimates towards the high end of consensus, and lowered our estimates and price target for BMO. We gave BNS a pass on a considered EPS reduction because of strength in International and potential for domestic cost cuts. Our top 3 banks are TD, RY and CIBC. BMO and BNS are least interesting at these valuations.

RY and TD Dominate Domestic Retail. Retail spread held or rose at RY, TD and NA, while for BMO, BNS and CIBC retail spreads dove. Retail revenue and operating leverage followed spreads: up for RY, TD and NA, less so at BMO and BNS. CIBC is still very strong on cost cuts.

Marking the Credit Turn. Except for CIBC, impaired loans rose in both corporate and retail, and reserve coverage declined. This is as anticipated and should not come as a surprise. TD maintains the highest reserve coverage at ~320%, BNS at 139% is lowest. The sector average is ~180%.

Corporate Loans up Sharply. Wholesale loan growth accelerated for two reasons: (i) a bulge in M&A and related bridge loans, and; (ii) higher drawings on existing committed lines. We estimate balances were up ~30% YoY in the sector, but loan market liquidity remains strong and we see this as a balance sheet blip, ahead of a round of syndication & sales.

BMO Investor Breakfast. Senior management profiled objectives and priorities for 2007, but we heard no new news. The focus for a turnaround in domestic retail was in a more productive, larger sales force, and management hinted at raising front-line staff. We question how this would also involve lowering cost/revenue, at least in the near-term.

Tight Valuation Range. The sector P/E at 13.5x forward consensus EPS is in-line with where the 10-year bond yield relationship suggests is fair, however the peer range is at the low end of its historic range. Investors are giving little or no incremental value for performance record discrepancies. However, we see sustainable differences emerging in retail performance, which, in our view, should drive valuation premiums for RY and TD. We also believe BMO and CIBC should trade to relative discounts until they demonstrate some market share ‘staying power.’

Scotiabank Q4 2006 Earnings

BMO Capital Markets, 11 December 2006

Scotiabank reported fourth quarter cash earnings of $898 million, or $0.90 per share, compared to $934 million, or $0.93 per share, in the last quarter and $809 million, or $0.80 per share in the fourth quarter of last year. All three quarters had unusual items, including this quarter with the bank reversing $60 million of general allowance. Excluding these items, the appropriate operating comparison is $0.86 this quarter, $0.88 last quarter, and $0.77 in the same quarter of last year. Results were slightly lower than our expectations of $0.88.

Overall though this was a great year for Scotiabank, and we would describe the quarter's results as strong, despite the minor earnings miss. The majority of growth in the quarter came from the International segment where acquisition activity has been high. The performance of the Domestic Banking and Scotia Capital segments was reasonable. Management provided a very bullish earnings outlook for 2007 - in the $3.80-4.00 range. As is the case for most other banks, our forecasts are towards the bottom end of this range.

Domestic Banking reported earnings of $345 million, up 6% over the quarter and 4% over the year. Results were just a shade below our expectations. Revenue growth was reasonable but expenses growth was affected by project spending and the impact of the acquisition of Maple Trust. This was offset by unusually low provisions in commercial banking. We expect to see better expense trends, but somewhat higher loan losses in 2007. It will be interesting to see how Scotia performs over the next 12 months as all banks seem to be refocusing on retail and wealth management.

International Banking results came in at $271 million, down 6% over the quarter but up 53% over the year. Results were somewhat stronger than our expectations. Currency headwinds were offset by the positive impact of good results out of Mexico and the bank's relatively recent acquisitions in Peru, El Salvador, Costa Rica and the Dominican Republic. The decline in earnings from the third quarter simply reflects the VAT refund in that quarter. This was a great year for International, with earnings up 32%. Mexico contributed about three quarters of the earnings increase. Management appeared very confident that earnings trends out of these regions would continue to be favourable in 2007 and is certainly very open to pursuing additional acquisition opportunities. We note that the scope of future acquisitions will be in similar geographies but will likely be broadened to include insurance and wealth. We are forecasting earnings growth of about 13% with strong fundamental growth offset by higher taxes in Mexico.

Scotia Capital reported earnings of $236 million, down 16% over the quarter and roughly flat from the fourth quarter of last year. Strong capital markets and investment banking revenues were offset by lower securities gains and lower interest recoveries. Trading revenues, at $254 million, were strong. The segment continues to operate with net recoveries. We think that this is modestly below the run rate of earnings for 2007.

Our cash EPS estimates for 2007 and 2008 remain unchanged at $3.80 and $4.05. As is the case with our other bank forecasts, our 2007 forecast is at the bottom end of the range of management guidance. We are assuming a continued benign credit environment in North America and forecast that the International operations of Scotiabank will more than earn through higher taxes in Mexico. Both seem very reasonable assumptions.

We recently downgraded Scotiabank to Underperform from Market Perform. We continue to believe that the bank has an excellent international banking footprint, and competitive franchises in wholesale and domestic banking. However, we note that we are now in the later stages of a remarkably good credit cycle and that the international businesses have had an excellent run. While we see little specific signs that either of these situations will deteriorate anytime soon, we believe that there is better value elsewhere. We note that investors can buy TD or CIBC (both rated Outperform) at cheaper multiples with lower risk, and similar medium term growth profiles.
• Blackmont Capital maintained Scotiabank at Buy.

• Desjardins Securities maintained Scotiabank at Buy; the target price was increased from $54.50 to $57.00.

• Merrill Lynch maintained Scotiabank at Neutral. The target price is $51.00.

• National Bank Financial maintained Scotiabank at Sector Perform. The target price is $58.00.

• TD Securities maintained Scotiabank at Buy; the target price was increased from $56.00 to $57.00.
Financial Post, Duncan Mavin, 9 December 2006

Bank of Nova Scotia delivered record annual earnings yesterday on the back of surging profits from its expanding international operations.

The bank announced profits for 2006 of $3.5-billion, up from $3.2-billion last year. Fourth quarter earnings were $890-million or 89 cents per share, up from $803-million or 80 cents a share in the same period in 2005.

Total revenue for 2006 was $11.6-billion, up $922-million from the previous year.

Chief executive Rick Waugh said the record annual results were achieved on the back of a strategy of "diversifying across businesses and geographies."

Scotiabank has expanded throughout much of Latin and Central America and the Caribbean. The bank has spent more than $1-billion on acquisitions in Peru, El Salvador, Costa Rica and the Dominican Republic this year alone.

The strategy appears to be paying off as Scotiabank's international division delivered profits of $1-billion, up $254-million or 32% from last year. The bank earns about 30% of its profits from outside of Canada.

Rob Pitfield, head of Scotiabank's international division, said he is looking for more banks to buy in markets where Scotiabank already has a presence. He said the bank will also consider acquiring businesses with "complementary" operations like insurance or wealth management.

Scotiabank is "aggressively" expanding its existing international banking network by adding more than 150 branches to its overseas operations next year, as well as more than 100 new automated banking machines.

Analysts were generally impressed by results from Scotiabank's international operations, but they were less enthusiastic about its domestic bank which turned in flat results.

"International carries the quarter," said UBS Investment Research analyst Jason Bilodeau. But, he said, "Domestic trends are modest."

Scotiabank's domestic franchise reported net income of $1.3-billion in 2006, $26-million or 2% higher than last year.

Mr.Bilodeau said Scotiabank had made market share gains in Canada. But lower margins and increasing costs are an issue. "The resulting slow growth indicates Scotiabank is not keeping pace with its peers," Mr. Bilodeau said.

RBC Capital Markets analyst Jamie Keating said, "We do not view this as a high-quality [domestic] retail result."

He noted that "peer-like retail revenue growth of 4% was overshadowed by 5% expense growth."

Scotia Capital's earnings grew 14% from last year to $1-billion. The bank said Scotia Capital's results were helped by revenue growth of 10%, as well as a "benign credit environment" resulting in low loan loss provisions.

As expected, Scotiabank said it will increase the dividend on its common shares by 3 cents to 42 cents per common share.
Bloomberg, Sean B. Pasternak, 8 December 2006

Bank of Nova Scotia, Canada's third- largest bank by assets, said profit climbed for the 14th straight quarter, led by its international businesses in Mexico and the Caribbean.

Net income rose 11 percent to C$897 million ($781 million), or 89 cents a share, from C$811 million, or 80 cents, a year ago, the Toronto-based bank said today in a statement sent by Canada NewsWire. Revenue rose 9.7 percent to C$3 billion.

Chief Executive Officer Richard Waugh has spent more than C$1 billion on acquisitions abroad in the last year, leading to a 54 percent increase in international banking profit. Almost a third of the bank's profit came from outside Canada, compared with 19 percent in 2000.

``We're now starting to see the cumulative impact of all these smaller acquisitions,'' Jason Bilodeau, a bank analyst at UBS Canada, said before results were released. ``They're starting to have a very positive impact on their international results.''

Scotiabank boosted its quarterly dividend by 7.8 percent to 42 cents a share, the fourth increase in two years. Bank of Montreal and National Bank of Canada also raised their dividends this quarter.

Shares of Scotiabank rose 3 cents to C$51.60 at 4:10 p.m. trading on the Toronto Stock Exchange. They've risen 12 percent this year, compared with a 15 percent gain for the 39-member S&P/TSX Financials Index.

Scotiabank bought two banks in Peru for C$390 million in March, making it the third-largest bank in that country. Scotiabank also agreed in June to buy Corporacion Interfin SA, the owner of Costa Rica's largest private bank, for about C$330 million.

The bank reported in October that profit at its Scotiabank Mexico unit rose 30 percent to 1.08 billion pesos ($100 million) as the business set aside less money for bad loans.

Profit from domestic consumer banking climbed 3 percent to C$338 million on higher mutual fund and brokerage fees. Investment banking profit rose 2.2 percent to C$236 million.

National Bank Financial analyst Robert Wessel was expecting the bank to earn 90 cents a share, compared with the 88 cent-a- share median estimate of nine analysts surveyed by Bloomberg News.

For the year, Scotiabank had record profit of C$3.58 billion or C$3.55 a share, compared with C$3.21 billion, or C$3.15 a share, a year ago.
Donw Jones Newswires, Monica Gutschi, 8 December 2006

Bank of Nova Scotia has set even more aggressive targets for its 2007 performance after easily breezing by its 2006 goals.

"The bottom line is, we fully expect to deliver another year of record results," chief executive Rick Waugh said Friday.

He said the bank expects its earnings to grow by 7-12% per share in fiscal 2007, while return on equity should be between 20-23%. Its productivity ratio is expected to fall below 58% and the bank plans to maintain strong capital ratios and credit ratings.

Bank of Nova Scotia had targeted earnings growth of 5-10% per share in 2006, but propelled by strong growth in its international division and wealth management, earnings rose 12.7% per share. Its return on equity of 22.1% in the year was at the top end of its targeted range of 18-22%. Meanwhile, it easily met its goal of maintaining a strong capital ratio in 2006, coming in with a Tier 1 ratio of 10.2%, among the highest of its peers.

Bank of Nova Scotia earned C$897 million or 89 Canadian cents a share in the fourth quarter, up from C$811 million or 80 Canadian cents a year earlier and in line with the Thomson First Call mean earnings estimate of 88 Canadian cents.

Revenue rose to C$3.00 billion from C$2.74 billion a year earlier.

The bank's domestic operations had net income in the quarter of C$335 million, up 3% from the same quarter last year. Its international banking group had net income of C$268 million, up 54% on the back of a series of small acquisitions. However, excluding the impact of foreign exchange, net income rose 63%.

Net income at Scotia Capital rose 2.6% to C$235 million.
RBC Capital, 8 December 2006

First Impression

• Underlying EPS In Line at 89¢, Up 10% YoY. Cash EPS of 90¢ was helped by a $60MM general loan loss release (4¢) but BNS also recorded a 3¢ hit from non-core AcG-13 hedge mark-to-market. International was above our expectation to offset weakness in wholesale. Retail was in line. The tax rate at 26% (teb) was as expected, as was the underlying loan loss (i.e., excluding the general release), all to suggest we detect no reason to change estimates at this juncture. BNS valuation is still rich by our P/E estimates – hence our Sector Perform rating.

• Domestic Bank In Line (1/3 of Earnings). Cash net income of $342MM (we estimated $337MM) was up 4% YoY. An $11MM YoY decline in the loan loss drove half (2%) of the growth. Peer-like retail revenue growth of 4% was overshadowed by 5% expense growth. Spread was down again – this may not improve until we have a steeper yield. We do not view this as a high-quality retail result.

• Wholesale Low (1/3 of Earnings). Wholesale cash net income at $235MM missed our $285MM estimate, and $279MM in Q3/06. The primary factor was a $45 million swing in loan loss from recovery last quarter to expense this quarter, the first of significance in over 8 quarters. BNS’ trading business was solid and in line with our estimate. Securities gains again exceeded our estimate, but came in below the prior quarterly average (although most of these gains are housed in the “other” segment). Impaired loan development was benign.

• International Stronger Than Expected (1/3 of Earnings). With income of $269MM relative to our $234MM estimate, International looked very strong. Revenue jumped 26% YoY on acquisitions (Peru and Costa Rica) – and broad-based organic growth. Loan losses remained very low, helping the division earn through higher taxes.

TD Bank Q4 2006 Earnings

BMO Capital Markets, 11 December 2006

TD Bank reported fourth quarter cash EPS of $870 million, or $1.16 per share, compared to $880 million, or $1.17 per share, in the last quarter, and $765 million, or $0.94 per share, in the fourth quarter of last year. There were a number of unusual items in each of the quarters. Specifically, this quarter included an AcG-13 accounting charge for hedging derivatives as well as a charge for the setup of specific allowances for credit card and overdraft loans. Excluding these unusual items, the appropriate operating comparison is $1.20 this quarter compared to $1.21 last quarter and $1.06 in the fourth quarter of last year. Results were ahead of our estimate of $1.16, and in line with street estimates. Though the earnings were, in aggregate expected, there were certainly a number of cross currents in the quarter. Loan losses in the retail bank rose more than we had expected and this was offset by higher securitizations earnings and interest on tax recoveries. TD Securities earned through a relatively disappointing trading quarter. On the other hand, the bank is showing impressive market shares trends and the investments in 2005 and 2006 appear to be delivering results.

All in all, this was a good year for TD and we believe that the bank is well positioned for the future. There has been material investment in the domestic retail operation and the outlook is for higher contribution from Ameritrade (and to a lesser extent Banknorth largely coming from additional investment) in 2007. We remain comfortable with our Outperform rating.

The Canadian Personal and Commercial Banking segment reported earnings of $501 million, down from $524 million last quarter, but up from $443 million in the same quarter of last year. Revenue growth remained solid, but this was offset by higher expenses. Market share trends in all products remained very strong. Given the significant build-out of the branch network in 2007, we believe that revenues in coming years are likely to surprise on the upside. The one negative development was the substantial increase in loan losses coming from the Small Business and Commercial lending. We now believe that it is prudent to assume higher losses in this loan book than we had previously.

TD Banknorth's pre-released results were $63 million, down slightly from both the last quarter and fourth quarter of last year. Lower results were due to the continuing currency headwind combined with a challenging operating environment. We expect this segment to continue contributing at current levels until the second half of 2007, when the additional earnings from TD's acquisition of the remaining shares will be incorporated.

The Wealth Management segment, which includes both Canadian Wealth and AMTD, reported earnings of $148 million, down slightly from the last quarter but up 9% from the previous year. Domestic wealth management earnings were down slightly over the quarter as a result of somewhat lower direct brokerage revenues and slightly higher expenses. However, market share remained strong, with solid improvements in both long-term and money market funds. TD Ameritrade's pre-released earnings results came in at $53 million, down slightly from the last quarter. We note that due to the timing of the deal closing, we do not have year-over-year comparison results. We expect to see continued growth in asset balances and earnings.

The Wholesale Banking segment reported earnings of $146 million, down from a very strong $179 million last quarter but up from $115 million in the fourth quarter of last year. Overall, we note that this was a solid result in a quarter when trading revenues were $174 million - one of the poorest contributions in over two years. We believe that TD Securities will continue to contribute at this rate through 2007.

The Corporate Segment reported cash earnings of $17 million, excluding an $18 million (after-tax) charge for specific allowances for credit card and overdraft loans. We believe that the $17 million result is above a 'normal' run rate as it incorporated higher securitization revenues and interest on tax refunds.

Our 2007 and 2007 cash EPS forecasts are unchanged at $5.15 and $5.65. TD Bank has provided some guidance that earnings growth should exceed 10% in 2007, off the adjusted EPS base of $4.66 in 2006. As with other banks, we are at the low end of guidance. We believe that TD Bank will have relatively low risk, high quality earnings growth in 2007. Most of it will come from domestic retail banking where the bank has invested heavily and as a result of the annualization of acquisitions already announced or completed. We believe that at an average P/E, TD Bank shares continue to be attractive.
Scotia Capital, 11 December 2006

Fourth Quarter Earnings Increase 13%

• Toronto-Dominion Bank (TD) reported cash operating earnings of $1.20 per share, an increase of 13% from $1.06 a year earlier. Wholesale led earnings growth at 27%, with Canadian P&B earnings up 13%, Wealth Management up 9%, offset by earnings decline of 9% at TD Banknorth.

• Cash ROE in the quarter was 18.1% versus 19.1% a year earlier.

• Reported earnings were $1.04 per share which included the following after-tax items: the amortization of intangibles of $87 million or $0.12 per share, the impact of hedging relationships accounting guideline (AcG-13) of $8 million or $0.01 per share and the initial set up of specific allowance for credit card and overdraft loans of $18 million or $0.03 per share.

F2006 Earnings Increase 12%

• Fiscal 2006 cash earnings were $4.65 per share, up 12% from $4.14 per share a year earlier.

Cash operating ROE for fiscal 2006 was 18.8% versus 19.8% a year earlier.

• Fiscal 2006 net income increased 18% to $3,376 million, with weighted average diluted shares outstanding increasing 4%, muting earnings per share growth.

High Operating Leverage; Revenue Growth Solid

• TD's operating leverage in Q4 was strong at 4% with revenue growth of 4% and expenses flat.

• Operating leverage for fiscal 2006 was also strong at 5% with revenue growth at 9% while expenses increased 4%.

Canadian P&B Earnings Up 13%

• Canadian P&B earnings in Q4 increased 13% to $501 million. Total revenue in Q4/06 increased 13% with expenses increasing 10%. The efficiency ratio improved 120 bp to 54.8%.

• Total revenue increase was mainly due to volume growth across most products, in addition to margin expansion in personal deposits from the rising interest rate environment. VFC contributed 5 bp to the margin improvement. In terms of volume growth, real estate secured lending was up 10%, with Visa up 23%.

• The high expense growth reflects significant reinvestment in the business, including an ABM replacement program, 31 new branches in 2006, launching of a Visa platform, and an In- Branch customer authentication program.

• Retail market share remained stable with a slight upward trend, with the largest improvement in total personal deposits, up 17 bp sequentially.

• Card service revenue increased to $113 million from $103 million in the previous quarter and $85 million a year earlier.

• Loan securitizations were $97 million versus $85 million in the previous quarter and $120 million a year earlier.

• Insurance revenue was $214 million, down sequentially from $230 million, and up slightly from $210 million a year earlier.

• TDCT fiscal 2006 earnings were $1,966 per share, up 16% from $1,702 million a year earlier.

Canadian Retail NIM at 3.07%

• Canadian retail net interest margin (NIM) was 3.07% in the quarter, down 1 bp sequentially, but up 11 bp from a year earlier.

• Canadian retail NIM for fiscal 2006 was 3.04%, up 8 bp from fiscal 2005.

• The bank indicated that Canadian retail NIM will tread lower toward 3.00%, due to a mix shift with lower margin assets growing at about 10% and deposit growth of 6%.

New Branch Openings

• The bank opened 31 new branches in 2006, with 24 being opened in the fourth quarter alone.

TD Banknorth Earnings Decline - Drag on Profitability

• TD Banknorth continues to be a drag on TD Bank earnings, declining 9% to $63 million from $69 million a year earlier. Earnings were negatively impacted by higher loan loss provisions and higher advertising and marketing expenses.

• TD Banknorth contributed $0.09 per share to earnings in the quarter and $0.35 per share per share to earnings for fiscal 2006 with fiscal 2005 earnings not comparable as TD Banknorth acquisition closed in March 2005, with only 7 months included in earnings.

• Net interest margin at TD Banknorth declined 6 bp from the previous quarter to 4.01% due to intense competition for both loans and deposits, and margin compression. NIM was down 8 bp from a year earlier.

• Net interest margin for the fiscal year declined 14 bp to 3.97% versus 4.11% a year earlier.

Total Wealth Management Earnings Up 9%

• Wealth Management earnings, including the bank's equity share of TD Ameritrade, increased 9% to $148 million.

Canadian Wealth Management

• Domestic Wealth Management earnings increased 12% to $95 million from $85 million a year earlier, due to higher transaction revenue and higher mutual fund fees from asset growth.

• Revenue increased 8% with expenses increasing 5% to $504 million and $357 million, respectively.

• Mutual fund revenue increased 5% to $162 million from $155 million a year earlier.

• Mutual fund revenue for fiscal 2006 was $639 million, a modest 2% increase from $624 million in fiscal 2005. Mutual fund assets under management (IFIC, includes PIC assets) increased 18% to $52.3 billion. For the fiscal year, TD ranked second in the industry with $3.7 billion in net long-term asset sales.

TD Ameritrade

• TD Ameritrade contributed $53 million or $0.07 per share to earnings in the quarter versus $55 million or $0.08 per share in the previous quarter. TD Ameritrade's contribution represented 6% of total bank earnings.

Wholesale Banking Earnings Increase 27%

• TD Securities earnings in Q4 increased 27% to $146 million from $115 million a year earlier, driven by strong investment banking revenues and security gains, and partially offset by weak trading revenue.

• Operating leverage was very high at 13% with revenue increasing 3% and expenses declining 10%. Expenses declined significantly due to lower payroll taxes and lower variable compensation.

Capital Markets Revenue

• Capital Markets revenue was $335 million versus $343 million in the previous quarter and $479 million a year earlier.

• Capital markets revenue for fiscal 2006 was $1,532 million.

Trading Revenue Weak

• Trading revenue in Q4 was relatively weak at $174 million versus $242 million in the previous quarter and $187 million a year earlier (excluding the loss on the sale of the structured products portfolio in Q4/05).

• Trading revenue in equity and other portfolios was particularly weak in the quarter at negative $3 million, with interest rate and credit portfolios trading revenue declining to $45 million from $63 million in the previous quarter and from $81 million a year earlier. Trading revenue in foreign exchange products was $54 million versus $80 million in the previous quarter and unchanged from a year earlier.

• Trading revenue in fiscal 2006 was $1,042 million, a modest 1% increased from $1,034 million a year earlier (excluding the loss on the sale of the structured products portfolio).

Security Surplus Increases to $774 Million

• Security gains were $87 million or $0.08 per share, compared with $113 million or $0.10 per share in the previous quarter and $76 million or $0.07 per share a year earlier.

• Unrealized security surplus increased to $774 million, versus $707 million in the previous quarter and $750 million a year earlier.

Loan Loss Provisions

• Specific loan loss provisions (LLPs) increased to $142 million or 0.33% of loans versus $109 million or 0.26% of loans in the previous quarter. The increase in LLPs was due to higher provisions on personal loans related to volume, higher write-offs and lower SB&C recoveries.

• Total LLPs for the fiscal year were $424 million or 0.25% of loans compared to $319 million or 0.20% of loans in 2005.

• We are increasing our 2007 LLP estimate to $600 million or 0.35% of loans from $500 million or 0.30% of loans due to higher loan loss provisions in Personal & Commercial driven mainly by volume, lower recoveries in small business in addition to higher loan losses at TD Banknorth (due in part to the Hudson United acquisition) and lower corporate loan recoveries.

• Our 2008 LLP forecast is $675 million or 0.40% of loans.

Loan Formations

• New gross impaired loan formations were $299 million versus $206 million in the previous quarter and $214 million a year earlier, with $47 million arising as a result of moving the credit card portfolio to non-accrual status upon 90 days in arrears as opposed to 180 days. This shift in accrual recognition to a more conservative stance results in the bank receiving capital relief from Basel II.

• Net impaired loan formations were $218 million versus $148 million in the previous quarter and $41 million a year earlier.

Tier 1 Capital 12.0%

• Tier 1 capital ratio was 12.0%, compared to 12.1% in the previous quarter, and 10.1% a year earlier.

Share Buyback

• The bank repurchased 4.0 million common shares at an average cost of $66.00 per share for $264 million.

• On October 19, the bank announced a normal course issuer bid to repurchase up to 5 million common shares or approximately 0.7% of shares outstanding.

Recent Events

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

• Between October 26 and October 30, TD purchased 233,000 shares of BNK at an average cost of US$29.86 per share, bringing its total ownership level of BNK to 130.1 million shares or 57.0%.

TD Bank to Acquire Remaining 41% of TD Banknorth

• On November 21, TD announced that it will acquire 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 transaction will be financed by $3.0 billion primarily of subordinated debt.

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

• TD's Tier 1 capital ratio will decline to 9.8% from 12.1% and tangible common equity ratio will decline to 7.0% from 9.1%.

• Upon privatization, 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.

• 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. We view this step as necessary in an attempt to maximize returns from this investment over the next two to three years.

• 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.


• Our 2007 earnings estimate remains unchanged at $5.15 per share. We are introducing our 2008 earnings estimate at $5.65 per share.

• Our 12-month share price target is unchanged at $81, representing 15.7x our 2007 earnings estimate and 14.3x our 2008 earnings estimate.

• We maintain our 2-Sector Perform rating on TD with earnings strength at TDCT and Wealth Management expected to be muted by weak performance in the bank's U.S. platforms, particularly TD Banknorth.
• Blackmont Capital maintained TD Bank at Hold.

• Merrill Lynch maintained TD Bank at Buy. The target price is $74.00.

• National Bank Financial maintained TD Bank at Sector Perform. The target price is $76.00.
newratings, 11 December 2006

Analysts at UBS maintain their "buy" rating on TD Bank Financial Group. The target price has been raised from C$76 to C$77.

In a research note published this morning, the analysts mention that the company has reported healthy volume growth, margin expansion and market share gains for the latest quarter. TD Bank Financial is expected to continue to generate robust results in 2007 due to the ongoing investment, the analysts say. The company expects to continue to exceed its 7%-10% EPS growth target in the medium term.
Financial Post, Duncan Mavin, 9 December 2006

Toronto-Dominion Bank said annual profits more than doubled on the back of its domestic retail banking network but analysts raised concerns about a weakening of the bank's loan portfolio in the upcoming fiscal year.

Net income for the quarter was $762-million, up from $589-million in the fourth quarter of 2005, the bank said yesterday. Core cash earnings per share of $1.20 were in line with consensus estimates among bank analysts of $1.19 per share.

TD also said its annual profit more than doubled to $4.6-billion compared with $2.2-billion in 2005.

The results are "a clear example" of how the bank has "focused on building and enhancing TD's strong domestic business" in 2006, said chief executive Ed Clark.

For instance, the bank has opened 24 new branches and upgraded its entire network of automated banking machines during the year.

That investment appears to have paid off as TD's Canadian retail banking franchise, TD Canada Trust, saw earnings grow 13% in 2006 compared with last year. Profits from domestic retail banking jumped $58-million to $401-million.

UBS Investment Research analyst Jason Bilodeau said the results reflect "very solid trends in core domestic personal and commercial and wealth management lines."

The bank has "one of the strongest domestic platforms," he said.

Wealth management earnings were also up, by 9% compared with the fourth quarter of 2005, on the back of a strong performance by the bank's TD Ameritrade unit in the United States.

TD Ameritrade contributed profits of $53-million to the bank's wealth management segment.

As expected, TD's U.S. retail bank, TD Banknorth, was the weakest performing unit. Earnings at Portland, Maine-based Banknorth fell $6-million from the fourth quarter of 2005 primarily due to tough competition in the U.S. banking industry, which put pressure on margins.

TD announced last month that it intends to buy the 43% of TD Banknorth that it doesn't already own for US$3.2-billion.

Mr. Clark said there are "several key initiatives" underway to improve the performance of TD Banknorth.

The bank recently announced TD veteran Bharat Masrani will be the new chief executive of the U.S. subsidiary from March 2007 when long-time head Bill Ryan steps aside.

"We remain committed to growing and improving TD Banknorth for the future," said Mr. Clark.

Higher loan loss provisions at TD also raised some concerns among analysts. The bank recorded a provision of $170-million for bad loans for the three months ended Oct. 31, compared with a provision of $109-million in the previous quarter.

Desjardins Securities analyst Michael Goldberg said there are "signs of weaker credit quality" at TD.

Blackmont Capital analyst Brad Smith said higher loan loss provisions were required "in response to a broad-based sequential increase in impaired loans."
The Globe and Mail, Andrew Willis, 8 December 2006

On the heels of a year that saw the six big banks post a record combined profit of $19-billion, Canada's bankers are confidently forecasting they can do even better.

Moments after revealing a $3.2-billion annual profit yesterday, driven in part by 17-per-cent earnings growth from its foreign operations, Bank of Nova Scotia chief executive officer Rick Waugh bumped up the bank's targets for both profitability and return on equity.

"In 2007, we fully expect to deliver another year of record results," said Mr. Waugh, who stressed that his bank, like its rivals, is focused on business lines that deliver sustainable earnings, such as wealth management.

The same confidence shone through at Toronto-Dominion Bank, which yesterday reported profit of $4.6-billion for the year, and faces the challenge of improving performance at its U.S. branch network, TD Banknorth.

Since Ed Clark took the helm as chief executive officer, TD has consistently grown earnings and dividends by 10 to 13 per cent annually. Yesterday, Mr. Clark said: "You know I'm conservative in my approach. But assuming there aren't any major changes to the economic outlook, we expect we will continue to exceed our 7- to 10-per-cent [target] range."

The previous high-water mark on combined bank earnings was $13.1-billion, set in 2004. While the banks are breaking new ground with both their profits and share prices, the good times can only continue if the institutions continue to enjoy a combination of decent economic growth and loan losses that are at or near historic lows.

Montreal-based money manager Stephen Gauthier at Gauthier & Cie predicted earnings growth will "be tougher, because the economy won't grow as fast. It'll be a more difficult environment."

Record profits mean Canadian banks now enjoy premium valuations compared with most global peers -- the exception is takeover-friendly U.S. regional banks. Analyst James Bantis at Credit Suisse said lofty share prices are justified by double-digit earnings growth and the banks' diversified revenue base, but cautioned that any misstep in acquisition-driven growth strategies will put an end to the joy ride.

At TD, giveaways of Apple iPods to new retail clients and 25 branch openings in the fourth quarter helped boost earnings from its Canadian retail division by 13 per cent to $501-million. The Toronto-based bank's quarterly profit in the three months ended Oct. 31 climbed to $762-million or $1.04 a diluted share from $589-million or 82 cents a year ago.

On an adjusted basis, TD Bank earned $1.20 a share.

"TD's numbers reflect very solid trends in core domestic personal and commercial and wealth management lines," said bank analyst Jason Bilodeau at UBS Securities.

In contrast to TD's domestic success, Scotiabank looked to foreign operations to charge its profits.

The bank earned more than $1-billion from each of its major divisions: domestic retail banking, investment bank Scotia Capital Inc. and international banking.

Scotiabank's offshore revenue grew by 17 per cent following a series of South American acquisitions. The bank has spent $1.5-billion on seven takeovers in the past 18 months.

"International remains a key driver of Scotiabank's [quarterly results] . . . However, domestic challenges are evident," said analyst Jason Bilodeau at UBS Securities. He was one of several analysts to flag the fact that Scotiabank's retail branches and investment banking results were disappointing, while the international division did better than expected.

Scotiabank boosted its dividend by 7.8 per cent yesterday to 42 cents a share, making it the third big bank to raise its payout in this quarter, and beat analysts' forecasts by tabling earnings for the three months ended Oct. 31 of $897-million or 89 cents a share. The bank is now targeting 7-to-12-per-cent annual growth in earnings per share, and return on equity of 20 to 23 per cent.
The six biggest Canadian banks earned a total record profit of about $19-billion for the 2006 financial year ended Oct. 31. Total earnings: $19-billion

Previous record: $13.1-billion in 2004

Reason: Profited from a strong Canadian economy, especially in Western Canada. Growth in mortgages, credit cards and other consumer lending, as well as trading fees and corporate loans.

Past annual profits: $9.7-billion in 2001, $7-billion in 2002, $11.1-billion in 2003, $13.1-billion in 2004 and $12-billion in 2005.
Reuters, Lynne Olver, 8 December 2006

Toronto-Dominion Bank reported a 29 percent jump in fourth-quarter profit on Friday, as strength in its domestic retail business outweighed weakness in the United States, but its shares slipped in Toronto.

TD Bank Chief Executive Ed Clark said earnings per share should continue to grow faster next year than his bank's long-term goal of 7 percent to 10 percent EPS growth. In 2006, adjusted earnings per share grew by 13 percent.

"Looking forward, I'm feeling pretty optimistic," Clark said on a conference call.

Revenue growth in TD's powerhouse Canadian retail operations will likely slow next year, but expense growth will follow suit, Clark said. And investments made in the domestic retail business, such as new branches and additional staff, should help that segment deliver double-digit earnings growth.

Canada's third-biggest bank by market value reported net income of C$762 million ($663 million), or C$1.04 a share, in the quarter ended October 31, up from C$589 million, or 82 Canadian cents a share for the same time last year.

Diluted earnings per share were C$1.20 when adjusted to exclude amortization of intangible assets, the impact of hedging accounting, and initial specific allowance for credit card and overdraft loans.

That was just ahead of the C$1.19 a share that analysts had expected, according to Reuters Estimates.

Still, TD stock fell 1 percent on Friday to C$67.35 a share, down 65 Canadian cents, on a volume of 3.1 million shares. It traded as low as C$66.56 early in the session.

One analyst said banks will be hard-pressed to duplicate this year's stellar results, and that may have fueled the stock decline.

"We believe much of the positive news for TD and the Canadian banks in general are already priced into the stocks," said Edward Jones analyst Tom Kersting.

TD's results were driven by its strong performance in Canada, but hurt by the difficult operating environment for TD Banknorth in the United States, Kersting said.

TD owns 57 percent of Portland, Maine-based Banknorth, and plans to buy out minority shareholders for US$3.2 billion.

For the full year, TD's net income was C$4.60 billion, or C$6.34 a share, more than double its 2005 profit of C$2.23 billion, or C$3.20 a share. Earnings rose a more modest 18 percent on an adjusted basis.

In the fourth quarter, TD said total revenue was C$3.29 billion, up from C$3.08 billion.

Not surprisingly, TD's quarterly provision for credit losses rose from very low levels. Provisions were C$170 million, compared with a C$15 million reversal a year earlier.

UBS analyst Jason Bilodeau said TD's fourth quarter reflected "very solid trends" in its core domestic personal and commercial lines, including market-share gains in personal deposits, small business loans and other products.

TD said profit in its Canadian personal and commercial banking unit rose 13 percent to C$501 million in the last three months of 2006. Net income in U.S. personal and commercial banking fell 9 percent to C$63 million, primarily due to lower net interest income and a stronger Canadian dollar versus the greenback.

Wholesale banking profit more than tripled to C$146 million in the latest quarter, thanks to strong investment banking revenues and securities gains, TD said.

Profit in wealth management, which includes its 39.8 percent stake in TD Ameritrade , was C$148 million, up 9 percent.
RBC Capital, 8 December 2006

First Impression

• TD Met Consensus. TD reported $1.20 adjusted cash EPS (excludes 4¢ in items), in line with the Thomson First Call mean estimate, indicating a 13% increase YoY. This result demonstrated continued retail revenue and operating leverage momentum, but this time the bank ‘earned through’ higher impaired loans and losses.

• Retail (77% of Earnings) - Revenue Strong But Loan Losses Rise. Domestic retail revenue grew 13% YoY, which combined with 10% higher expenses to power +3% operating leverage and 13% earnings growth to $501MM (our estimate was $525MM). Most of the difference was a high loan loss at 0.41% of L&A. Expenses were also a bit higher than expected related to new growth initiatives and technology streamlining costs. In our view, these are costs of growth and TD is earning through those costs. Market share in personal deposits and most loan categories remained in an upward track. The Wealth contribution was $5MM (5%) below our estimate and the Banknorth and Ameritrade results were as pre-reported.

• Credit Topical This Quarter. Retail impaired loans (IL’s) jumped 39%, and commercial IL’s tripled, but most is owing to a stated change in methodology (i.e., not fundamental). Cards and overdraft loans are now to be recognized at 90 days, rather than just written off at 180 days. This also relates to the $28MM ‘one-time’ retail reserve set-up, all to conform to audit and Basel standards. Underlying retail credit development looks moderate in light of this adjustment. Also, of significant comfort is that TD’s excess reserve coverage at 320% remains double the industry standard.

• Wholesale (23% of Total) – Not Stellar. Cash earnings of $146MM were 3% below our estimate of $150MM. It looks like a low tax rate helped offset very low trading revenue. Loan losses of $13MM were level and not a factor. Variability is high, so we are inherently conservative.

• No Dividend Hike, But Payout May Be Under Review. TD did not raise its dividend (just did so last quarter), nonetheless, with the recent decision to take Banknorth private and presumably to suspend large acquisitions, we thought management might look at (i) raising the payout, and (ii) increasing share buybacks (TD just repurchased 2.5MM shares).