29 June 2007

TD Banknorth Investor Day

Scotia Capital, 29 June 2007


• TD Banknorth's new management team presented to investors in Toronto, June 28 highlighting the "Actions" that are being undertaken to grow the franchise and improve financial performance.

• Mr. Clark, CEO of TD emphasized three points: "New Management Team That Can Execute", "Bank is Taking Action Now" and "Confident They Can Deliver in Existing Environment".

What It Means

• The major strategic shift at TDBN is the focus on organic growth rather than M&A. TDBN will only make acquisitions if pricing shifts or an exceptional opportunity presents itself.

• We believe the shareholder dilution from the TDBN purchase is fully priced into TD's stock and that TD is taking "Concrete Action" to reverse the fortunes of this acquisition.

• If TD can use its best in class retail banking expertise at TDBN we would expect the acquisition to create shareholder value for TD in the long term and overcome the shareholder dilution that has occurred in the bank over the last two years.

TD Banknorth Dilutes Shareholder Value to Date

• TD Bank's acquisition of Banknorth has not gone well since it acquired a majority stake (51%) in March 2005. This is due to a number of factors including price, timing, yield curve shift, competition, appreciation in C$ and decline in M&A opportunities which was BNK's key competency and main driver of growth. TD bought in the remaining 41% minority stake of Banknorth/TD Banknorth in April 2007.

• TD's original purchase of Banknorth was at US$40.00 per share (C$/US$ exchange rate at 1.18) with the share price declining 25% to US$30.00 per share by November 2006 prior to the privatization announcement. TD privatized TD Banknorth buying in the 41% minority interest at US$32.33, closing April 2007. We estimate the acquisition of TDBN to date has impaired shareholder value by approximately $2.6 billion or $3.60 per TD share excluding the opportunity cost on the appreciation of TD shares since the original purchase in March 2005. TD issued 44.3 million shares on original purchase at $44.89 per share totalling $2 billion. These shares now have a value of $3.2 billion, appreciating $1.2 billion for net impairment of $3.8 billion or $5.30 per TD share.

• TDBN's financial performance has been extremely disappointing with a lack of earnings growth from the US$300 to US$350 million levels achieved in 2002 - 2003 which is essentially unchanged from recent earnings run rates in the US$300 million range.

• TDBN expects to exceed $500 million in 2008 and to achieve a long term earnings growth rate of 7% - 10% in line with TD objectives. TDBN achieving $500 million would add a $0.15 per share to TD 2008 earnings which would represent an estimated $2.00 to TD's share price. In addition, we expect an overall multiple bump as the operating/earnings risk at TDBN declines.

TD Banknorth Underperformance Fully Priced In

• We believe the shareholder dilution from the TDBN purchase is fully priced into TD stock and that TD is taking "Concrete Action" to reverse the fortunes of this acquisition.

TD Takes Action to Improve TD Banknorth Performance

• The key question is can TD Bank add value to the TD Banknorth franchise. If TD can use its best in class retail banking expertise at TDBN we would expect the acquisition to create shareholder value for TD in the long term and overcome the shareholder dilution that has occurred in the bank over the last two years.

• TDBN's new management team presented to investors in Toronto, June 28 highlighting the "Actions" that are being undertaken to grow the franchise and improve financial performance.

• Mr. Clark, CEO of TD emphasized three points: "New Management Team That Can Execute", "Bank is Taking Action Now" and "Confident They Can Deliver in Existing Environment".

Strategic Shift to Organic Growth

• The major strategic shift at TDBN is the focus on organic growth rather than M&A. TDBN will only make acquisitions if pricing shifts or an exceptional opportunity presents itself.

• TDBN plans to drive earnings and growth by increasing market share in retail, small business and wealth management where the bank doesn't have its natural market share. The bank expects to enhance its retail platform by optimizing its branch network, building its brand and improving pricing, processes and products. The bank intends to maintain its strong commercial banking franchise and further leverage its capabilities in terms of large transactions.

• The bank also plans to increase its small business loan penetration to 9.3% in line with commercial banking market share versus its current underrepresented 3.4% market share. The bank also has four growth businesses; wealth, insurance, credit cards and TD Bank USA.

Optimizing Branch Network

• TD Banknorth has undertaken certain initiatives to optimize its current branch network such as upgrading branches, relocating branches and adopting longer branch hours. Before branch hours were extended, TD Banknorth's average branch hours of 46.1 lagged the market average of 49.7 hours. Currently, TD Banknorth's average branch hours are 54.0, significantly above the market average.

Bringing Brand to Life - Brand Awareness

• TD Banknorth has also begun advertising and has improved its signage to increase brand awareness. TD Banknorth currently has the #1 brand awareness in New England and in the Mid-Atlantic brand awareness has doubled to 28% from 14% in one year.

Pricing, Process & Product

• TD Banknorth has also made efforts to closely monitor pricing which is generally more varied in the U.S., as well as streamline processes and close product gaps. For example, TD Banknorth introduced a high savings account, is taking steps towards instant issue debit cards and is planning to launch a line of credit cards.


• Our 2007 and 2008 earnings estimates remain unchanged at $5.45 per share and $6.00 per share, respectively, however, TD Banknorth earnings are expected to be much more supportive in achieving or exceeding our 2008 earnings estimates for TD.

• We reiterate our 1-Sector Outperform rating on shares of TD based on strong earnings momentum, expected P/E multiple bump with lower risk from TD Banknorth.
Financial Post, David Pett, 29 June 2007

TD Bank is cleaning house at it's TD Banknorth operations south of the border in an attempt to increase profitability at the division and improve sentiment regarding the bank's overall U.S. retail strategy.

On Thursday, the bank held an investor day in Toronto to discuss several initiatives it has put in place at Banknorth in order to deliver on its promise to achieve at least $500-million in earnings for 2008.

If successful, that would result in an increase of 43% versus the $349-million in earnings that RBC analyst Andre-Philippe Hardy expects in 2007.

"Part of the growth is due to increased ownership, part due to expense reductions," Mr. Hardy told clients, saying he expects Banknorth to account for 10% of the bank's total earnings in 2008.

Notably, the bank has reduced its workforce by 13% in the last year and closed a number of underperforming branches, which has accounted for $80-million in expense savings, the analyst wrote.

The company has also been opening new branches, refurbishing old ones, extending opening hours and introducing new products, including a new credit card line that is expected in the fall.

Employee compensation has also been revamped to better align individual performance with incentives.

That said, Mr. Hardy said there are still challenges ahead for the Banknorth division including the deterioration of its real estate construction portfolio and tight margins regarding its commercial loans portfolio.

He maintained his outperform rating on the stock and left his $82 price target unchanged.

UBS analyst Jason Bilodeau believes TD's earnings goals for Banknorth are certainly achievable, saying the division will benefit from the bank's commitment to export TD Canada Trust's superior customer service and sales culture stateside.

As well, he said Banknorth is benefiting from TD's capabilities in a number of other areas including marketing, risk management, product design and treasury function.

But despite his increasing optimism, Mr. Bilodeau left his "buy" rating and $85 price target for the stock unchanged.

"Given the challenges to date, and the persistently difficult operating environment, we are holding our conservative view and our model continues to incorporate relatively modest estimates coming out of the US retail operations (i.e. below managment's $500-million target)."
Bloomberg, Sean B. Pasternak, 28 June 2007

Toronto-Dominion Bank, Canada's third-largest lender, plans to increase deposits at its U.S. consumer bank by about a third, or as much as $10 billion, over five years through extended bank hours and new products.

"We have tremendous opportunities to grow organically in retail, small business and commercial deposits," Bharat Masrani, chief executive officer of the TD Banknorth unit, told investors today in Toronto.

The Toronto-based bank is trying to increase earnings at the U.S. unit by 7 percent to 10 percent a year, after profit declined in six of the last eight quarters because of higher acquisition costs and a decline in lending.

``We are not sitting idly by watching the environment to improve,'' said Masrani, a 20-year Toronto-Dominion veteran who became CEO in March.

In 2006, the Portland, Maine-based bank had $27.4 billion in total average deposits.

Planned changes include increasing average branch hours, adding and renovating new offices, and expanding the number of insurance and asset-management advisers inside the branches.

Banks Can Now Issue Covered Bonds

Financial Post, Barry Critchley, 29 June 2007

The federal financial services regulator, the Office of the Superintendent of Financial Institutions, has given the green light for financial institutions to issue covered bonds, a form of security that has been used in Europe for more than 250 years and is now enjoying a growth in popularity.

At least one big bank is already lining up to hit the market with a massive issue of the attractive securities.

After reviewing the regulatory considerations from financial institutions issuing covered bonds, OSFI "has decided at this time to limit the issuance of covered bonds."

Such bonds are in essence AAA-rated debt obligations issued by a deposit-taking institution and secured by assets, mostly mortgages of the institution or its subsidiaries.

One of the key limits is that covered bonds cannot make up more than 4% of the assets of a deposit-taking institution. Four months ago, OSFI requested financial institutions refrain from issuing covered bonds pending the outcome of its review.

In its decision, OSFI spoke of the benefits and concerns for institutions issuing covered bonds. It was impressed with the funding diversification and lower costs that flow to the issuers. But it was concerned the bonds create "a preferred class of depositors, reducing the residual level of assets available to be used to repay unsecured creditors."

The term "covered" is used because if the financial institution is unable to make interest and capital repayments on the bond, investors have access to the underlying mortgages for repayment.

The OSFI decision means the race is on to see which local financial institution will be the first to issue covered bonds.

It's understood Royal Bank of Canada, the country's largest bank, is gearing up to try and capture a piece of a large, liquid and growing market.

Total global issuance of these bonds is expected to reach ?220-billion ($313.18-billion) this year.

The talk in the market yesterday was that RBC would unveil a ?15-billion ($21.37-billion) program by year-end. In this way, the program is similar to a shelf filing in Canada.

RBC has declined comment.

Sources indicated that if RBC does unveil such a program, it will raise capital via a series of bite-size chunks, likely in the ?2-billion to ?3-billion range.

The bank is believed not to be interested in receiving euros, so it will swap proceeds into dollars. The result is that it will raise capital at an attractive rate, certainly lower than what the institution pays for its capital.

Covered bond issues differ from an offering of collateralized mortgage-backed securities. In those deals, the issuer is a stand-alone entity.

With a covered bond, the bank is the issuer --meaning the financing is "on balance sheet."

In a business dominated by German and Spanish banks, only two U.S. financial institutions, Bank of America and Washington Mutual, have raised capital using these bonds.

28 June 2007

TD Ameritrade May Have Breached Duties, Jana, SAC Say

Bloomberg, Bradley Keoun, 28 June 2007

TD Ameritrade Holding Corp., the third-biggest online broker, was accused by two hedge funds of allowing executives from part-owner Toronto-Dominion Bank to thwart its sale.

Toronto-Dominion Chief Executive Officer Edmund Clark has played a ``significant role'' in merger discussions and is an ``impediment'' to a deal, Jana Partners LLC and SAC Capital Advisors LLC said today in a letter to Omaha, Nebraska-based TD Ameritrade. The funds, which are pressuring the company to merge with a rival, demanded access to boardroom minutes and other records related to any merger talks.

The records are needed ``to investigate whether any members of the board have breached their respective fiduciary duties,'' said the funds, which represent a combined 8.4 percent stake in TD Ameritrade. Toronto-Dominion is TD Ameritrade's largest shareholder, with a 40 percent stake, and has five of 12 seats on the company's board.

Jana and SAC have said a merger with Charles Schwab Corp., the biggest discount brokerage, or No. 4 E*Trade Financial Corp. may lead to as much as $800 million in annual benefits. A deal hasn't taken place partly because Toronto-Dominion wants to preserve the benefits of its ownership stake, including U.S. advertising that carries the initials ``TD,'' and favored access to the brokerage's banking business, the funds say.

``We've received the letter and we're reviewing it,'' said TD Ameritrade spokeswoman Katrina Becker.

Clark, speaking to reporters today after a company-hosted meeting for investors in Toronto, said he didn't want to respond to "people making up allegations that have no basis in fact.''

"This is a game that they play,'' Clark, 59, said. "If you knew all the facts, the TD Ameritrade board is managing the situation to impeccable standards.''

Jana, headed by Managing Partner Barry Rosenstein, and SAC, led by CEO Steven Cohen, said they made the records request based on corporate law in Delaware, where TD Ameritrade is incorporated. The funds may ask a court to order the disclosures if the company doesn't respond within five days.

Larry Hamermesh, a professor at Widener University School of Law in Wilmington, said the funds may be using the request as a pressuring tactic. The court is unlikely to side with them without more serious allegations of misdeeds, he said.

TD Ameritrade said earlier this month it was willing to engage in talks with merger partners. Toronto-Dominion representatives also said their interests are aligned with those of other shareholders.

TD Ameritrade's shares rose 3.8 percent on June 6, the day after the hedge funds' stake was disclosed. The stock fell 5 cents to $20.09 in 4 p.m. composite trading on the Nasdaq Stock Market.

BMO Capital Markets Aims to Double US Revenue in 5 Years

Bloomberg, Doug Alexander, 28 June 2007

BMO Capital Markets, the investment banking unit of Bank of Montreal, plans to double its U.S. revenue in five years by hiring more investment bankers to boost advisory fees from mergers.

Canada's fourth-largest bank by assets has hired 13 senior investment bankers in the U.S. since November, David Casper, co-head of U.S. investment and corporate banking, said today in an interview. The bank may also add an advisory business in the U.S. to help financially troubled companies restructure.

``We continue to be excited about that opportunity as the cycle in business turns,'' said Casper. ``We think now is probably a good time to be looking at it.''

The firm's investment banking activities in advisory, leveraged finance, equity and debt capital markets are increasing revenue by "double digits," Casper said. The Toronto-based bank is focusing most of its U.S. business on companies with a market value of $50 million to $2 billion, he said.

"We view this to be a very, very high return business for the firm," Casper said.

The U.S. accounted for 40 percent of the C$860 million in profit last year at BMO Capital Markets, and 47 percent of its C$2.78 billion in revenue.

BMO Capital Markets may hire more investment bankers in the U.S., Casper said. The latest hire was Paul Hawkinson, 36, who joined from Bank of America on June 26. Hawkinson is based in Chicago and heads the bank's commercial and industrial group.

Banks & Insurance Companies Should Be Allowed to Merge: CD Howe

The Globe and Mail, Tara Perkins, 28 June 2007

The government urgently needs to reform the regulations governing banks and insurers in this country, says a new report released by the C.D. Howe Institute.

It calls for Ottawa to allow mergers among banks, as well as between banks and insurers, while also making it easier for foreign financial institutions to enter the Canadian market.

“Even if the two largest Canadian banks were to merge they would barely break into the list of the 25 largest banks” in the world, says the report, written by two university economics professors. “Moreover, their merged size would still put them at roughly half the size of the 10th largest bank in the world.”

Observers are unanimous in the belief that the current minority government will not take on the thorny issue of bank mergers. But this report adds another voice to the number of people who have spoken out recently in favour of regulatory reform. Last month, former progressive conservative prime minister Brian Mulroney said the banks should be allowed to merge. This month, IMF chief Rodrigo de Rato said the same thing.

The business of banking is increasingly global, but Canada's banks are at risk of missing the boat, suggested the C.D. Howe report.

None of the Canadian banks seems to be big enough to seriously compete with European-based global banks, or the top banks in the United States, when it comes to nabbing cross-border business from multinational corporations, the report said.

“A further casual comparison of size suggests that the largest Canadian banks are comparable in size to large regional American bank holding companies, and are roughly only half the size of U.S. banks that are internationally active,” it added.

The report sought to refute the idea that bank mergers would lead to fewer branches and less service for Canadian consumers.

“Even if the number of branches declined as the result of a merger, the social costs of such a decline seems overstated,” it said. The big banks decreased the number of branches they had in recent years as a result of new competition from players such as President's Choice Financial and Canadian Tire Bank that have little reliance on branches, it said.

“Moreover, a reduction of bank branches by large banks following a merger would likely be followed by an expansion of branches by smaller institutions.”

New competition could also come from foreign banks, it said. Currently, there is only one major foreign-owned bank (HSBC Bank Canada) that is actively building a significant network of retail branches, it said. And ownership rules prevent foreign banks from gobbling up the big domestic players.

Right now, the six biggest banks in Canada hold about 90 per cent of the total assets held by all chartered banks, it said.

The level of concentration is much higher than in most countries, although there are a few others with five or fewer dominant banks, such as Australia, Netherlands and Switzerland, it said.

“After domestic consolidation we expect that only some of the remaining banks will be truly internationally operating banks, with the remaining banks focused on serving mainly domestic markets,” it added.

The immediate challenge facing Canadian policy makers now is to put forward clear and transparent merger guidelines, it said.

“While the banks are in the best position to evaluate their own business strategies, they are poorly situation to judge what banking arrangement would be best for society,” it said.

“A government move to provide clear guidelines on the merger process and conditions combined with a decision to delegate the evaluation of proposed mergers to the Competition Bureau and OSFI would depoliticize the merger process and put in place the foundation for financial consolidation that could strengthen the financial sector in Canada,” concluded the report, which was written by Thorsten Koeppl, assistant professor in Queen's University's department of economics and James MacGee, assistant professor at The University of Western Ontario's economics department.

27 June 2007

Analysts' Comments on Effect of C$/U$ & Interest Rates on Banks

Financial Post, Jonathan Ratner, 27 June 2007

Given the Bank of Canada’s indication that it feels both inflation and economic growth have been stronger than expected, Citigroup analyst Shannon Cowherd thinks the bank will likely raise interest rates by 25 basis points eventually.
Its next interest rate decision is on July 10, while the key rate is currently 4.25%.

Higher short-term rates would likely hurt CIBC the most given the bank’s high leverage to domestic net interest income, she said in a research note.

In terms of the rising Canadian dollar relative to the U.S. greenback, she said Bank of Montreal and Royal Bank of Canada are most exposed given their U.S. operations.

The fall-out from sub-prime lending in the U.S. meanwhile, will also have some impact on Canadian players, although they have virtually no domestic exposure to non-prime residential lending, she added. However, the asset securitization market does present some U.S. exposure for Royal, BMO and CIBC, and is expected to impact them in upcoming results.

Ms. Cowherd reiterated her “buy” ratings on CIBC, BMO and Bank of Nova Scotia, while her estimates fall slightly below consensus due to expectations of higher provisions for credit losses in the second half of 2007.
Financial Post, Duncan Mavin, 27 June 2007

Bank of Nova Scotia’s international expansion makes it the Canadian bank with a plan when it comes to spending all that excess cash the banks are generating these days.

But having a high proportion of top line growth coming from overseas operations can also be a drag when the Canadian dollar is riding high.

“The rapid increase in the Canadian dollar, up 10.5% since February 7, 2007 is most negative for Scotiabank amongst the banks,” says RBC Capital Markets analyst Andre-Philippe Hardy. “About 45% of the bank’s income comes from outside of Canada, with the net highest bank at approximately 30%.”

Mr. Hardy also points out that Scotiabank’s Mexican unit, a key part of its international operations, could struggle to match high earnings expectations because of rising loan losses, the expiration of historical tax loss carry forwards, and rising costs associated with branch network expansion.

The RBC analyst has a 12-month target price of $57 for Scotiabank, with a “sector perform” rating. But that doesn’t make Scotia his least favourite bank stock.

Bank of Montreal, as well as National Bank, both get “underperform” ratings from Mr. Hardy.

“It is overly simplistic to suggest that BMO’s stock will outperform its peers solely based on having underperformed in recent years,” he says.

Among the reasons why Mr. Hardy doesn’t favour BMO: revenue growth will continue to struggle while cost-cutting measures are taking place; the bank can no longer justify being labeled Canada’s least risky bank; and with bank mergers unlikely in the near term “buying the bank’s stock in the hopes that it gets taken out is premature.

He has a $71 price target for the stock.

RBC Bulks Up for Infrastructure Boom

The Globe and Mail, Tara Perkins & Lori McLeod, 27 June 2007

The Royal Bank of Canada is pouring resources into bulking up its global infrastructure business in the belief that the private sector is embarking on a buying binge of assets such as roads and prisons, especially in the United States.

RBC has been putting dozens of investment bankers into its M&A advising and financing team, whose ranks have swollen towards 80. It's now contemplating a push into directly investing in the booming sector.

The moves have vaulted the bank into an arena where it's going head to head with global heavyweights such as Goldman Sachs Group Inc., the Royal Bank of Scotland Group PLC and France's BNP Paribas SA to advise on and fund deals.

The team of bankers that RBC has built up to help other organizations buy and sell infrastructure assets is housed in offices stretching from Sydney to Madrid, with U.S. bases in Massachusetts, New York, Florida and California. The bank rakes in fees from dispensing advice to buyers and sellers, or raising financing for the deals.

The team's revenue has been growing by about 50 per cent each year for the past three years, the bank said, although it won't disclose numbers.

It believes it is one of the top five contenders in this arena around the world.

Since the start of November it has closed about 30 deals, and is working on 50 more.

As RBC continues to aggressively bulk up on expertise, it is also considering becoming an equity investor in infrastructure assets. "This is an area we are looking at," said spokesperson Katherine Gay.

That could mean going head to head with - or partnering up with - buyers in the market including Canada's biggest pension funds, which are recognized as top deal makers in the infrastructure arena.

Multibillion-dollar funds like Ontario Teachers Pension Plan, the Canada Pension Plan Investment Board, the Ontario Municipal Employees Retirement Board and the Caisse de dépôt et placement du Québec have snapped up assets including airports, water and power utilities, and toll roads.

In 2005, the City of Chicago kicked off what many expect to be a wave of government sales or leases of infrastructure assets in the U.S. by taking $1.8-billion (U.S.) for a 99-year operating lease on the Chicago Skyway. Some observers say that tens of billions of dollars worth of road deals are on the way in the U.S., as governments turn to the private sector to fund construction or refurbishment of essential services, and that could mean hundreds of millions of fees for bankers.

"The U.S. has been [in] a bit of a rush over the last 18 months," Adrian Bell, the head of RBC's infrastructure team, said in an interview from London.

The country has been underinvesting in its infrastructure for the last five to 10 years and "there is therefore a huge forward capital investment program needed to play catch-up on that," he said.

For instance, road systems haven't been expanded even though car travel is going up.

"In our view, we are going to see an increasing number of, first, roads and then municipal car parks, and we suspect airports as well," Mr. Bell said. "That's because there's a $1-trillion catch-up program over the next 10 years that has to be spent on infrastructure, and frankly the states have not got capital to spare to fund all of that."

Around the world, the total value of infrastructure deals this year has already hit $237.6-billion, compared with $294.2-billion for all of 2006, according to Thomson Financial.

And three of the ten largest proposed M&A deals by dollar value in the world this year involve infrastructure assets, according to Bloomberg, including the $67.5-billion acquisition of Spanish power utility Endesa SA to the $43.2-billion deal for U.S. power utility TXU Corp.

The competition has noticed that RBC's team is getting bigger. Roland Davis, the head of European infrastructure for CIBC World Markets Inc., said "I watch RBC with interest because it's absolutely right that they have grown very fast."

Most of the big Canadian banks are now also putting more resources into their infrastructure teams, though not to the same degree as RBC.

The Canadian banks were a bit slow off the mark when it comes to cashing in on the global infrastructure boom, some observers say. On the financing side, that may be because, on its face, it doesn't appear to be all that lucrative. "They've all been very slow to get it, and so have the American banks," Mr. Davis said.

"And the reason is that infrastructure finance, the debt structures, just don't fit with the way that the North American style of banking works. They're low-margin, low-risk, very long-term," he said. "And the credit community of North American institutions, including RBC, including CIBC, including I think any other bank there, they just have never liked that sort of thing."

But it's not an area they can afford to ignore, Mr. Davis suggested. "In my view, it's a completely new sector of the finance economy. And, in years to come, there will be bonds, there will be equities and there will be infrastructure, and people will wonder how it was that infrastructure didn't used to exist."
RBC's infrastructure strategy

The Game

Infrastructure encompasses public services such as ports, roads, airports, prisons, hospitals, schools and utilities. The definition is expanding rapidly to include areas like water and waste, and some eager investment bankers have been pitching deals for assets ranging from telecom companies to lotteries as "infrastructure" to capitalize on the term's hype.

The History

Britain delved into "private finance initiatives" (known in Canada as "public private partnerships") 15 years ago. Canada got into the game about a decade ago, beginning with airports. The U.S. only caught up with the trend with the $1.8-billion (U.S.) long-term lease of the Chicago Skyway, a deal that closed in 2005. That was followed up by a $3.8-billion 75-year lease of the Indiana Toll Road in 2006. Observers say Asia and South America could both be on the verge of massive infrastructure investments in the years ahead.

The Investors

Canada's pension funds have been pouring money into global infrastructure deals, and are recognized as major players in the space. Top deal makers include Teachers, CPP, OMERS and the Caisse. These multibillion-dollar pension funds have snapped up assets including airports, water and power utilities and toll roads. Another big player is Brookfield Asset Management Inc., whose more than $70-billion (U.S.) in assets under management include Chilean power lines and stations. Observers say that, increasingly, it's the European and Australian infrastructure funds and construction companies that are driving the process in North America. Australia's Macquarie Infrastructure Group is recognized as being a leader when it comes to road investments. "The problem with the U.S. for a lot of people is that Macquarie is very dominant in roads, and a lot of the U.S. work is going to be roads, and I think it scares people a bit," said CIBC's Roland Davis. "At the moment, I think a lot of people take the view that if Macquarie is bidding for a project, you just won't bid against them, because the only way you could beat them is if you're doing something stupid."

26 June 2007

Banks' Valuation Imply a 21% Earnings Decline or 10-year Bond Yield of 5.8% to 6.5%

Scotia Capital, 26 June 2007


• Bank earnings have been extremely strong in the first half of 2007, significantly better than expectations. Earnings growth in the second quarter was high at 17%, although down from the first quarter blockbuster with 24% growth.

What It Means

• One of the keys to the bank earnings growth picture has been the acceleration in risk-weighted assets and revenue growth, as the banks have stopped delevering for the first time since the early 1980s. Bank revenue growth was 10% in the first half of 2007, one of the highest levels in the past five years. Bank profitability has soared to new heights with an ROE of 24% in Q1 and 22% in Q2.

• Bank share price performance has been muted, in our view, due to a backup in bond yields, concerns about higher short-term rates, and appreciation of the CAD, as well as liquidity offered by bank stocks. In addition, bank shares are in their seasonally weak performance period.

• The market, we believe, is very aggressively discounting bank earnings.

• Reiterate overweight recommendation on the bank group based on attractive valuation and strong fundamentals.

Banks Second Quarter Overview : Earnings Growth 17%, ROE 22%

• Bank earnings have been extremely strong in the first half of 2007, significantly better than expectations. Earnings growth in the second quarter was high at 17%, although down from the first quarter blockbuster with 24% growth.

• Earnings growth and resilience has surpassed market expectations for the past three years. We are forecasting earnings growth in 2007 of over 14%, which would represent the fifth straight year of 14%-plus earnings growth for the bank group and has never been achieved before in history. One of the keys to the bank earnings growth picture has been the acceleration in risk-weighted assets and revenue growth, as the banks have stopped delevering for the first time since the early 1980s. Bank revenue growth was 10% in the first half of 2007, one of the highest levels in the past five years. Bank profitability has soared to new heights with an ROE of 24% in Q1 and 22% in Q2.

• Despite the earnings performance bank share prices are unchanged year-to-date versus a market gain of 8% (assisted by M&A activity). Bank share price performance has been muted, in our view, due to a backup in bond yields, concerns about higher short-term rates, and appreciation of the CAD, as well as liquidity offered by bank stocks. In addition, bank shares are in their seasonally weak performance period. The bank group’s trailing P/E multiple has declined to 13.6x from the 14.5x range earlier in the year due to earnings growth. This pattern is similar to that of last year when bank P/E multiples drifted to a low of 13.0x in June 2006 from the February 2006 peak of 15.1x. If we use 13.0x as support, bank stock downside risk is very modest from these levels at 3%.

Bank valuation is implying a 21% decline in bank earnings or a 10-year bond yield of 5.8%-6.5%, or combination of both. The implied bond yield is substantially above the current 10-year bond yield of 4.65%.

• We have stress-tested bank earnings for a recession and believe earnings would decline approximately 8% with ROE levels expected to trough above the mid-teens. The market, we believe, is very aggressively discounting bank earnings.

• Bank earnings strength in the second quarter has been derived from all business lines, with wholesale earnings exceeding expectations the most and wealth management and retail remaining extremely robust. In the cases of Toronto-Dominion Bank (TD) and Royal Bank (RY), wholesale earnings growth was the determining factor between a positive earnings surprise and disappointing earnings. Both RY and TD had strong earnings growth from their respective retail and wealth management platforms. However, TD reported impressive wholesale earnings growth of 55% while RY’s wholesale earnings declined 15% from a year earlier.

• Credit quality remains at very high levels, although loan loss provisions are increasing modestly and impaired loans are also rising slightly. Bank of Montreal (BMO) had extremely low levels of loan loss provisions this quarter at 8 bp and 14 bp, respectively. Canadian Imperial Bank (CM) and TD continue to have higher levels of loan losses at 47 bp and 39 bp, respectively.

• The rapidly appreciating CAD and possible short-term rate hikes are causing some investor concerns about the negative impact on earnings. If the CAD were to remain at the current level of $0.935 against the USD, we estimate bank earnings in 2007 would be negatively impacted by 1.1%, with 2008 earnings estimates negatively impacted by 2.0%. The individual bank’s impact varies, with National Bank (NA) being impacted the least.

• The bank group’s strong earnings and profitability is being translated into consistent and frequent dividend increases. Banks have increased their dividends by 211% since the beginning of 2000. NA raised dividends this quarter by 7%. This follows dividend increases by the remaining major banks in the range of 5% to 15% in the previous quarter. Bank dividend payout ratio is 43% based on our 2007 earnings estimate, in the low end of the target ranges.

• Bank valuations are extremely compelling on both a yield and P/E multiple basis. Bank valuations on a yield basis relative to bonds, pipes and utilities, income trusts, and the S&P/TSX Composite are all in the strong buy range, with reversion to the mean suggesting an increase in the bank index of 52%, 30%, 28%, and 44%, respectively.

• Bank dividend yields have increased to 3.4% or 72% relative to the 10-year bond yield, which is 2.1 standard deviations above the mean (Exhibit 26). Reversion to the mean would imply a 6.4% bond yield or a 37% increase in the bank index. Bank valuations are extremely attractive with a P/E multiple of 12.9x our 2007 earnings estimate and 11.6x our 2008 earnings estimates.

• We reiterate 1-Sector Outperform ratings on TD and RY.

• TD had particularly strong earnings in the second quarter (leading earnings momentum), driven by TDCT and Wealth Management and impressive earnings growth from wholesale banking. Wholesale banking was the main source of TD’s positive earnings surprise this quarter with earnings growth of 55%. TD’s valuation relative to the bank group is attractive given the strength of TDCT’s operating platform and the decline in earnings risk at TD Banknorth. We expect strong relative share price performance.

• RY, despite a relatively weak quarter, reported 24% ROE with both retail and wealth management earnings growth of 20% plus. RY has no meaningful P/E premium despite higher profitability and strength of its higher P/E retail and wealth management businesses.

• We maintain 2-Sector Perform ratings on Laurentian Bank (LB), Canadian Western Bank (CWB), and CM, with 3-Sector Underperform ratings on BMO and NA. We have no sell recommendations on an absolute return basis.

• Our 12-month bank index target is 30,700 for a total expected return of 29%. Our target is based on a forecast P/E of 16.2x our 2007 earnings estimate or 14.6x our 2008 earnings estimate.

• Our 12-month share price targets on BMO, CM, NA, RY, TD, LB, and CWB are $80, $115, $75, $75, $90, $39, and $30, respectively.

• Reiterate overweight recommendation on the bank group, based on record profitability and capital levels, low financial and earnings leverage to credit, diversified revenue mix, reasonable earnings growth outlook, low earnings volatility, ability to increase dividends, and attractive valuation, including extremely high dividend yields, low P/E multiples, and low relative risk.

Second Quarter Earnings Highlights

Dividend Increases : BNS, NA

• NA increased dividends this quarter as expected by 11%. NA indicated that it intends to review its dividend more frequently, every quarter as opposed to every other quarter, in order to remain within its targeted payout ratio of 40%-50%. NA’s dividend of $2.40 per share represents a 42.5% payout ratio on our 2007 earnings estimate, the lower end of management’s target range.

TD and BNS : 13% Revenue Growth

• Revenue growth for the bank group was 10% in the second quarter. Four of the six banks had double-digit revenue growth. TD and BNS led the banks with revenue growth of 13%, followed by NA with revenue growth of 11% and RY at 10%. CM’s revenue growth was 9%; however, excluding First Caribbean growth was modest at 3.2%. BMO was the outlier this quarter with relatively weak revenue growth of 3% primarily due to commodity trading losses recorded this quarter.

Retail and Wealth Management

• Domestic retail and wealth management earnings were strong, increasing 20% year over year, but declined 5% sequentially (due to fewer number of days). CM led retail earnings growth at 24.9% (14% excluding First Caribbean), primarily due to its recent acquisition of First Caribbean. BNS recorded impressive growth of 23% after five quarters of modest growth. RY earnings increased 21.2%, led by strong retail and wealth management results. BMO and TD also recorded solid earnings growth of 18.2% and 16.6%, respectively. NA earnings growth in retail and wealth management lagged the bank group at 10.1%.

• In terms of personal deposit market share CM is leading the bank group with a 140 bp increase. The remaining four banks all experienced market share declines of 7 bp to 64 bp, with RY at a high of 64 bp and NA at a low of 7 bp.

• CM and NA had solid gains of 58 bp and 29 bp in demand and notice deposit market share, respectively, followed by TD with gains of 14 bp resulting in a leading market share of 25%.

Underlying Retail Margins Stabilize

• Retail net interest margin (NIM) (Exhibit 6, columns 4 and 5) was unchanged from the previous quarter, but declined a modest 3 bp year over year to 2.99%. TD showed strongest margin results with increases of 7 bp YOY and 2 bp from the previous quarter.

Wealth Management Earnings Strong, Led by TD, RY

• Wealth management earnings results were mixed this quarter despite an extremely strong RRSP season. TD and RY experienced high levels of growth in their wealth management businesses, whereas BMO and NA recorded modest growth. TD had 30% growth, the strongest of the bank group, with domestic wealth management earnings increasing an impressive 19%. RY’s newly created wealth management segment recorded solid earnings growth of 21% this quarter. NA and BMO had lacklustre growth of 10% and 4%, respectively.

• Mutual fund assets for the bank group increased 16% to $254 billion after a nearly record breaking RRSP season. RY led growth at 21%, followed by TD at 18%, BNS at 15%, BMO at 14%, NA at 10%, and CM at 9%. RY and TD remain the industry leaders in net long-term asset (LTA) sales including transfers, with impressive market share of 20% and 14%, respectively.

International Divisions - Earnings Growth Modest

• International earnings were lacklustre for the bank group this quarter with growth of 11%, as U.S. operations continue to suffer from the difficult operating environment and net earnings were weaker from Mexico. RY, BMO, and TD reported modest earnings growth of 11%, 6%, and 5%, respectively. RY’s U.S. & International earnings weakened due to the absence of the U.S. Wealth Management business line, which has become a part of the new RY Wealth Management segment. We believe that downside earnings risk at TD Banknorth is low.

Wholesale Banking Earnings Increase 14%

• Wholesale banking earnings varied considerably this quarter, ranging from an increase of 55% at TD to a decline of 15% at RY and a decline of 19% at BMO due to a large commodity trading loss. Wholesale earnings for the bank group increased 14% excluding the impact of BMO’s large commodity trading loss (7% including the commodity trading loss). CM and NA reported strong wholesale earnings growth of 49% and 32%, respectively. BMO (excluding the commodity trading loss) and BNS also had growth of 17% and 15%. RY was the laggard this quarter with a decline in earnings of 15% due to lower trading revenue and lower loan loss recoveries.

• NA continues to have the highest earnings reliance on wholesale banking at 41% of earnings, followed by BMO at 37% (excluding the commodity trading loss), BNS at 32%, RY at 27%, CM at 26%, and TD at 22%.

Trading Revenue

• Trading revenue in Q2/07 was $1,610 million (excluding BMO’s large commodity trading loss of $171 million), an increase of 3% year over year but a decline of 10% from the seasonally high Q1 (excluding BMO’s large commodity trading loss of $509 million). Including the trading loss, trading revenue for the bank group was $1,439 million, an 8% decline from a year earlier. The trading revenue strength indicator excluding the commodity trading loss was 110% versus 103% including the trading loss.

• NA and TD had the strongest trading revenue growth at 61% and 15%, respectively. CM had a modest year-over-year declines in trading revenue of 5%, with RY experiencing the largest decline in trading revenue of 7%. RY’s weakness in trading revenue was due to lower fixed income trading revenue.

Capital Markets Revenue Strength Indicator : 112%

• Capital markets revenue was $2,378 million, a 10% increase year over year. The capital markets revenue strength indicator was at 112%, with BMO, and RY above average at 126%, and 117%, respectively, with TD and CM the weakest at 98% and 104%, respectively.

Market-Sensitive Revenue - NA High Reliance, BNS Low

• Market-sensitive revenue (trading and capital markets revenue) for the bank group represented 20% of total revenue, slightly below the eight-year average of 21%. NA led the group with market-sensitive revenue representing 30% of total revenue, with BNS at the low end representing 17% of total revenue. BMO’s market-sensitive revenue was fairly high at 19% of total revenue (26% excluding commodity trading loss) despite the $171 million commodity trading loss it recorded this quarter. Market-sensitive revenue for CM, RY, and TD represented 19%, 20%, and 21% of total revenue, respectively.

Loan Loss Provisions

• Specific loan loss provisions (LLPs) increased 39% year over year to $677 million but remain extremely low at 27 bp.

• BNS and BMO recorded the lowest LLPs, at 8 bp and 14 bp, respectively. CM and TD had relatively high levels of LLPs at 47 bp and 39 bp, respectively.

• We have reduced our 2007 LLP forecast by a modest $50 million or 2% to $2,500 million or 23 bp of loans due to continued strong credit quality and lower-than-expected LLPs at BNS. Our 2008 LLP estimate remains unchanged at $3,025 million or 27 bp.

Impaired Loan Formations Increase Moderately

• Gross impaired loan formations increased modestly to $1,637 million versus $1,435 million in the previous quarter and $1,320 million a year earlier. Gross impaired loan formations are at extremely low levels, at 16 bp of the bank group’s loan portfolio, for an annualized rate of 66 bp.

• Net impaired loan formations declined slightly to $830 million versus $961 million in the previous quarter but increased from $574 million a year earlier.

Risk-Weighted Asset Growth Continues

• Bank risk-weighted asset (RWA) growth has been accelerating over the past three years from the lows of 2002 and 2003, which saw actual declines in RWA levels. Bank RWA growth in first half of 2007 was 13%, the highest growth since 1996/1997. Market at risk growth was high at 45% in the second quarter. Banks have increased their trading operations, with market at risk being a growth driver in overall bank RWA levels. However, market at risk as a percent of RWA has been relatively stable and is now at 5%, only slightly higher than the 4% range since mid-2003. The leaders in RWA growth have been RY, and BMO. Despite RWA and market at risk growth leverage has not increased meaningfully.

Extremely High Profitability : RRWA : ROE

• The bank group recorded extremely high profitability in Q2 with return on equity (ROE) of 22% and return on risk-weighted assets (RRWA) of 2.09%, near the record highs of Q1/07.

• CM, RY, and BNS led the bank group in ROE at 24.9%, 24.0%, and 23.2%, respectively. BMO was the laggard this quarter with an ROE of 18.3% including the commodity trading loss (ROE of 20.8% excluding commodity trading loss).

• Bank RRWA ranged from a high of 2.72% at TD to a low of 1.57% at BMO, a spread of 115 bp. TD and BMO were the major outliers. The remaining four banks recorded RRWA within a 32 bp range with CM leading at 2.17%, followed by RY with 2.16%, and BNS and NA at 1.99% and 1.85%, respectively.

• 15 June 2007 More Analysts' Remarks on Banks' Q2 2007 Earnings
• 6 June 2007 Review of Banks' Q2 2007 Earnings
• 24 May 2007 BMO
• 1 June 2007 CIBC
• 1 June 2007 National Bank of Canada
• 28 May 2007 RBC
• 30 May 2007 Scotiabank
• 30 May 2007 TD Bank;

23 June 2007

CIBC & Scotiabank in Belize

Financial Post, Duncan Mavin, 23 June 2007

The island of Ambergris Caye is a 30-kilometre-long slither of jungle 75 minutes by boat from Belize City. "La Isla Bonita" -- the island lent this second name to the title of a Madonna hit single -- is a fabulous place to relax with book and cocktail. But at first glance it seems an unlikely arena for two of Canada's big banks -- peddlers of some of the most advanced banking products on the planet -- to battle it out for market share.

First appearances suggest there is not much call for some of retail banking's biggest sellers -- home loans, small loans for cars and household goods, or wealth management products.

For instance, there are only three ways to get around once you are here -- golf cart, bicycle, or flip-flops. A brief network of roads, some paved, some dirt tracks, carve out a dusty checkerboard across the capital, San Pedro, which is the only town on the island. Housing for many of the 15,000 permanent inhabitants is rudimentary, and commerce revolves around a handful of luxury hotels, scuba dive shops, rum punch and tourist trinkets.

Yet tucked between stores selling "Down in Belize" shot glasses and guava ice cream you will find branches of FirstCaribbean Bank -- owned by Canadian Imperial Bank of Commerce -- and Bank of Nova Scotia.

"We see this as a tremendous opportunity for both retail banking and small business and commercial banking," says Pat Minicucci, Scotiabank's senior vice-president for the Caribbean, without a moment's hesitation.

Ambergris Caye represents a realistic growth engine fuelled largely by tourism, says Mr. Minicucci, who was speaking by cellphone from the mainland as he wheeled south on one of Belize's bumpy highways en route to the opening of the bank's tenth branch in the country, in the town of Punta Gorda.

The number of tourists visiting Belize grew by about 20% from 196,000 to 237,000 between 2001 and 2005, the latest year for which the country's tourist ministry has released data.

"We saw that there was a need for us to join hands with the tourism sector here in Belize and its really served us well," says Scotiabank's managing director in Belize, Patrick Andrews.

The San Pedro branch finances small hotels and has about 4,000 deposit accounts, but it also has a thriving line of business servicing foreigners on vacation and some who want to stay longer.

"Especially lately," says Mr. Andrews, "we've seen some Canadians who come down and they find out a bit about Belize and investing here. Slowly they begin to consider investment opportunities in Belize, buying investment properties and so on. The Scotiabank name is very recognizable and they feel comfortable coming to us."

Crazy Canucks, a wooden hut that opens on to the beach a few feet from the ocean, is one of a handful of bars and hotels that sport their Canadian connections with pride. The number of Canadian tourists to Belize is increasing by about 23% a year.

But Scotiabank doesn't have things all its own way. Belize represents a tiny fraction of the Canadian bank's bottom line -- Belizean operations made about $4-million for Scotiabank last year -- but competition to cash in on the growing tourism trade is heating up, says Mr. Andrews.

On Ambergris Caye, for instance, First-Caribbean landed just last year.

"The opening of this bank in our community gives its residents and tourists a choice when it comes to banking," said Mayor Elsa Paz at the opening ceremony of the branch in January, 2006.

FirstCaribbean, which has four branches in Belize, is the bank formed when CIBC and Barclays Bank PLC of the U.K. merged their Caribbean operations in 2002. Last year, CIBC announced it was buying out Barclays and has raised its stake in First-Caribbean to 91.5% from 49.5% for a total cost of $1.1-billion.

The Caribbean bank contributed about $38-million to CIBC's second-quarter results. Some analysts believe CIBC is on the prowl for other banks in the region to expand its operations there. Caribbean-based media reports persist that the Canadian bank is a possible bidder for Royal Bank of Trinidad and Tobago.

Back in Belize, Mr. Andrews says the best way to deal with the competition is to offer better customer service. At the San Pedro branch -- he flies in to visit at least once a month -- the Scotiabank chief oversaw a recent expansion of the branch's hours, including opening on Saturdays.

"In Belize there are four or five banks including ourselves," Mr. Andrews says. "The largest bank is Belize Bank which way back when was once the Royal Bank of Canada. We are always competing for market share. At Scotiabank we have about 23% of market share after Belize Bank but we are closing in quite nicely."

22 June 2007

Blackmont Capital Comments on RBC's Insurance Operations

Financial Post, Jonathan Ratner, 22 June 2007

After a luncheon hosted by Blackmont Capital, where Royal Bank of Canada’s head of domestic banking and global insurance, Jim Westlake, spoke about the importance of scale in achieving growth and profitability in Canada’s property and casualty insurance market, analyst Brad Smith continues to be optimistic about RBC’s prospects.

Mr. Westlake highlighted how RBC’s diversified insurance offerings have created cross-selling opportunities and growth, Mr. Smith told clients in a note.

Due to his expectations for growth in core domestic property and casualty banking, Mr. Smith thinks other domestic banks will continue to grow more interested in insurance.

RBC’s “formidable scale, distribution and brand will lead to strong future profit growth,” he said, reiterating his “buy” recommendation and $65 price target.

CIBC Denied Speculation of U$2.6 Billion Subprime Exposure

The Globe and Mail, Tara Perkins, 22 June 2007

Canadian Imperial Bank of Commerce denied speculation yesterday that it might have significant exposure to the U.S. subprime mortgage market.

An American newsletter making the rounds on Bay Street speculated the bank's exposure could be as much as $2.6-billion (U.S.).

"The report is not accurate and makes certain assumptions which are simply not true; therefore it is not a reliable source of information," CIBC spokesperson Stephen Forbes said.

"As we have commented previously, our exposure to the subprime market is indirect through our participation in structured credit transactions. The majority of this exposure is rated Triple-A. Our direct exposure is well below what the report suggests."

Mr. Forbes would not say to what extent the bank is exposed.

On a conference call with analysts three weeks ago, CIBC acknowledged it had bought part of a CDO - a collateralized debt obligation - called Tricadia that's tied to U.S. subprime mortgages.

CDOs like Tricadia are formed when thousands of residential mortgages are pooled together, then sliced and diced into pools of different risk and sold as securities.

Bear Stearns Cos. hedge funds recently posted losses because of bets on CDOs tied to U.S. subprime mortgages.

The latest edition of Grant's Interest Rate Observer, a New York-based financial newsletter, said CIBC put $328.5-million into Tricadia CDO 2006-7 Ltd. Tricadia is technically a CDO of CDOs, or "CDO squared," it said. Its assets consist of slices of other CDOs, and those are rated single-A.

Dan Gertner, an analyst for the newsletter, spoke to researchers who infer "the bank could own five or six structures besides Tricadia," the newsletter said. That was based on conversations they had with dealers, debt rating agencies and others.

A back-of-the-envelope calculation led the newsletter to say the "hypothetical" exposure could be $2.6-billion.

Mr. Gertner said the exposure beyond Tricadia "is speculation at this point."

21 June 2007

Scotiabank Mexico to Co-Finance Homes for Government Workers

Dow Jones Newswires, Anthony Harrup, 21 June 2007

The Mexican unit of the Bank of Nova Scotia, Grupo Scotiabank, signed an agreement Thursday with the State Workers Social Security Institute, or Issste, to co-finance mortgages for government employees.

The program is similar to one implemented by Infonavit, the government-run mortgage fund for private-sector workers, where employees can use funds accumulated in their housing accounts as down payments on home loans.

Ricardo Garcia, head of mortgage lending at Grupo Scotiabank, said in a telephone interview that the bank expects to grant about 2,500 mortgages in the first year under the agreement, which includes two programs.

Under one program, for homes valued up to about $95,000, workers would provide the down payment and a loan from Fovissste, with Scotiabank financing the rest.

A second program has no upper limit, and would include the down payment with the bank financing the rest. Those mortgages could also be for up to 100%, Garcia said, adding that the program opens up greater possibilities for middle- and higher-level government employees to obtain mortgages.

In a joint press release, Issste said that its expects the program will allow its home financing fund Fovissste to grant 30,000 more home loans to workers over the next five years than it would have been able to under its traditional system, where mortgages are allocated by lottery.

Scotiabank is the first to join the co-financing agreement with Issste, which is also open to other banks.

Sun Life Investor Day

Financial Post, Duncan Mavin

Citigroup analyst Colin Devine was largely unimpressed with Sun Life Financial Inc.’s investor day it seems.

“Not a lot of new information,” he says in a note. “The meeting did not yield any basis to change our opinion on [Sun Life’s] relative attractiveness nor did it cause us to change our earnings estimate.”

Mr. Devine left his target price for Sun Life’s stock at $55.

Nevertheless, the analyst did find a spark of interest. “One exception [to the lack of new material] was the news management has found a funding solution for the U.S. life insurance line where surplus strain from new sales has meaningfully been squeezing earnings.”

Sun Life announced it is implementing a new U.S. domestic funding solution, which includes reducing new business strain in the remainder of 2007. Management also said the company is continuing to pursue alternative funding structures.

Sun Life also highlighted the turnaround at money manager MFS Investment Management and its expanding Asian operations. “They remain relatively small contributors,” Mr. Devine.

In the absence of any more exciting news from Sun Life, it will take “a major upward move by Sun U.S. to make the company’s shares attractive,” he added.
Scotia Capital, 21 June 2007


• This note follows our "Investor Day Announcements" note released this morning, and attempts to quantify the EPS impact of two significant announcements, namely the 66% increase in U.S. variable annuity sales in the first five months of 2007 (better than expected) and the U.S. individual insurance funding arrangement (put in place now much faster than expected). We are leaving our numbers unchanged for now.

What It Means

• We expect the funding arrangement could increase 2007 EPS by $0.05 to $0.07 in 2007. We had previously expected it to be fully in place by the end of Q4/F07, not in Q2/F07 as was announced today. The funding arrangement should likely reduce strain by US$20M to US$25M (after tax) for the remainder of 2007, with an additional US$13M to US$16M in the second half of 2007 as the funding arrangement allows for the recovery of the additional strain booked in Q4/F06 and Q1/F07.

• Assuming the pace of U.S. variable annuity sales continues at the clip over the last two months (US$529 million) for the remainder of 2007, with a modest 10% increase in 2008, we would increase our EPS estimates by $0.01 in 2007 and $0.03 in 2008.
RBC Capital, 21 June 2007

Investment Opinion

Highlights from the investor day include: (i) New funding structure for U.S. insurance operations, which should have a positive impact on near-term earnings; (ii) Management's expectations for further expansion in margins at MFS; (iii) Impressive U.S. variable annuity sales growth, up 66% YoY (year-to-date); and (iv) Management's expectation that China and India operations will not be profitable until 2010.

Investment Thesis

Sun Life is currently trading at 12.6x 2007E earnings compared to its 5-year average of 12.1x and the current lifeco median of 13.6. However, Sun Life is highly capitalized, has exposure to large asset management businesses and has a well-positioned domestic group platform. Also, the company would benefit more than banks from rising interest rates, while it would be less impacted by deteriorating credit quality. The discount to Manulife and Great-West is justified, in our view. Sun Life's international platforms are less well established than Manulife's, while earnings quality and medium-term embedded value growth has been weaker. Compared to Great-West, Sun Life is more exposed to deteriorating credit quality and has less upside potential from recent acquisitions. Our 12-month price target remains $57.
Financial Post, Duncan Mavin, 21 June 2007

Sun Life Financial Inc. said yesterday it has approval to sell insurance in booming Shanghai, and revealed its plans for growth in China are focused on cities most Canadians have likely never heard of.

The economic boom in China's mega-cities such as Shanghai, Beijing and Guangzhou has attracted dozens of financial institutions from around the world that have opened up business there.

But a key focus of Sun Life's China strategy is the so-called "tier-two" cities, the 20 to 40 cities that are smaller than the biggest centres but still large by North American terms, said Stephan Rajotte, president of Sun Life's operations in Asia.

The life-insurance market will expand by 70% in the next three years in the cities Sun Life is targeting such as Jinan, Nanjing and Chengdu, according to consultants McKinsey and Co.

There are fewer foreign competitors in those cities, said Mr. Rajotte, who was speaking at Sun Life's annual investor day in Toronto yesterday via video conference from Hong Kong.

Although a handful of big-name Chinese cities attract most attention in the West, there are dozens of others that are growing economically and in size, said Paul Beamish, director of the Asia Management Institute at the University of Western Ontario's Richard Ivey School of Business.

"Most people in this part of the world know very little about the reality of the Chinese market in terms of the number of cities that are quite large," Mr. Beamish said.

"There are three or four cities in Canada with a million people, and maybe a dozen in the U.S. But in China there's a hundred cities that most people don't know about that have a million people in them."

Sun Life operates in China through a joint venture, Sun Life Everbright Life Insurance Co.

Yesterday's announcement that the company has received China Insurance Regulatory Commission preparatory approval for Shanghai is a step toward full approval to begin operations there, which will bring to 14 the number of cities in China in which the joint venture operates. Based on experience in other Chinese cities, Sun Life expects to be able to begin selling insurance in Shanghai by the fourth quarter of 2007, a company spokesman said.

Sun Life also announced yesterday that its gross sales of U.S. variable annuities have exceeded US$1-billion for the first five months of 2007,marking a 66% increase over the same period last year.

Don Stewart, Sun Life chief executive, attributed the higher sales to a new product and better distribution.
The Globe and Mail, Tara Perkins, 21 June 2007

Sun Life Financial Inc. expects that its Canadian operations will be a significantly smaller part of its bottom line in the not-so-distant future.

Just under half of the insurer's profit last year came from its home country. But Sun Life believes it can begin breaking even in India and China by 2010. That growth in Asia, coupled with growth in the U.S., means "you will see the percentage change; it will drop," chief financial officer Rick McKenney said in an interview following the company's investor day yesterday in Toronto.

Sun Life revealed yesterday it received approval last week to start operating in Shanghai. It hopes to begin selling products there in the fourth quarter.

But its strategy in China is to concentrate on so-called "tier 2" cities such as Jinan, Nanjing and Chengdu, where fewer foreign competitors are active, said Stephen Rajotte, president of Sun Life Financial Asia.

Those locations are also more attractive because insurance penetration is currently about 2 per cent of gross domestic product, compared with 4 per cent in the larger cities such as Shanghai, Beijing and Shenzhen.

Sun Life now has approval to operate in 14 cities in China.

Excluding Japan, Asia accounted for about 10 per cent of the world's insurance market in 2005, and that's projected to grow to 23 per cent by 2020. Japan, where the market is already more developed, accounted for 19 per cent of the total world insurance market in 2005. That's expected to fall to 13 per cent by 2020. North America's share is expected to dwindle from 28 per cent to 23 per cent.

Sun Life's Asian operations contributed 5 per cent of the company's bottom line last year, earning $101-million.

The insurer is also hoping that some acquisitions will fuel its growth abroad. "We're continually looking at acquisition opportunities in the U.S. and in other locations as well," Mr. McKenney said.

"We have excess capital, and we'd like to acquire some businesses," he added, noting Asia is another hunting ground.

Sun Life is "a national champion. I think it's important for Canada to have national champions," he added.

The company also said yesterday that its U.S. variable annuity gross sales topped the $1-billion (U.S.) mark in the first five months of this year, an increase of 66 per cent over the same period last year.
Bloomberg, Sean B. Pasternak, 20 June 2007

Sun Life Financial Inc., Canada's third-biggest insurer, plans to expand in Chinese cities such as Nanjing where it says demand for insurance will grow faster than in the biggest cities, Asia President Stephan Rajotte said.

Most of Sun Life's foreign competitors are focusing on places such as Shanghai and Beijing, Rajotte said today at an investor conference in Toronto. Sun Life plans to target the next 20 to 40 largest cities such as Jinan and Nanjing, he said.

``That's where we feel there's the highest growth potential,'' Rajotte said today. ``The middle class is where we're focusing our geographic expansion.''

Life insurance in the so-called ``Tier 2'' cities is expected to grow 70 percent in the next few years, compared with 40 percent in larger municipalities, Rajotte said.

Sun Life also announced today it received approval from the China Insurance Regulatory Commission to operate a life insurance joint venture in Shanghai.

Separately, Sun Life said today that gross sales of variable annuities in the U.S. were at least $1 billion for the first five months of 2007. That's a 66 percent increase from the year- earlier period.

``It really shows the fruition of a strategy we've had in place for some time,'' Chief Financial Officer Richard McKenney said in an interview following the meeting. ``We obviously want to see that momentum continue, but we're happy with the early indications.''

Shares of Toronto-based Sun Life rose 70 cents, or 1.4 percent, to C$49.94 at 4:15 p.m. trading on the Toronto Stock Exchange, the biggest gain in a month.
Reuters, 20 June 2007

Shares of Sun Life Financial Inc. rose as much as 2.5% on Wednesday after Canada's third biggest life insurer announced an expansion into China's richest city as well as sturdy insurance sales in the United States.

Sun Life made the announcements as part of an "investor day" in Toronto, at which company executives also sketched out a tough environment for acquisitions with prices propelled by strong equity markets and a superabundance of available funding worldwide.

"Acquisitions that are out there are difficult. The market is tight," said Chief Financial Officer Rick McKenney.

Sun Life's most recent acquisition was the US$650-million purchase in January of Genworth Financial Inc.'s employee group benefits business. But analysts have speculated that more U.S. buys could be in the offing as the company generates around US$1-billion in free capital each year.

Sun Life has frequently said it is comfortable with acquisitions around the US$500-million to US$700-million range, but McKenney said that was not an upper limit.

"We would do larger acquisitions if they presented themselves," he told Reuters in a telephone interview.

McKenney also told investors that Sun Life's order of priority for its cash was: Grow organically, pay dividends, make acquisitions, and finally, if no acquisitions materialized, return money to shareholders through its share repurchase program.

Earlier, Sun Life said its Chinese joint venture, Sun Life Everbright Life Insurance Co., had received "preparatory approval" from regulators in China to start operations in Shanghai, the country's economic center.

The company, which operates in 14 Chinese cities, said it expects sales from the Shanghai unit to begin in the fourth quarter, subject to approvals.

"China will take a bit of time but it is critical for us to be there," said Stephan Rajotte, president of Sun Life Asia.

Sun Life also announced that its life insurance variable annuity sales in the United States exceeded US$1-billion for the first five months of this year, two-thirds more than in the same period last year.

Succession Planning at Life Insurance Cos

The Globe and Mail, Tara Perkins & Andrew Willis, 21 June 2007

The three tall ships in Canadian insurance, a trio of formidable North American players, are all captained by CEOs cruising through their early 60s. Succession is very much in the air at Great-West Lifeco Inc., Manulife Financial Corp. and Sun Life Financial Inc.

But observers are calling for one or more major takeovers to play out before the hand-offs take place.

Dominic D'Alessandro took the reins at Manulife a dozen years ago and is now 60 years old. Donald Stewart, who has been at the helm of Sun Life since 1998, also turns 61 next year. And, at age 63, Raymond McFeetors is coming up on his 15-year anniversary as chief executive officer of Great-West Life.

Their legacies are assured. Investors have benefited handsomely since these CEOs stepped on the bridge, ahead of demutualization of the Canadian insurance industry in the late 1990s. Manulife and Sun Life successfully navigated going public, and the stormy takeovers that followed.

Mr. McFeetors and Mr. Stewart proved apt domestic consolidators, while Mr. D'Alessandro wins universal respect for vaulting Manulife into the top ranks of U.S. insurers with its $15-billion purchase of John Hancock in 2004.

Mr. Stewart stumbled on the acquisition trail in the U.S. by paying $2.6-billion for Keyport Life Insurance back in 2001, as the U.S. annuity business did not produce strong profits. The $7-billion purchase of domestic rival Clarica in 2002 provided better results.

As for Mr. McFeetors, who has homes in both Winnipeg and London, Ont., the final verdict on his recent $4.6-billion gamble for troubled mutual fund manager Putnam Investments Trust is not yet out, but the white knight purchases of Canada Life and London Life were winners.

Before the next batch of CEOs takes the bridge, at least one of this current lot will likely take one more shot at burnishing his legacy with a major acquisition. In the anything-but-sleepy insurance world, the coming year marks the last act.

Although Manulife has been touting its ability to grow organically - believing its current platform can deliver 15-per-cent growth to its earnings per share in the medium term - "a deal would still be nice," UBS Investment Research analyst Jason Bilodeau said in a note to clients last week.

The ideal purchase would be another large transaction in the U.S., similar to the company's acquisition of John Hancock Financial, Mr. Bilodeau said.

Over at Sun Life, Mr. Stewart said last month that the company is always on the hunt for acquisition opportunities, and many of the deals are outside of Canada. Mr. Stewart has been lobbying against the federal government's budget proposal which would kill a tax break for companies that make foreign investments. It was Sun Life's operations in California that landed Mr. Stewart on stage at an event for The Economic Club of Toronto, where he introduced California Governor Arnold Schwarzenegger.

Succession planning at many major companies is a lengthy process of grooming. Not so in insurance, Moody's Investors Service Inc. said in a special report on Tuesday.

"The insurance sector stands apart from most other financial service sectors in the manner in which insurers' boards have traditionally selected new CEOs," it said. "Large insurers have been much more willing than other financial service firms to recruit CEOs from outside the company."

A notable number of large insurers in North America hire top talent from outside, either directly as CEO, or by bringing them in to another senior position for a term before promoting them.

And, even among those who rose through the ranks of their respective insurance companies, a large number had experience in other sectors or fields first.

"This distinctive approach is visible in both U.S. and Canadian insurers," Moody's said.

Mr. D'Alessandro is a case in point. He went to Manulife after a history at the banks, having worked at the Royal Bank of Canada and then going on to become CEO of the Laurentian Bank of Canada.

Moody's said "there are signs, however, that the distinct bias to bringing in outsiders as CEOs is starting to change. Insurance company boards are beginning to recognize the inherent difficulties in such recruiting. Outside CEOs can find it difficult to get accustomed to the company's culture or to develop rapport with key executives and employees. Moreover, the expectations placed on outsider CEOs, particularly from equity investors, can be overwhelming. Finally, outside recruiting can demoralize existing senior management because it signals failed succession-planning to them."

Boards of directors appear to be more focused on succession now, Moody's said. They are now routinely meeting executives several ranks below the CEO. And they're pushing for a more systematic hand-off of responsibilities to those executives who are in the running for the top job.

"It is still too early to tell if this enhanced focus on succession planning will enable more insurers to select CEOs from within their own ranks," the report concluded.
The Next Skippers

The three largest Canadian insurers may look to Americans as their next CEOs. Here are contenders to the thrones:

Great-West Lifeco

Here's an insurer that could look outside for a new CEO, as the ranks of parent Power Corp. and its subsidiaries are filled with management talent. Leading internal candidates would be Denis Devos, who runs the Canadian operations and is an actuary with 30 years experience at the firm. Consideration would also likely be given to two business heads running U.S. operations: Richard Rivers and Douglas Wooden, along with the CFO for the American division, Mitchell Graye.

Manulife Financial

John DesPrez, a Boston-based executive who was given responsibility for all North American business this month, will likely get the nod. Internal rivals include Don Guloien, the chief investment officer who also started running the Asian unit this month, and J-P. Bisnaire, head of business development and the insurer's general counsel. Manulife's board went outside for its last CEO, plucking Mr. D'Alessandro from a bank.

Sun Life Financial

The heir apparent, president Jim Prieur, resigned to become chief executive officer of Conseco Inc., a rival U.S. insurer. Succession is now something of a mystery. Insiders say the board is keeping an eye on Kevin Dougherty, who runs the Canadian operations, and Robert Salipante, who heads up the U.S. division and joined in 2003 after holding the top job in ING's U.S. operations. Other contenders are Thomas Bogart, the company's general counsel, Dean Connor, who's an executive vice-president, and Rick McKenney, the chief financial officer.

19 June 2007

Financial Services Sector Has 6 of Top 10 Brands

The Globe and Mail, Tara Perkins, 19 June 2007

Insurer Manulife Financial Corp. has elbowed a number of contenders out of the way to take the No. 3 spot in a list of Canada's most valuable brands, up 12 notches from where it stood a year ago.

The financial services industry again swept the podium, with the Royal Bank of Canada's "RBC" brand coming in No. 1 (with an ascribed brand value of $5-billion), and Toronto-Dominion Bank's "TD" No. 2 ($3.4-billion).

Six of the top ten brands were in the financial services sector.

The value of the brand "Manulife Financial" more than doubled from a year ago to $3.2-billion, according to Level5 Strategic Brand Advisors and Brand Finance Canada PLC, the companies behind the ranking.

The rapid jump came after the insurer began using more consistency in its message and unveiled several product launches and customer service initiatives to improve communications, said Peter Drummond, a vice-president and senior adviser at Level5.

Manulife chief executive officer Dominic D'Alessandro "had a real eye for business growth," Mr. Drummond said.

Manulife hasn't rebranded John Hancock Insurance and Financial Services, the Boston-based company it bought a few years ago, so the Hancock brand was not included in the ranking. But the Canadian insurer's name is sprinkled around the globe through operations such as Manulife Singapore, Manulife-Sinochem Life Insurance Co. Ltd. in China, Manulife Thailand and Manulife Japan.

This year, Manulife (International) Ltd. in Hong Kong won its fourth Trusted Brands Gold Award in the insurance category, in a contest set up by Reader's Digest.

Rival insurer Sun Life Financial Inc., which came in No. 16 on this year's list, is in the midst of making changes it hopes will help it compete with global mega-brands. It recently decided to rebrand its Clarica operations under the Sun Life banner, and plans to unveil an image-building advertising campaign this year to capitalize on the change. Sun Life's brand was valued at $1.7-billion.

Meanwhile, grocery giant Loblaw Cos. Ltd. tumbled five spots to No. 7 this year, reflecting "unclear strategic brand and business objectives amidst increased competition from players including Wal-Mart," the ranking said. Its brand was valued at $2.5-billion this year, down from $3.3-billion.

This year's list included business-to-business brands, allowing aluminum maker Alcan Inc. and Magna International to muscle onto the list at No. 9 and No. 11.

Aside from the usual banks, insurers and telecom companies in the top ranks, there were also Imperial Oil Ltd. (whose brand is Esso) and Thomson Corp.

Other notable names in the top 50 were Research In Motion Ltd.'s BlackBerry, which ranked No. 18 with a value of $1.6-billion and is now "truly a global brand," and Tim Hortons, which came in at No. 29 , and whose brand value of $1.2-billion represents 17 per cent of the total value of the company.

The ranking defines a brand as the trademark and associated goodwill.

Canada's priciest brands

1. RBC
Brand value: $5-billion
2006: $4.5-billion

2. TD
Brand value: $3.4-billion
2006: $2.8-billion

3. Manulife
Brand value: $3.2-billion
2006: $1.4-billion

4. Bell
Brand value: $3-billion
2006: $3.1-billion

Brand value: $3-billion
2006: $2.8-billion

6. Scotiabank
Brand value: $2.9-billion
2006: $2.2 -billion

7. Loblaws
Brand value: $2.5-billion
2006: $3.3-billion

8. Bank of Montreal
Brand value: $2.5-billion
2006: $1.8-billion

9. Alcan
Brand value: $2.2-billion
2006: N/A

10. CN
Brand value: $2.1-billion
2006: N/A

Total value of Canada's 50 most valuable brands: $74-billion

18 June 2007

RBC Capital Markets in the US

The Globe and Mail, Sinclair Stewart & Boyd Erman, 18 June 2007

On a mild evening in late March, 600 business types, including several top officials from Royal Bank of Canada, mingled in a cavernous expanse of New York's Museum of Modern Art, swilling complimentary champagne and munching on Asian tapas.

They had gathered for an exclusive showing of the critically-lauded Vancouver photographer Jeff Wall, whose massive, backlit portraits were the subject of a career retrospective.

But this night was as much a coming-out party for event sponsor RBC Capital Markets, a Canadian investment bank that, after some fitful progress here and more than a few growing pains, had mustered enough swagger to emerge as a cultural patron on arguably this city's grandest stage.

"Tonight, I think, this is one of the first times I can remember that we sponsored an event in the United States that has pretty broad appeal," acknowledged Peter de Vos, a grey-haired former submarine officer who heads RBC's U.S. investment-banking business.

"It's almost like borrowing a line from Avis Rent A Car: We've got to try a little bit harder."

At home in Canada, RBC can rely on brute size, unsurpassed financial muscle, and decades-old relationships to maintain its dominance. In New York? Not so much.

Instead, the bank has had to learn - sometimes the hard way - to hand responsibility to local managers, and resist the temptation to micro-manage from Toronto. It has endured culture clashes and learned to expect mistakes, even failures, as it bought new businesses and expanded into everything from investment banking and trading to fixed income, derivatives, and municipal bonds. And it has learned that things rarely go as planned.

"You have to be patient, and you have to expect it. Believe me, these aren't things that we knew at the beginning," conceded Chuck Winograd, who heads RBC's global capital market business out of Toronto. "Some things haven't become substantial businesses. None of them have worked out exactly. Some have been better, some have been worse, some have taken longer and a few have been shorter. But basically business plans generally take longer."

RBC's New York nerve centre occupies 120,000 square feet in One Liberty Plaza, a hulking black skyscraper just a half-block away from Ground Zero. A swarm of people are hunched over computer screens or bustling about the long corridor of the trading floor, oblivious to the hand-scrawled sign that promises "Blood pressure screening and cookies" - think Wall Street stress with a dash of Canadian nicety.

Soon, many of them will be moving across the street.

The bank's U.S. trading corps has swelled to 500 people, in part from internal growth, and in part because of recent acquisitions like Carlin Financial Group, an electronic trading outfit that caters to small hedge funds.

Space has become an issue, so the bank has quietly arranged to lease another 200,000 square feet at a nearby building this fall.

Of course, the words "expansion" and "United States," at least when they are conjoined, usually conjure a bleak vision for Canadian investors. These investors are all too familiar with the travails of Canadian Imperial Bank of Commerce, which attempted to go toe-to-toe with the biggest U.S. investment banks in the late 1990s, and only ended up stubbing itself. Bank of Montreal has maintained a modest trading and capital markets business here, but that, too, fell prey to the jinx in recent months, amidst a gas-trading scandal that has already cost the bank $680-million (Canadian). And both RBC and Toronto-Dominion Bank have suffered setbacks with their push into U.S. retail banking.

Some of these mistakes have been chalked up to poor timing; others to bad strategy or even arrogance.

Whatever the case, Canada's largest bank has stuck with it, even when things appeared bleak.RBC took a significant step into the U.S. capital markets in 2001, when it paid $2.1-billion to acquire Dain Rauscher and Tucker Anthony Sutro, a pair of Midwestern brokerages. The idea was to create a leading "mid-market" player, catering to smaller companies that weren't viewed as big enough fish for the top Wall Street firms.There were issues from the beginning. On the investment banking front, Dain had a reputation for being "co-manager of choice" - a banking euphemism for bridesmaid. It was in plenty of deals, but only led about one in 10. It also placed a large emphasis on the technology industry, which went into the tank after the dot-com crash. Soon, analysts were griping that RBC had overpaid for Dain.

In the first four years after RBC bought Dain, the investment bank generated just $90-million (Canadian) in profit. After 2004, RBC reorganized its structure, and did not break out specific numbers for its U.S. unit, making it difficult to get a handle on profitability. But there is little debate that the operations are improving.

The U.S. arm now accounts for almost 40 per cent of the company's overall capital markets revenue, and all indications suggest it will surpass Canada soon as the biggest single source. Profit for the global business, meanwhile, climbed to a record $1.4-billion last year, almost double its contribution from 2005 (when the bank suffered from an Enron charge) and well ahead of the $827-million it made in 2004.

Part of the turnaround can be attributed to RBC's recognition that it couldn't oversee the business from Toronto. Six months after it made the Dain purchase in 2001, RBC attempted to integrate its energy and technology businesses into a North American unit, giving some bankers cross-border responsibilities. Then, in 2003, it reversed course, tacitly acknowledging that the markets were far different.

"The game used to be you used to send a Canadian down to do things," Mr. Winograd said. "The fundamental change was recognizing you needed Wall Street people to run it. You could send down the odd Canadian but basically it had to be done with local talent."

It also required new talent. Of the 40 managing partners who worked at the firm when it was acquired, only four are still with RBC.

This is fairly dramatic turnover, and in many ways it has been good. RBC now says it leads about 35 per cent of the deals it is in, and recently won the mandate of sole adviser to specialty grocer Whole Foods Market in its planned $565-million (U.S.) purchase of Wild Oats Market.

Tony Munoz, a young health care services banker who joined this spring from UBS, said he was drawn to RBC because it wasn't a big firm: the clients may be smaller, but that allows bankers to deal directly with more senior executives.

"It's a lot more entrepreneurial here," he said. "Things were sort of cookie-cutter at UBS."

This is precisely the sort of critique an investment banker at an independent Canadian firm might level at RBC's Toronto mother ship. And it brings up an interesting challenge: creating a culture that entices hungry and aggressive young bankers, but at the same time doesn't invite the sort of cowboy theatrics sometimes associated with boutique firms.

"It requires, in my job, I'd say eternal vigilance," said Mr. De Vos. "Do we have to monitor it closely? Do we have to hold up some people's promotions? Yes. And it's hard going through that balancing act."

Taking companies public or advising them on mergers and acquisitions, the business of investment banking, tends to get the headlines.

A great deal of RBC's success resides in the less glamorous worlds of debt and derivatives. Mark Standish, a London native who joined RBC in 1996, oversees both these divisions from his New York office, perched just above the trading floor.

Mr. Standish, recently named co-president of RBC's global capital markets business along with Doug McGregor, who works out of Toronto and heads investment banking, admits it was difficult to get American clients to take his calls initially.

The bank was always strong in municipal bonds, which provide project financing for schools and cities, but less so in the corporate world. He credits a Canadian invention with helping him to bridge the chasm.

Maple bonds, a type of corporate debt sold to Canadian investors by foreign companies, have become a huge business since they were introduced a few years ago, and RBC is the leading player.

"That gave us a really strong calling card," said Mr. Standish. "It suddenly made the Canadian market relevant to a lot of global issuers."

That has helped pave relations not just in the United States, but in Europe as well. The global debt operations, based in London, led $30-billion worth of U.S. dollar issuance in 2005. This year, they're on pace for $80-billion, which would eclipse the entire annual bond sale total in corporate Canada.

In derivatives, RBC is bucking the trend. While some Canadian banks, most notably Toronto-Dominion Bank, have cut back, RBC has bulked up in what is considered one of the more complex - and risky - areas of finance. RBC officials have bristled over suggestions they're climbing the risk curve, and Mr. Standish insists that any fears over the bank's appetite in this regard are misguided.

"I love risk, but I love smart risk," he said. "We can easily up our risk profile."

Mr. Winograd, who prepared for his succession last fall by appointing Mr. Standish and Mr. McGregor as co-presidents, said it's "inexorable" that the U.S. business will become much larger than the Canadian division at some point, but stressed it will do so in a measured and careful fashion. Message? Don't expect any game-changing acquisitions.

"When you take a look at foreign banks in the U.S. that have come and tried to do it, that wanted to do it with a bang, they usually did," he said. "I always say I wish I knew as much as I knew now when I started, because it would have been easier. Some of my lessons in this business have been very expensive."

15 June 2007

RBC's U$40 Million Exposure in NC Real Estate

The Globe and Mail, Tara Perkins, 15 June 2007

The Royal Bank of Canada indirectly has $40-million (U.S.) in exposure to a North Carolina real estate development that has been under attack from the state's Attorney-General, a Citigroup Global Markets analyst said in a note Friday.

Last week, Attorney-General Roy Cooper announced that he won a court order to stop the venture, which he alleges sold overpriced lots in the North Carolina mountains by promising consumers they could make a profit without having to invest any of their own money.

“These developers squandered more than $100-million in financing, leaving consumers stuck with property that isn't worth what they owe on it,” Mr. Cooper said in a release.

The project allegedly used inflated appraisals and phony second mortgages as down payments to entice consumers to borrow millions of dollars to buy property.

Citigroup analyst Shannon Cowherd's $40-million figure for Royal Bank's indirect exposure comes from the regulatory filings of a company that is not named in the Attorney-General's allegations, but which she said is affiliated with the development and the developers.

Royal Bank Friday that it does not comment on analyst speculation.

Three other local banks have reported a potential combined total of $57.8-million in losses as a result, Ms. Cowherd wrote in a note to clients. On Friday, Capital Bank announced that it has “limited exposure” to the project, and said that “multiple community, regional and super-regional banks, in and out of North Carolina, are connected to the project in a wide range of investments.”

Ms. Cowherd is keeping her forecast of Royal Bank's earnings this year 2 per cent below consensus, or at $4.16 (Canadian) per share, to reflect anticipated losses from this type of exposure.

More Analysts' Remarks on the Banks' Q2 2007 Earnings

Financial Post, Duncan Mavin, 15 June 2007

As the dust settles on the second quarter results of Canada’s big banks, analysts are reflecting on uneven reaction from the markets despite bumper profits across the sector.

“Canadian bank results were generally ahead of expectations during the quarter,” said Blackmont Capital analyst Brad Smith. Yet, he pointed out that “several minor misses combined with a perceived decline in earnings quality contributed to a broad-based bank stock sell-off in the post release period.”

As a whole, the banks reported earnings of $5.0-billion, down 4% from the previous quarter but up 18% compared to the second quarter of last year. Total revenue of $18.7-billion was up $1.8-billion, or 9.6%, from $16.9-billion last year.
Domestic retail banking was the best performer.

“Most banks reported good loan volume growth and some stability in net interest margins,” said Odlum Brown analyst Murray Leith.

“The major Canadian banks are maintaining strong underlying domestic personal and commercial business, including wealth management momentum this year,” said Lidia Parfeniuk, an analyst at Standard & Poor’s.

Another key trend was continued strength in credit quality.

“In aggregate, the banks have $5.1-billion in non-performing loans (down from a peak of $14-billion in 2002) and reserves of $8.3-billion to cover problem loans,” said Mr. Leith. “The banks are well reserved,” he added.

The banks’ “outsized provisioning levels reflect a continuing cautious stance,” said Mr. Smith.

But with expectations so high for the banks these days, the solid second quarter could not prevent investors reacting with disappointment.

An “unforgiving” market “demonstrated a high sensitivity to variances from expected results and underlying earnings quality assessment,” Mr. Smith said.

Royal Bank of Canada in particular suffered from “lofty expectations,” said Odlum’s Mr. Leith. RBC’s adjusted earnings per share of 99¢ fell short of analysts’ forecasts of $1.01, prompting investors to drive the bank’s stock price down.

However, the downturn in banking stock prices likely does not reflect a solid outlook for earnings and profitability.

“At current valuation levels ...overweight positions in strategically advantaged, above-average–scale banks, such as buy-rated [RBC] and Bank of Nova Scotia, are likely to deliver above-average investment returns,” said Mr. Smith.

• 6 June 2007 Review of Banks' Q2 2007 Earnings
• 24 May 2007 BMO
• 1 June 2007 CIBC
• 1 June 2007 National Bank of Canada
• 28 May 2007 RBC
• 30 May 2007 Scotiabank
• 30 May 2007 TD Bank;