29 April 2009

Macquarie's Ratings on Banks

Macquarie Capital Markets, Sumit Malhotra, 29 April 2009

BMO - Underperform,
CIBC - Neutral, $48 target price
National Bank - Neutral, $43 target price
RBC - Neutral, $40 target price
Scotiabank - Underperform, $30 target price
TD Bank - Underperform, $42 target price.
Financial Post, David Pett, 30 April 2009

The pre-provision, pre-tax earnings (PPE) of Canada's banks are more than ample to cushion the impact of rising loan losses, says UBS analyst Peter A. Rozenberg.

"We think that PPE are the most important line of defence against projected credit losses, he said in a note to clients. "We project significant PPE of $34-billion in F2009 compared to $9.3-billion in projected provisions.

Mr. Rozenberg said Canadian banks have historically enjoyed strong provision coverage with PPE:PCLs no less than 1.5x. Currently, the analyst noted the average coverage is 3.6x with National Bank at 7.3x and Bank of Nova Scotia at 4.8x, leading the pack. Bank of Montreal at 2.5x would be the lowest.

He added that PPE is also a good way to judge bank valuations and following the recent rally in the sector, Canadian banks are now trading at 5.4x PPE, compared with their historical average of 5.6x. CIBC and Bank of Montreal trade at the most attractive valuations, he said, while Royal Bank and Bank of Nova Scotia trade modestly above average, TD is below average and National Bank trades higher than average.

"Lower valuations at TD and BMO likely reflect lower implied US returns while discounts at CM likely reflect higher [collateralized loan obligations] risk," he wrote. "The relative premium valuation at NA is likely due to lower than average provisions and higher implied returns."

27 April 2009

CIBC & TD Bank to Reduce Wholesale Banking Operations

Financial Post, Eoin Callan, 27 April 2009

In the executive suites of Bay Street's bank towers, industry chieftains have been huddling with their top managers to make tough calls about which units within their banks should get the lion's share of capital -- a scarce commodity since the onset of the credit crisis.

Participants in these internal bank negotiations tend to agree that managers who run the street-level branch networks have been gaining the upper hand.

With a premium on retail deposits as a reliable source of funding in uncertain times, most of the country's top banks have been favouring their retail franchises.

But some are going further, putting their riskier trading operations on a crash diet, starving them of cash as part of a strategy to shrink the units down to a more manageable size.

Leading this trend are Ed Clark, chief executive of Toronto-Dominion Bank, and Gerry McCaughey, chief executive of Canadian Imperial Bank of Commerce, who have positioned themselves at the crest of a wave sweeping the global banking industry.

As international policymakers prepare to force banks to reduce risky trading activity and embrace a more balanced business model, TD and CIBC are taking the leap on their own.

TD's Mr. Clark says his bank is going to give up the industry-wide practice of placing casino-like bets with the bank's own capital. The 61-year-old's decision to halt this profitable-but-risky activity -- known as proprietary trading--makes TD one of only two big banks in the world to make such an explicit pledge, along with Germany's Deutsche Bank.

Mr. Clark says the "wholesale" side of his bank, which advises institutional clients and handles market trades, should not behave like "a hedge fund in disguise."

He wants to stick to activity that produces economic value as the core of new banking model that is emerging from the financial crisis

"Our simple test is to ask: Would the Gross National Product of Canada go down if we eliminated our wholesale activity?" he says.

Under Mr. Clark's direction, the proportion of the bank's income derived from capital market operations has undergone a staggering drop.

Last year it fell from a peak of more than 50% to a mere 2% amid cutbacks and investment losses.

The bank's internal target for the future is thought to be below 15%, with retail banking pegged to account for a whopping 85% of income.

This same big shift from wholesale to retail is also underway on the other side of Bay Street at CIBC, where top managers are working on transforming the bank into a business that looks more like a "utility," according to a person familiar with executives' thinking.

Retail operations accounted for all of last year's profits as Canada's fifth-largest bank wrote off investments, and the contribution from wholesale banking appears set to hug low double digits for the foreseeable future.

The idea behind this model is that banks will perform steadily during economic downturns, benefit from updrafts and be spared the periodic blowouts that have plagued Bay Street for decades.

In theory, this kind of stability is what Canadian institutional investors crave, and there is some evidence that banks such as TD are winning backing for their strategy.

When the Ontario Teachers' Pension Plan recently revealed its biggest stock holdings, all of the usual Bay Street suspects were missing, save TD.

This is a sign the $100-billion pension fund views the bank as promising the best return for the least risk, despite TD's heavy exposure to beleaguered U. S. consumers.

The downside for investors is that as banks become more like utilities they will sacrifice growth.

As others beat a hasty retreat, Royal Bank of Canada has shown it is not afraid to step forward and grab market share on Wall Street from weakened foreign rivals. Pride in having the biggest and the best capital markets operation among Canada's banks remains a strong part of its internal culture.

The country's largest bank saw the contribution of wholesale banking to income reach levels above 40% in the first quarter of 2009, according to the bank's adjusted figures.

RBC also appears likely to apportion a healthy share of capital to the profitable unit as world markets recover. Yet the bank remains firmly committed to a long-standing target under Gord Nixon, chief executive, of deriving 20% to 30% of income from wholesale banking, and 70 to 80% from retail.

"We believe the model of 25/75 is extremely appropriate for the new world," Mr. Nixon says.

The RBC model is designed to allow the bank to remain a competitive global player while minimizing earnings volatility and keeping liquidity risk under control -- and may be a template for U. S. banks.

"We think a lot of banks are going to move toward that model," Mr. Nixon says.

Up at the top of Bay Street, Bill Downe, chief executive of Bank of Montreal, agrees.

"I have a very strong view. I think that the universal banking model is a necessary model," says the head of Canada's fourth-largest bank.

He says this model of having a healthy balance between a retail and wholesale banking operation combines the "virtues of a secure deposit base" with a "capacity for innovation."

"The Canadian banking system is the best example I can think of, of the universal bank functioning well," he says.

Next door on Bay Street, a similar view is taken by Rick Waugh, chief executive of Bank of Nova Scotia.

The head of Canada's most international bank has been extolling the virtues of the traditional Canadian banking model to international policymakers like Paul Volcker, the former Federal Reserve chairman who is advising U. S. President Barack Obama on redesigning the U. S. financial system.

"I have had direct talks with Paul on this," Mr. Waugh says.

Scotiabank's international orientation means it has a somewhat different risk profile than the other Bay Street institutions, with an emphasis on building retail chains in emerging markets such as Latin America and Asia.

This has prompted it to elevate risk management to the highest level within the organization, earning it a ranking as one of the top 10 most stable banks in the world, according to Oliver Wyman, the financial services consultancy.

When viewed from outside the country, analysts tend to see all of the Canadian banks as clustered relatively close together, with broadly similar models, despite degrees of difference in strategy.

Yet in executive suites on Bay Street, the credit crisis has created intense internal debate over allocation of capital as bankers place their bets on the way forward following one of the most testing periods in history for the industry.

"At our management committee level, the engagement around that allocation process has to be high," Mr. Downe says. "The last 24 months have been an exciting time, because management action will have consequences, and if you're on your toes, will have positive consequences."
Financial Post, John Turley Ewart And Eoin Callan, 27 April 2009

When William Downe moved into the corner office at First Canadian Place in downtown Toronto two years ago, he decided he didn't like the view at the country's fourth-largest bank.

"The visibility of the service we provided was so low it was like a grey institution," recalled the chief executive of Bank of Montreal in a recent interview.

So Mr. Downe-- who was catapulted to the helm of the country's oldest bank on the winds of change --decided to spruce things up.

Today, a visit to a BMO branch finds new blue signage and open-concept branches where staff patrol the floor looking for clients to assist.

The fresh strategy for the bank's branch network entails organic growth and expansion aided by good old-fashioned retailing skill.

"We have opened 40 new branches, we have redeveloped over 60, and we have done major renos on 60 [more], and that is a major change from what we were doing in the early part of this decade," says Frank Techar, head of Bank of Montreal's personal and commercial bank in Canada.

All of this is Mr. Downe's way of declaring BMO is back in the retail banking market.

The chief executive said staff morale is also being lifted by efforts to put a different face on a bank that operated for a decade with a giant for-sale sign out front.

Ten years have passed since a bid by BMO to merge with the Royal Bank was dismissed by the Liberal government of Jean Chretien. In the months before the decision, the future of BMO was painted as bleak.

The bank's then-CEO Matthew Barrett warned that the Bank of Montreal "would no longer be a nationwide full-service bank with an ubiquitous community presence" if the merger was rejected.

Bank of Montreal would become, said Mr. Barrett, "the remarkable shrinking bank. "After the decision, it was as if the bank was determined to fulfill that prophecy. The bank's retail branches languished, many were closed. BMO "Investstores" were opened, tiny branches tucked away in grocery stores that were staffed by one or two employees and equipped with an ATM.

"Can a bank change?" was the theme of a Bank of Montreal television ad campaign in the mid-1990s. After another failed merger attempt in 2002, with Scotiabank, BMO had no choice but to try and prove it.

Change was the main theme of Bill Downe's first speech as BMO's incoming president and chief executive officer in 2007. "What I heard most strongly was our largest competitors saying that they were taking our business from us and they were going to continue to do that, and that did catch my attention," he said.

"Reversing market share erosion was the No. 1 assignment," he added.

It was an objective that Mr. Downe said he had no trouble selling to BMO staff as he embarked on a coast-to-coast tour of branches.

To turn things around, BMO launched an advertising campaign and customer-service strategy driven by extensive research showing customers find banking confusing and would like it to be simpler.

Mr. Techar said BMO is making a promise to customers "to provide them the clarity they need to have more confidence in their financial decisions." The chain is "going back to basics," he adds.

The head of retail points to one of BMO's newer branches on Church Street in Toronto -- open seven days a week and powered by green energy -- as a model for the makeover that has altered the bank's image over the past two years.

During a visit to the branch, Mr. Techar gestures approvingly to the vivid hues of blue that stand out amid the rainbow of storefronts in Toronto's gay village.

"With respect to our branch network, we had a little bit of catching up to do," he said.

Before the change, Mr. Techar admits, BMO was "not getting to enough customers" and many of its rivals were "counting it out" of the retail banking market. They had cause. The retail unit's revenue growth, net income growth and internal customer loyalty scores at the end of 2007 put the bank in fourth or fifth place compared with its peers.

While the bank is still far from being an industry leader, those key measures of its retail performance -- customer loyalty scores, revenue growth, net income growth -- at the end of 2008 suggest BMO is moving into the middle of the pack.

BMO also sees opportunities to grow the bank's U. S. footprint by building on its Harris Bank unit, which is based in Chicago. Over the next one or two years, said Mr. Downe, "there will be consolidation opportunities" in the United States. "What we don't want to do is buy someone else's loan portfolio that is struggling, but what we would like to do is buy a loyal customer base that values high service and that fits in with our business model.

According to Mr. Downe, "the chance to grow market share with our existing facilities is one we cannot miss."

Back at the Church Street branch, staff are working to make the strategies of Mr. Techar and Mr. Downe have meaning for customers. In the cafe next door, the clientele offer some encouragement for the bank's new approach, giving the bank's bright-blue makeover a half-hearted thumbs up. Its not a return to the former glory of the country's oldest bank, but it's a start.

20 April 2009

RBC's US$850M Goodwill Impairment Charge

Scotia Capital, 20 April 2009

• RY announced that it expects to record a US$850 million ($1,020 million or $0.72 per share) goodwill impairment charge on its U.S. & International Banking segment in the second quarter ending April 30, 2009.

• The impairment charge the bank indicated was a result of the prolonged economic difficulties in the U.S., in particular the deterioration of the U.S. housing market, and the decline in market value of U.S. banks.

• The writedown represents 22% of the $4.6 billion in goodwill attributed to the U.S. & International Banking segment. The net goodwill after the writedown is now $3.6 billion.

• Total goodwill at RY is $10 billion before the writedown, comprised of $1.9 billion in Canadian Banking, $2.2 billion in Wealth Management, $1.0 billion in Capital Markets, and $4.6 billion in US & International (Q4/08).

• RY's book value is expected to be reduced by a modest 3.3% with no impact on Tier 1 and total capital ratios.

• In terms of valuation and share price, we expect minimal impact. The bank's International business unit has contributed very little to earnings over the past several years and actually recorded a loss in Q1/09. Thus, the valuation of this unit is already reflected in the earnings and P/E of the bank.

• RY's announcement is likely to focus the market on TD's $16.7 billion in goodwill (TD USA $11.9 billion as at Q4/08) and total $20 billion in goodwill and intangibles. Thus, we expect a similar 22% writedown on goodwill from U.S. retail would result in $3 per share charge.


• Our quarterly operating earnings estimate remains unchanged at $1.00 per share, with reported earnings for Q2/09 expected to be $0.28 per share. Our 2009 and 2010 operating earnings estimates remain unchanged at $4.25 per share and $4.65 per share. Our target price is unchanged at $48 per share representing 11.3x our 2009 earnings estimate.

• RY - 1-Sector Outperform, TD - 3-Sector Underperform.
TD Securities, 20 April 2009


Thursday (04/16) after market close, RY pre-announced a Q2/09E goodwill impairment charge of US$850 million (pre and post tax) related to its International Banking business.


Slightly Negative. The write-down itself is largely a non-issue. However, we think it speaks to our standing concerns around the bank's medium-term growth prospects in U.S./International banking. While still a solid platform, the stock appears to be relatively fully valued with little room for disappointment in our view.


Non cash charge is not the issue. The US$850 million charge (pre and post tax) has no impact on our estimate of core earnings nor on regulatory capital levels or our preferred metric TCE:RWA (tangible common equity: risk weighted assets). In that sense, a goodwill write-down is a non-issue.

Concerns around future growth are. Goodwill impairment tests are forward looking in that they consider the present value of future profits. While the analysis requires substantial guesswork, the move suggests that in the eyes of management the earnings base and/or future growth of the business has diminished relative to prior views. To us, this speaks clearly to our standing concerns around the bank's medium-term growth prospects which we believe will become increasingly reliant upon U.S./International banking.

Who shall follow next? The obvious candidates for concern in our view are TD (Q1/09 goodwill of C$16,662 million) and BMO (Q1/09 goodwill of C$1,706 million) both of which have fair amounts of goodwill on their books associated with their U.S. retail banking strategies. However, despite recent challenges, both platforms are generating profits (material profits in the case of TD) as per Exhibit 1. Both banks conduct regular reviews for goodwill impairment and neither bank have suggested any concerns at this point. In both cases our operating estimates, outlook and investment case reflects on-going challenges in the U.S. retail banking market.

Stock looking increasingly fully valued. Yesterday's announcement is not terribly significant in our opinion. We continue to view RY as a solid platform which is also benefitting from opportunities in its trading businesses. However, we remain concerned about the overall shift in business mix (in favor of trading/wholesale), medium-term growth strategies and the bank's credit exposures and thin reserve levels heading into the current downturn. This all against a relative premium valuation with the stock trading at 2.0x reported book after this charge (3.2x tangible book). From here we see relatively modest returns and little room for error/disappointment.

During Q1/09, RY had begun a two-stage goodwill impairment test of their International Banking operations. Yesterday after market close, RY announced the testing has been completed and determined a goodwill charge of US$850 million was warranted for their International banking business. The bank cited challenging economic conditions with particular emphasis on the declines in the U.S. housing and operating landscape as reasons for the charge.

As of Q1/09, RY had C$9,948 million in goodwill which will be reduced by approximately C$1,037 million (assuming f/x of $1.22) to C$8,911 million to reflect the charge.

Our Q2/09E core cash FD-EPS for RY is C$0.90, and the non-cash goodwill charge is worth approximately C$0.74 per share.


We have made no changes to our estimates.

Justification of Target Price

Our Target Price reflects a discount to our estimate of equity fair value 12 months forward (based on our views regarding sustainable ROE, growth and cost of equity), implying a P/BV of 1.75x.

Key Risks to Target Price

1) Increased competition and tighter margins in the U.S. banking environment, 2) integration challenges associated with recent acquisitions and 3) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

In our view, the goodwill charge speaks to our standing concerns around the bank's medium-term growth prospects in U.S./International banking.

Preview of Insurance Cos Q1 2009 Earnings

Scotia Capital, 20 April 2009

Canadian Lifecos - Another Tough Quarter but Capital Positions Remain Strong - Focus Turns to Credit

• Declining equity markets make for another tough quarter. Obviously, Manulife is the most sensitive, and with equity markets, on a Manulife weighted average basis, down 9% quarter over quarter (QoQ), its EPS should suffer to the tune of $0.88, as outlined in Exhibit 1. Despite its hedging efforts, Sun Life’s EPS should be hit by $0.45 EPS, consistent with its guidance, and could suffer more pain depending on any extraordinary hedging breakage costs. Due to Industrial-Alliance’s unusual Q4/08 practice of reserving more than what was needed under mark-to-market accounting in what was a throwaway quarter, the company has softened the blow of declining equity markets in Q1/09 (we estimate by as much as $0.15 in EPS), making the EPS hit from a 3% decline in the S&P/TSX just $0.07, as per guidance. Finally, for Great-West Lifeco, the least sensitive Canadian lifeco by far to equity markets due to its lack of U.S. variable annuity exposure and its decision to write Canadian segregated fund business with minimal guarantees, guidance suggests a $0.10 hit to EPS from a GWO weighted 6% decline in equity markets.

• We’ve significantly cut our 2009 and 2010 EPS estimates for Sun Life, largely due to credit concerns. We took $1.00 and $1.20, respectively, off our 2009 and 2010 EPS estimates for Sun Life, in part to reflect continued concerns with respect to credit (Sun Life makes us the most nervous in this regard) and in part to reflect continued profitability issues with respect to its sub-scale U.S. operations. GWO and MFC 2009 EPS estimates were each trimmed by $0.20 to reflect a more uncertain credit environment, with 2010 EPS estimates reduced by $0.20 (MFC) and $0.08 (GWO). With no sensitivity to U.S. credit, estimates for IAG were left unchanged. Our estimates assume markets end 2009 at 925 (S&P 500) and 10,000 (S&P/TSX) with a further 8% appreciation in 2010.

• We see healthy Q1/09 capital ratios. We peg MCCSR ratios at 232% for GWO, 202% for IAG, 218% for MFC, and 228% for SLF, as outlined in Exhibit 2, all well above regulatory minimums (120%), regulatory watch-list levels (150%), and comfortably above target ranges (175% or 180% to 200%). IAG can withstand a 17% drop in equity markets from current levels (i.e. S&P/TSX of 7100) before its MCCSR ratio hits 175%, and a 35% drop (i.e., S&P/TSX of 5450) before it hits 150% levels. We estimate MFC (on a do nothing basis) can withstand a 20% drop in equity markets from current levels (i.e., S&P 500 of 625) before its ratio hits 180%, and a 35% drop in equity markets (i.e., S&P 500 of 515) before it hits regulatory watch-list 150% levels.

• An increasing focus on credit. In our opinion, equity markets often move first and credit issues generally lag. While equity market volatility will continue to be an issue, we see 2009 unfolding with an increasing focus on credit. We believe the commercial real estate sector will continue to face strain as the macro economic downturn worsens. Moody’s now forecasts peak-to-trough commercial real estate price declines of 30%-plus, and while it did not speculate on commercial real estate loan delinquency trends, at over 5% currently, there’s clearly more downside (1991 peaks were 12%). It also indicated that commercial mortgage-backed securities (CMBS) delinquency rates are approaching 1% for more recent vintages, and delinquency rates should continue to head higher as economic fundamentals deteriorate (historical average is 0.6%), with CMBX spreads widening dramatically over the past 12 months.

• Sun Life most likely to suffer as credit continues to weigh. SLF’s track record in this regard speaks for itself. A total of $1.20 EPS in credit hits in the past two quarters (excluding LEH/Wamu and AIG) versus $0.04 for GWO, $0.21 for IAG, and $0.14 for MFC. As well, gross unrealized losses on fixed income securities trading below 80% of acquisition cost for more than six months represent 3.1% of fixed income assets for SLF, significantly higher than 1.8% for GWO, 0.8% for MFC and 0.4% for IAG.

• Relatively low CMBS exposure and generally of good quality – but NAIC filings show SLF’s CMBS portfolio is trading 57% of amortized cost, significantly below peers. CMBS relative exposures for the Canadian lifecos are significantly less than those of the U.S. lifecos, at 24%, 22%, and 12% of BV (ex AOCI) for GWO, MFC, and SLF, respectively, versus 43% on average for U.S. lifecos. As well, 90% and 85% of MFC’s CMBS investments are in relatively safer AAA tranches and pre-2005 vintages (75% and 86%, respectively, in the case of Sun Life) versus just 76% and 62% on average for U.S. lifecos. NAIC filings disclose the MV of the CMBS portfolio, and, assuming the unlikely case that CMBSs are written down to MV (liquidity constraints have blown out spreads on what are traditionally long-term holdings), we can estimate the after-tax EPS hit. Sun Life’s CMBS portfolio, with a market value at just 57% of amortized cost per the NAIC statements, is the most questionable (GWO is 95%, MFC is 85% and the average for the U.S. lifeco group is 78%). Furthermore, a full impairment down to MV would result in a $1.04 EPS hit for SLF versus $0.10 for GWO, $0.39 for MFC, and a very high $1.70-$2.00, on average, for the U.S. lifeco group.

• Relatively low U.S. commercial mortgage and real estate exposure and significantly less than U.S. lifecos. Total after-tax exposure as a percent of BV (ex AOCI) is just 7% for GWO, 24% for MFC, and 18% for SLF, well below the 79% for MET and PRU and the 45% average for the U.S. lifeco group. As well, defaults and losses on the lifecos’ commercial mortgage portfolios should perform better than CMBS conduits (especially those of the post-2005 vintage) because the loans are less leveraged (generally around 60% loan-to-value), were made on higher-quality property, and with higher-quality borrowers.

• U.K. financials hybrid exposure – a 50% write-down, although not expected, would hurt GWO by $0.74 EPS, SLF by $0.49, and MFC by $0.11. We suspect some hits will be taken in 2009, but given the long-term nature of these securities, we suspect the hits will be confined to only the riskiest preferreds, largely those in Tier 1. This would put GWO’s potential EPS hit in the $0.20-$0.30 range.

Great-West Lifeco Inc.
1-Sector Outperform – $27 one-year target, based on 1.8x 3/31/10E BVPS and 10.5x 2010E EPS
• We are looking for EPS of $0.45 for Q1/09, $0.01 below consensus.
• Another weak quarter for Putnam. We expect net sales of negative US$3-US$4 billion.
• We expect the decline in equity markets to hurt EPS by $0.10 and credit hits to be $0.03 EPS – while U.K. financial hybrid exposure weighs, we do not expect any significant hit in Q1/09 and expect a modest charge ($0.20) in 2009.

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $28 one-year target, based on 1.2x 3/31/10E BVPS and 8.5x 2010E EPS
• We are looking for EPS of $0.60 in Q1/09, $0.02 above consensus.
• A cleaner quarter than the rest of the group, with the decline in equity markets hurting EPS by $0.07 and credit hits hurting EPS by just $0.03. IAG is most likely to come out of the quarter with an increase in EPS estimates.
• Top line could very well continue to be weak. The negative top-line momentum in individual insurance sales will likely continue, building on a 14% YOY drop in Q4/08, a 16% YOY drop in sales in Q3/08 (22% organically), and a 1% YOY drop in Q2/08 (8% organically).

Manulife Financial Corporation
1-Sector Outperform – $30 one-year target, based on 1.6x 3/31/10E BVPS and 10.8x 2010E EPS
• We are looking for EPS loss of $0.40 for Q1/09, $0.05 below consensus.
• We expect the decline in equity markets to hurt EPS by $0.88 (per guidance), and credit hits of $0.08 in EPS, but increasing yields since Dec 31/08 could provide a modest boost.
• Conference call should have lots of talk about capital and acquisitions – likely no deal in immediate term.

Sun Life Financial Inc.
2-Sector Perform – $33 one-year target, based on 1.2x 3/31/10E BVPS and 9x 2010E EPS
• We are looking for EPS loss of $0.20 for Q1/09, $0.59 below consensus.
• We estimate the decline in equity markets to hurt EPS by $0.45.
• Credit makes us nervous with SLF. SLF’s recent track record has been one of more credit hits than its peers, as does its CMBS portfolio ($2B and trading at just 57% of amortized cost), and its fixed income security portfolio (3.1% of which is more than 20% below amortized cost for more than 6 months), and its $500 million (MV) U.K. bank hybrid portfolio.
RBC Capital Markets, 3 April 2009

Q1/09 results to be weak, but better than Q4/08, in our view

We expect the four lifecos to report YoY declines in earnings per share, driven by challenging equity and credit markets.

• Our EPS estimates for Industrial Alliance are in line with consensus, while they are below for the other three companies.

• Directionally, the short-term pressure on earnings is greatest on Manulife, in our view, driven by a much greater exposure to equities.

• Sun Life has the most exposure to deteriorating credit while Industrial Alliance has the least, in our view.

• We are lowering our Q1/09 EPS estimates for three of the lifecos. Our estimate for Manulife is up significantly as we had updated our numbers for the company near the market trough during the quarter.

Lifecos continue to be levered plays on equity markets

The most important factor for lifeco shares is equity market direction as, in the short term, the health of their capital positions is most impacted by movements in equity markets. This is particularly true for Manulife. Also key to the lifeco shares is the direction of credit spreads, which we view as a broad indicator of credit quality, although we believe that Canadian lifecos have less credit risk than both U.S. lifecos and Canadian banks.

Our favourite lifeco shares are Sun Life's

We think valuation (0.86x book value) is too low even though the company's performance in credit has been weaker than peers. Sun Life has a stronger capital position than peers and lower exposure to equities than Manulife. The company has exposure to a recovery in equities in 2009 as well as the higher U.S. dollar. The management changes in the U.S. division as well as the potential for acquisitions of assets from distressed sellers gives us hope that performance in the U.S. division, as well as the firm's competitive position, might improve. We rate Sun Life's shares Outperform.

ING Canada's shares are also attractive

We like the shares of ING Canada as the company has less exposure to credit and equity market challenges than banks/lifecos, in our view, and as a result the company is less likely to post weak earnings results. The company is well-capitalized, with $425 million in excess capital and no debt. We believe the probability of an acquisition this year has risen, and that it could be a positive catalyst for shares of ING Canada. In our view, ING Canada deserves a P/B multiple at the upper end of the industry, as it has a superior track record of ROE and underwriting outperformance, conservative reserving practices, a risk profile that is lower than that of the average U.S. P&C insurer and very little balance sheet leverage.

Company-specific highlights

Industrial Alliance (May 6)

• We expect Q1/09E core EPS of $0.56, in-line with consensus estimates of $0.58. Our EPS estimate represents a decline of 29% versus Q1/08 but is up significantly from the $1.47 per share loss in Q4/08.

• Our estimated Q1/09 hit from equity markets is $5 million ($0.06 per share), given the 3% drop in the S&P/TSX Composite Index since the end of Q4/08.

• Relative to its peers, Industrial Alliance should benefit from its more conservative credit exposure (62.5% of its bond portfolio is invested in government or government-related issuers and only 6.7% of bonds are BBB-rated, versus 22.1% for the Big 3).

• We expect EPS growth to face a relatively easy margin comparison on new individual insurance sales (at 56% of new sales in Q1/08, strain was slightly above management’s mid-term guidance of between 50% and 55%).

• We expect year over year comparisons in the company’s P&C insurance business to benefit from what we perceive to have been a relatively uneventful quarter in terms of harsh winter weather, particularly versus the difficult conditions faced in Q1/08. Q1 is typically the worst quarter for P&C insurance profitability.

• We reduced our full year 2009 EPS estimate by an additional $0.04 to reflect the negative impact of the company’s $100 million subordinated debenture issuance, which closed on March 27.

Great-West Life (TBD)

• We expect Q1/09E operating EPS of $0.37, below consensus estimates of $0.45. Our EPS estimate represents a decline of 38% versus Q1/08 and 37% sequentially, as the company’s earnings should be negatively impacted by weak credit and equity markets.

• Our estimated Q1/09 hit from equity markets is $190 million ($0.20 per share).

• The company disclosed that a 10% drop in equity markets would result in a $245 million increase in actuarial liabilities (assumes a 10% decline in the value of T.H. Lee – which we have excluded in our estimate). Our estimated impact from equity markets assumes a 9% blended decline in Q1/09 (Great-West has exposure to more than one country’s equity markets).

• Our estimated Q1/09 hit from credit markets is $115 million ($0.12 per share).

• We expect credit-related costs to be larger in Q1/09 than they were in Q4/08. We expect continued reserve strengthening as the ratio of downgrades to upgrades of bonds continued to climb in Q1/09. (Exhibit 7)

• We expect Putnam to report assets under management of US$99 billion as at the end of Q1/09, down 41% YoY and 6% sequentially. We forecast a pre-tax margin of negative 5.0% in Q1/09, well down from 14.2% in Q1/08 but an improvement from the negative 20.7% margin reported in Q4/08.

• We expect U.S. operations, which includes Putnam and financial services, to generate an $8 million loss in Q1/09 compared to $108 million in Q1/08. The primary differences versus Q1/08 are the negative impacts from credit and equity market weakness and the sale of the healthcare division (which closed on April 1, 2008).

• We expect the mid-Q1/08 $13 billion acquisition of Standard Life’s payout annuity block of business to positively impact Q1/09 earnings for the European division, but will likely largely offset by weakness in global credit and equity markets.

• Despite the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar, we do not expect currency translation to be material to Q1/09E earnings versus Q1/08, given weakness in the U.S. division. In a more normal year, we estimate that a 10% decline in the Canadian dollar versus all other currencies would positively impact Great-West’s earnings by 5%.

Manulife (May 7)

• We expect Q1/09E core EPS of ($0.18), slightly below consensus estimates of ($0.10). Our EPS estimate is well below the $0.57 reported in Q1/08 but an improvement from the $1.24 loss per share reported in Q4/08.

• Our estimated Q1/09 hit from equity markets is $1.4 billion ($0.86 per share).

• The company disclosed that a 10% drop in equity markets would result in a $1.6 billion decrease in earnings; our estimated impact from markets assumes a 9% decline in Q1/09, based on the company’s exposure to different equity markets worldwide.

• Our estimated Q1/09 hit from credit markets is $140 million ($0.09 per share).

• We expect credit-related costs to be above the $128 million reported in Q4/08 and expect continued reserve strengthening as the ratio of downgrades to upgrades of bonds continued to climb in Q1/09. (Exhibit 7).

• We expect sales growth to decline year over year, due to volatile equity markets and overall economic uncertainty.

• Recent price increases in certain product lines (i.e. U.S. retail LTC) and the revamping of the company’s U.S. variable annuity product line (less generous guarantees and higher pricing) will also hinder sales growth, in our view.

• Product introductions and the success of the still relatively new MGA channel in Japan should continue to bolster insurance sales in Asia/Japan, although we expect the pace to slow from the triple-digit growth of recent quarters.

• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales (outside the U.S.) will also begin to slow.

• We expect currency fluctuations to only modestly impact earnings this quarter versus Q1/08, as strength in the U.S. dollar versus the Canadian dollar and Japanese Yen versus the U.S. dollar (beneficial for MFC) are largely offset by weak expected results out of non-Canadian divisions. Manulife’s U.S., Hong Kong, Japanese and reinsurance operations typically account for almost 70% of earnings.

Sun Life (May 7)

• We expect Q1/09E core EPS of ($0.09), well-below consensus estimates of $0.21. Our EPS estimate represents a decline of 110% versus Q1/08, but an improvement from the $1.25 loss in the prior quarter. We believe consensus estimates do not fully reflect the negative impact from credit and equity market weakness during the quarter.

• Our estimated Q1/09 hit from equity markets is $285 million ($0.51 per share).

• Management has disclosed that each 10% decline in equity markets would reduce net income by $275-350 million ($0.49- $0.63 per share). Our estimated impact from markets assumes a 9% blended decline in Q1/09.

• Our estimated Q1/09 hit from credit markets (including credit spreads) is $272 million ($0.49 per share).

• Approximately $200 million of our estimated $272 million impact is related to writedowns and downgrades; we estimate that downgrades increased by 20% versus Q4/08.

• The remaining negative impact from credit relates to spread widening (primarily affecting the U.S. fixed annuity business). We expect the negative earnings impact to result from the widening of spreads on asset-backed securities, as CMBS spreads ended the quarter largely unchanged, despite widening significantly during the three months.

• We expect year-over-year growth in the Value of New Business (VNB) to be muted, hindered by weak expected wealth management product sales given the state of equity markets globally, and by our expectation that insurance sales will be challenged by the weakness in global economies.

• We expect MFS to report almost 60% lower YoY net income in Q1/09, primarily due to the impact of weak equity markets on AUM. Operating margins are likely to stabilize at 18% (they were 17% in Q4/08) but are well down from the 32% level in Q4/07.

• We expect currency translation to only minimally positively impact Q1/09E earnings versus Q1/08, as reduced earnings in the U.S. largely temper the positive effect of a 19% average increase YoY in the U.S. dollar versus the Canadian dollar. In a more normal year, we estimate that a 10% decline in the Canadian dollar versus all other currencies would positively impact Sun Life’s earnings by 5%.

Power Financial (May 12)

• We expect Power Financial to report Q1/09E EPS of $0.46, in line with consensus estimates. Our EPS estimate represents a decline of 31% versus Q1/08 and 22% sequentially.

• We expect Great-West to report Q1/09E EPS of $0.37, down 38% versus Q1/08. Great-West accounts for 70% of Power Financial’s Q1/09 estimated EPS.

• We expect IGM Financial to report Q1/09E EPS of $0.52, down 35% versus Q1/08. IGM Financial accounts for 22% of Power Financial’s Q1/09 estimated EPS.

• Pargesa and Other income are expected to report earnings of $26 million in Q1/09, above the $4 million recorded in Q1/08.

• Power Financial’s shares do not typically trade based on earnings as investors usually focus on net asset value.

Power Corporation (May 13)

• We expect Power Corporation to report Q1/09E EPS of $0.47, in line with consensus estimates. Our EPS estimate represents a decline of 27% versus Q1/08 and 12% sequentially. We expect lower earnings YoY at Power Financial to more than offset higher contributions from investment funds.

• Similar to Power Financial, Power Corporation’s shares do not typically trade based on earnings as investors usually focus on net asset value.

ING Canada (May 13)

• We expect Q1/09E operating EPS of $0.48, in line with consensus estimates. Our operating EPS estimate represents a decline of 14% versus Q1/08 and 23% sequentially. Note, consensus EPS is a blend of operating and GAAP EPS.

• The primary reason for our lower year over year EPS estimate is our expectation for lower interest and dividend income – the company’s investment portfolio (excluding cash) decreased from $7.2 billion to $6.1 billion in the past year.

• We believe a more benign winter for many regions of the country will positively impact year over year comparisons for Canadian P&C businesses. The company’s Q1/08 results were also negatively impacted by a $10 million increase in provisions for its Alberta auto business.

• We expect a 3.1% increase in earned premiums in Q1/09 versus Q1/08 primarily due to an increase in the number of insured risks and insured amounts in personal property and rate increases in personal auto.

• ING Canada began raising Ontario auto rates several quarters before its peers, however, based on the most recent available data, the industry’s rate increases have begun to close the rate gap (the entire industry raised rates by an average of 5.6% in 2008). Although being an early mover has hurt premium growth for ING Canada in recent quarters, we expect underwriting profitability and ROE to benefit longer term.

• Book value growth will once again likely be slowed by continued weakness in equity markets (although ING Canada’s exposure to common equities has decreased from 25% of invested assets to 12%).

• We estimate a net realized investment loss of $20 million (pre-tax) in Q1/09, given the combination of a 3% drop in the S&P/TSX Index and the company’s $134 million unrealized loss position on common equities as at Q4/08.

07 April 2009

Capital Trust Securities Q & A

CIBC Wood Gundy, Kory Brewster - Director, Fixed Income & Currencies, April 2009

Financial institutions have been issuing Capital Trust Securities (CTS) recently, prompting some questions by investors. CTS are investment grade debt instruments that currently offer attractive returns while still providing the stability common to bonds.

How Are They Structured – Why 99 Years?

Capital Trusts are structured as wholly owned trusts of the issuing financial institution. The trust holds an income-generating asset, such as a bank deposit note, which provides the funds to make coupon and principal payments to CTS holders.

Regulators require financial institutions to maintain specific levels of capital to provide depositors with protection against unexpected losses. The recent credit crunch has motivated many financial institutions to raise their capital ratios to satisfy regulators and investors alike, resulting in the issuance of new preferred and common shares, and CTS. To qualify as Tier 1 Capital, CTS must have 99 years to maturity, although their structure makes early redemption likely (more on that later).


The CTS available in Canada are named TD CaTS, BNS BaTS, BMO BOaTS, CIBC CoaTS, RBC TruCS, Manulife MaCS, Sun Life SLEECS, Great West GreaTS and Canada Life CliCS. While somewhat fun just to rhyme off, the significance of the names is that they all contain the letters “TS,” which stands for Trust Securities, or ”CS,” which stands for Capital Securities.

Why Are CTS Yields So High?

When investors see investment grade debt that yields 8% and higher, it gets their attention. Some may wonder why securities issued by high-quality financial institutions would have such high yields. There are five primary reasons.

Firstly, credit risk is a concern when holding these products since senior bonds have priority in the case of liquidation or asset distribution. For this reason, the credit rating for these products is lower than that for similar deposit notes.

Secondly, extension risk is the risk that the CTS will remain outstanding longer than the anticipated redemption date. Moreover, in cases where the regulator deems the issuer to be financially distressed, CTS could be converted into perpetual preferred shares.

Thirdly, interest is a pre-tax expense, making it more tax-efficient than dividends for the issuer. Yet for the investor, interest is taxed at a higher rate than are dividends; hence, the higher CTS yields help make their yields similar to those on preferred shares on an after-tax basis.

Fourthly, when trying to raise capital, issuers want to be sure that the deal is well received by the marketplace and that they are able to raise all the capital they require. The coupon rates on the last three CTS issues were all over 9.5% and all three issues were highly demanded.

Finally, the high yields are also a result of the ongoing credit crunch that has lifted the cost of borrowing. Some of the first CTS, which were issued back in 2000, offered yields that were about 150 basis points (bps) higher than that of a comparable Government of Canada (GoC) bond. The three most recent issues provide yield spreads of more than 650 bps.

What If Interest Rates Rise?

Interest rate risk is the risk that rising interest rates cause bond prices to fall. However, bond market yields would be expected to rise only as the economy recovers and inflation starts to creep higher. With the economy improving, it would be expected that yield spreads would start to narrow as the risk of default declines. Thus, there would then be two competing forces: rising government bond yields and tightening yield spreads. Yield spreads have increased much more than government bond yields have decreased during the crisis so if conditions revert to ”normal,” CTS prices could remain stable or even increase.

Where Do They Rank?

CTS are junior subordinated debt instruments which rank lower than senior debt. In situations of financial distress, all CTS are exchangeable into non-cumulative preferred shares at the issuer’s option. Therefore, they rank pari passu (equal) with preferred shares from a financial weakness/bankruptcy perspective. However, in terms of distributions, CTS have a “Dividend Stopper Undertaking” feature that prohibits the payment of any preferred or common share dividends if an interest payment owed to CTS holders is missed. Thus, from a distribution perspective, they rank ahead of preferred and common shares.

Will They Be Redeemed Early?

There are two compelling reasons why CTS are likely to be redeemed at their initial redemption dates, which are usually 10 to 30 years after their issuance dates. First, some of the older CTS give investors the right to exchange their holdings into preferred shares that in turn can be exchanged at principal value for common shares at a discount, which most issuers would prefer to avoid. As for the more recently issued CTS, if not redeemed, their coupon rates will reset to a specified Bankers Acceptance rate or GoC bond yield plus a very large spread. Second, issuers may face reputational risk, as investors purchased these products under the assumption that they would be redeemed early and that the 99 year final maturities were only there to satisfy regulatory requirements. If the issuer fails to redeem them early, they may have a difficult time raising capital using similar instruments in the future.


Basel II Disclosures Provide Greater Insight on Banks' Exposure to Credit Deterioration

RBC Capital Markets, 7 April 2009

Credit quality deterioration accelerated in 2008 and Q1/09, and we think provisions for credit losses will continue to grow and will likely be the biggest swing factor in bank earnings results in 2009 and 2010. In this report we look at the enhanced disclosure on credit risk exposures that the banks started providing in the last several quarters as a result of Basel II disclosure requirements.

Things that can be learned from Basel II disclosures include:

• Which banks have more exposure to unsecured retail loans. Of the four banks that provided disclosure, CIBC and TD have higher exposures to unsecured retail loans subject to the Advanced Internal Ratings Based (AIRB) approach for credit risk. Banks had previously disclosed total retail and credit card loans only, so the new disclosure helps isolate retail loans that are unsecured, which is the area that most concerns us in retail lending given the pace of job losses in Canada and the U.S.

• More stratified risk disclosures on business loan exposures. CIBC has the most exposure to wholesale loans subject to AIRB treatment that are non-investment grade, while TD Bank has the least exposure. We expect non-investment grade credits to default on loans quicker in an environment in which the economy is weak, credit spreads are wide and access to funding/liquidity can be difficult for lower quality borrowers.

• The higher relative retail and business loan exposures, in our view, would be related to product mix and, in the case of CIBC, having more of its loans subject to AIRB.

• Most banks that provided Q1/08 data saw faster year-over-year growth in exposures to higher risk borrowers in both retail and wholesale portfolios (largely driven by migration of existing customers, in our view).

• Banks are seeing growth in loans past due but not classified as impaired, which is new disclosure provided by some banks and is a good short-term indicator of impairment trends in our view.

• Some banks have yet to realize the full benefits of the Basel II implementation. National Bank will likely receive approval for AIRB in Q1/10, and we expect its Tier 1 ratio will rise by about 60–70 basis points at that time). Other banks such as TD and Scotiabank that still use the Standardized approach for large loan portfolios (mostly U.S. and international) may also see some benefit to capital ratios upon eventual adoption of the AIRB approach.

Bank disclosures under Basel II are still a work in progress and comparing bank exposures can be challenging in some areas because disclosures are different. We are monitoring the disclosures but believe that more time is needed before they become more consistent and can be relied on with full comfort.
Financial Post, Alia McMullen, 6 April 2009

The Canadian banking system is entering a period where two "mega trends" of remediation and deglobalization will pose significant challenges, the head of TD Bank Financial Group said Monday.

Ed Clark, president and chief executive of TD Bank said the global financial crisis, while now out of the panic phase, would take on a new dimension because of the large amount of government intervention in the world's banking system, namely in the United States, the United Kingdom and in parts of Europe.

He said the period the banking system was entering now would be defined by remediation within the industry, whereby Canadian banks would need to fund loans that would have previously been financed through securitization, and deglobalization, where banks retreat from foreign markets.

"The major foreign banks that used to play a role in Canada have all withdrawn from the marketplace, so Canadian banks have had to step in and replace that lending," Mr. Clark said. He said as the banking system deglobalizes, Prime Minister Stephen Harper appeared to be one of the few leaders in the world encouraging their country's banks to expand overseas.

Remediation is also starting to increase the pressure on Canadian banks to fund loans that were previously financed through securitization.

"The banks are having to fund industry where they used to be able to go out and use securitization vehicles to fund themselves, the auto industry would be the clearest example of that," he said.

Mr. Clark said government, particularly in the United States, had implemented partial solutions to the financial crisis. This has got the markets through the panic phase, but now left them "mystified" in their ability to respond to market conditions.

Mr. Clark said he did not agree with the U.S. government's two-prongued approach of addressing the financial crisis and the recession.

"They have the view that you can't have the economy work if the banks don't; I would say the banks won't work if the economy doesn't work," he said. He added this period of remediation, which was fuelled by a "false boom" in credit markets, would hurt Canada, and he did not believe the country could lead the world in recovery.

"Just because our banks didn't collapse, Canadians are running around saying, wow, aren't we terrific. But the reality is this economy is going to get whacked just as hard as economies around the world," Mr. Clark said.
Financial Post, Janet Whitman, 3 April 2009

Royal Bank of Canada is seeking to cash in south of the border on Canada's new cachet as the soundest financial system in the world.

The bank, which has about 450 RBC Bank branches in the southern United States as well as wealth management and investment banking services, launched an advertising campaign a few weeks ago that, for the first time, clearly plays up its Canadian ties.

"What we're doing now is taking advantage of the privileged position that Canadian banks are in," said Jim Little, chief brand officer with Royal Bank of Canada in Toronto. "Are we the new Swiss? I don't think so. We think there's a window. It may not last forever."

With more than 7,000 different banks to choose from around the country, most Americans have no idea or interest in whether theirs is Canadian-owned. But that is changing for a growing number of consumers and businesses who are concerned about the health of their banks as the U.S. financial system continues to teeter.

Whether it's because of their "Canadianness" or simply their strong financial shape, Royal Bank's RBC Bank, Bank of Montreal's Harris Bank and Toronto Dominion's TD Bank are seeing a surge in bank deposits, demand for loans and other business in the United States as their American rivals both big and small try to dig themselves out from years of reckless lending that has led to the massive U.S. government bailout of the industry.

With ailing U.S. banks clamping down on lines of credit and other loans, consumers and business customers are literally walking across the street and taking their business to Canadian-owned banks.

Worried about the safety of his account with a big American bank, Mark Stevens, a Bedford, N.Y.-based marketing consultant, is thinking about putting some of his money with a rival branch one town away owned by Canada's Toronto Dominion.

Yet, TD, like other Canadian banks historically, doesn't mention Canada anywhere in its advertising or at its branches in the United States.

Mr. Stevens, owner of marketing and P.R. firm MSCO and author of "Your Marketing Sucks," thinks that's a mistake.

"Canadian banks are like the equivalent of Swiss watches right now," he said. "It absolutely should be played up. Anyone who's shown Americans they can get higher quality elsewhere, they do. There was resistance to buying Japanese cars at first, but now Americans do."

TD Bank markets itself here as "America's Most Convenient Bank" and sees no need to tout its Canadian roots.

"The brand that we're trying to build is focused on convenience and service," said Neil Parmenter, a spokesman for TD's U.S. operations headquartered in New Jersey. "The mere fact that we're opening stores when our rivals are closing shows our strength."

Royal Bank's last-minute decision to add "Canada" to its new ad blitz came after its marketing research showed - in a surprise to the bank's executives - that Canada has a new appeal with Americans.

"It was an a-ha moment for us," said RBC's Mr. Little. "Canada is cool and relevant in the banking sector."

Even so, the Canada mention isn't being included at retail bank branches nor in ads directed at consumers, where being "local" is more important.

Instead, RBC is playing up its Canadian roots in ads appearing in places like the Wall Street Journal, BusinessWeek, The Economist and CNBC to appeal to investment bankers and wealthy individuals.

Yet, even without direct advertising, Canada is coming on the radar screens of U.S. consumers. The troubled U.S. banking system has sparked a lot more interest from its customers on the issues of strength and stability – two buzzwords with an increasingly strong association to the Canadian banking sector.

Recent media coverage in the U.S. and around the globe touting Canada's healthy financial system has caught the attention of a lot of customers, said Chris Nardella, a spokeswoman for BMO's Harris Bank in Chicago.

Still, no one is expecting "Bank Brand Canada" to sweep America. The average American customer is likely to remain preoccupied with the level of convenience and service a bank offers.

"The Canadian banks with their strong balance sheets have a great opportunity to grow their business at the expense of weaker American banks," said Gerard Cassidy, bank industry analyst with RBC Capital Markets in Maine. "The new business generated in this kind of environment is oftentimes quite good because the lender is going to be ultraconservative in its underwriting."
Financial Post, Theresa Tedesco and John Turley-Ewart, 3 April 2009

Mark Carney, governor of the Bank of Canada, neatly summed up this week what a growing number of financial leaders are saying about Canada's banks: "Our system is better."

From the World Economic Forum, which ranked it the soundest in the world, to U.S. President Barack Obama's reverent musings and Prime Minister Stephen Harper's gloating on the eve of the G20 meetings in London this week, the Canadian banking system is being feted for its resilience amid the economic mayhem.

Now, a study by a highly respected U.S. economist provides further grist for the adoring throng.

The research paper, Global Banking Rubble: Analyzing the Decade of Western Bank Value Destruction, for a Washington non-profit organization, reveals that conservatively managed, risk-averse and government-coddled Canadian financial institutions have made significant gains for the past 10 years, while their swashbuckling U.S. and British counterparts have steadily declined in value.

According to the study, led by Jan Vanous, a Yale University-trained economist and former senior economist and research director at Wharton Econometric Forecasting Associates, the market value of Canada's major chartered banks increased about 85% since 1999, at a time when the aggregate market capitalization of the top 50 international banks declined by 26%.

"Canadian banking is in great shape in relative terms," Prof. Vanous said in an interview with the Financial Post. "Canadian banks have shown significant value creation over the last decade."

The top five Canadian chartered banks, for example, have experienced a 99% increase in their market capitalization since 1999, despite being "more restrained" by strict government regulation and a prohibition on domestic mergers that forced them to grow organically. Major Canadian banks now account for 6.68% of the value of the world's 50 top banks, up from 2.48% in 1999.

More significantly, the top "value-destructing" global banks in the United States, the United Kingdom, Switzerland and Japan wiped out "a staggering 56%" of market value during the past decade. In fact, the study estimates the top 20 "destroyers" eliminated US$1.06-trillion in market capitalization between May, 1999, and mid-March, 2009.

Consider that in 1999, U.S. banks accounted for 42.93% of the total market value of the 50 most valuable financial institutions in the world.

Today, the study says, that figure has been slashed in half, to 21%. Ditto for the once-mighty British banks, which accounted for 14.87% of the world's most valuable banks a decade ago, and now represent 8.04% of that value.

"The destruction of value among the U.S. and British banks is mind-boggling," declared Prof. Vanous, whose research is part of a non-profit project to develop a warning system about asset-price bubbles and market distortions for the University of Michigan.

"There is little doubt the rest of the world could learn a good deal from how banking is done in Canada," Prof. Vanous told the Financial Post, "especially U.S. bankers who normally tend to look down on their Canadian counterparts as pedestrian."

Over the years, Canada's banking system has been much maligned for its notoriously conservative culture and government oversight. But that caution developed out of necessity, after its own eerily similar Wall-Street-style collapse nearly a century ago.

The five major Canadian banks that survive today -- from the 52 that existed in 1891 -- are the descendants of institutions that adopted prudential policies as the best defence against Canada's boom-bust economic cycles.

During its first 56 years -- 1867 to 1923 -- this country's banking system saw the collapse of about one-quarter of all Canadian banks. Stakeholders in failed banks lost an average 47 cents on the dollar, and generated political fallout for MPs and governments.

The banks were not audited by government and most bank boards paid too little heed to what management was doing. The outrage Canadians expressed after bank collapses roused the curiosity of U.S. business leaders, who were baffled by such uproars. Writing anonymously in New York City's Bradstreet's in March, 1888, one Canadian bank executive explained to Americans that the "unusual stability required by the Canadian people in their institutions" meant that bank failures caused "much sensation and distrust" in Canada.

That "unusual stability required by the Canadian people" was felt keenly by Canada's first government in 1867, which promised to create a safe banking system.

Instead, Ottawa gave Canadians the 1871 Bank Act, which amounted to a collection of banking pointers rather than enforced regulations. Soon after the First World War, the cracks in Canada's unregulated banking system grew too big to ignore.

In 1914, Canada had been a debtor nation. Four years later it was lending what today would amount to billions of dollars to the British to finance the purchase of war supplies and agricultural produce from Canada.

The number of Prairie farmers grew by 114%; acres under cultivation in Canada climbed from 48.3 million in 1911 to 70.8 million by 1921. Between 1913 and 1919, Canada's national income soared from $2.4-billion to $4.2-billion and inflation was running at more than 20% a year when the war ended.

Armed conflict had created an economic bubble.

Between the Armistice in November, 1918, and January, 1919, 200 new bank branches opened across Canada. There was approximately one bank branch for every 3,500 people -- today that number is closer to one branch for every 5,000.

Consumer financing took off: Loans for cars were granted, driving up the demand for autos; people borrowed money to invest and speculate on land -- and the leverage grew.

Canada's financial reckoning began in the summer of 1920, when the bubble finally burst. Peace-time could not generate war-time demand for Canadian produce and manufactured goods.

Banks began to falter led by feckless executives. Among the first was the Merchants Bank of Canada, the fourth largest bank in the country at the time.

D.C. Macarow, a suave banker well-known in Montreal's gilded social circles, became the Merchant's chief executive in 1916. Competition between the banks was fierce and Macarow risked large loans to unproven enterprises.

In 1920, he approved loans to two questionable firms from $800,000 to $6-million. It soon became apparent the loans would not be repaid. This, plus heavy losses incurred at other branches in 1920 and early 1921, moved the bank's president, Sir Montagu Allan, to have an independent audit undertaken.

The inspection revealed that Macarow and a small number of other senior managers had gambled with the bank's future and lost. Millions were written off, leaving little provision for coming losses that would surely hit as the economy spiralled downwards. Behind closed doors, a deal to merge the Merchants with the larger Bank of Montreal began with the minister of finance's approval.

When the merger was announced on December 16, 1921, Merchant bank shareholders were shocked to learn they were much poorer than they thought. More importantly, the heated public reaction meant the old political rules -- leaving banking to bankers -- were now untenable.

The Financial Post at the time editorialized that the Merchant Bank fiasco demanded a thorough investigation and that the Bank Act was "defective." Calls for an investigation turned to public outrage when criminal prosecutions against Macarow and Allan were dismissed in court.

Ottawa's response inadvertently culled the weak and insolvent banks that continued to operate after the Merchants demise.

The Bank Act was to be revised with new standards and enforceable regulations. Assets had to be marked-to-market and all Canadian banks were expected to operate according to conservative principles -- that is, to ensure they fulfilled their primary duty to remain solvent. Independent audits were to be standard, performed by firms prohibited from taking retainers or any extra work from banks they were reporting on.

The revised Bank Act was passed by Parliament and went into force on Oct. 1, 1923.

But before it did, the law unleashed a wave of panic in many bank boardrooms.

The Winnipeg-based Union Bank of Canada announced it was writing off millions in losses that just months before it had characterized as valuable assets. Similarly, Toronto-based Standard Bank of Canada wrote off millions that it too had previously classified as valuable assets.

The Bank of Hamilton chose a different path. Rather than admit it had been massaging the books, its management sought a quick merger with the larger Canadian Bank of Commerce.

Similar scenarios involving other banks played out in Montreal.

However, one bank was beyond help -- the Home Bank of Canada. Based in Toronto with most of its 72 branches located in Ontario and western Canada, the relatively small Home Bank had been a fraud since it was chartered in 1903, and catered largely to working-class families. Their savings were used to finance ludicrous ventures such as Casa Loma, the castle-like home that the eccentric land-speculator, hydro-developer Henry Pellatt erected in Toronto. Pellatt couldn't repay his loans; neither could a large number of the firms and individuals to whom the Home Bank had lent working people's money.

With the revised Bank Act in hand, the Home Bank's management shuttered the bank in August, 1923, ensuring they would avoid criminal conviction under the new federal rules.

Canadians were enraged. A Royal Commission was eventually struck as compensation was demanded for depositors, who in the end lost 68 cents on the dollar.

The Home Bank failure led to Ottawa's imposition of government bank inspection on all banks in 1924, laying the foundation for the regulatory system now being celebrated around the world.

Canada's major five banks are reaping the rewards of that conservative culture nurtured so long ago.

Few would have predicted that Canadian banks, long derided as among the least autonomous because of strict government oversight, would emerge from the global mayhem as the most independent international players.

"One could say we were over-regulated, but our solution is going to lead to us having the most free-enterprise financial sector in the world," beamed Prime Minister Harper to the British press at the G20 summit in London this week.

Today, Canada's major banks remain profitable and are still paying dividends to shareholders, while their global competitors are being bailed out with taxpayers' money. While their American peers were loading up their books with toxic mortgages, Canadian banks appeared leery of the housing market risks.

Although Ottawa has committed to buying $125-billion worth of insured mortgages, increasing banks' capacity to lend, but has only spent $40-billion of that so far. The move is not expected to cost taxpayers a penny. In fact, most analysts predict Ottawa will eventually make money on those assets.

Another sign of their growing strength: All five major Canadian chartered banks currently rank among the top 50 in the world; all five are listed in North America's top 12 and two Canadian banks -- Toronto-Dominion Bank and Royal Bank of Canada -- are among the seven major global financial institutions that currently enjoy a coveted triple-A credit rating from Moody's.

Manulife's Variable Annuity Business Cushioned

CIBC Wood Gundy, April 2009

The primary concern surrounds Manulife’s variable annuities, which are equity-related products that guarantee customers will receive fixed annual income streams, even if stock markets fall. Although many of these products do not begin to mature for five to seven years, leaving considerable time for markets to recover, Manulife must set aside reserves to cover any potential shortfall between the value of the guarantees and the assets it has invested to cover the guarantees. Setting aside such reserves hurts the company’s earnings and lowers its capital ratios, which must stay above predetermined levels. As of March 12, when global stock markets were more than 10% below current levels, CIBC World Markets Inc. analyst Darko Mihelic estimated that Manulife’s capital ratios were still at the upper end of the company’s target range.

Mr. Mihelic believes, however, that Manulife could take steps to boost its capital ratios if markets were to decline significantly below their recent lows; such measures could include a dividend cut. Even if the company decided to issue additional shares to shore up its capital position — a worst-case scenario in Mr. Mihelic’s view — he believes Manulife could still earn $2.18 per share on a normalized basis, leaving its shares trading at an attractive 6.8x. If equity markets recover, the insurer’s stock could look even more compelling.

While the recent rebound in equity markets has already provided a lift to Manulife’s shares, if markets continue to rise, its stock could still be one of the biggest beneficiaries yet. Mr. Mihelic rates Manulife Sector Outperformer (Price Target: $25.00).
Financial Post, David Pett, 7 April 2009

The concerns about the health of Manulife Financial Corp.'s segregated fund and variable annuity business appears to be misguided based on the latest number crunching from Scotia Capital analyst Tom McKinnon.

In a new report that combs over Manulife's variable annuity guaranteed cash flows, reserve, required capital and related sensitivities, Mr. McKinnon says the lifeco is in solid shape.

He told clients that the minimum continuiing capital and surplus requirements for Manufacturers Life Insurance Company, the Manulife subsidiary from which all equity related business flows through, was 218% at the end of the first quarter and likely around 228% currently.

"We believe the company has more than an adequate cushion, and estimate that a 25% drop in equity markets from Mar. 31, 2009 levels (an S&P 500 below 600) would put the ratio at the bottom of its 180% - 200% target range," he wrote.

If markets fall by more than 25%, Mr. McKinnon still believes Manulife has options at its disposal to maintain its ratio at an adequate level, including a subsidiary reorganization, "whereby John Hancock Life Insurance Company, with no variable annuity exposure is consolidated into Manufacturers, thus reducing equity market sensitivity by one-third."

The analyst added that Manulife could also issue more debt or preferreds and possibly reinsurance.

He maintained his "sector outperform" rating and left his $30 one-year price target unchanged.
Financial Post, Jonathan Ratner, 7 April 2009

The decision by Seamark Asset Management Ltd.’s largest wrap partner to stop using the Halifax-based firm’s investment services has a growing list of analysts suggesting privatization is the only way out.

John Aiken at Dundee Capital Markets told clients the current environment shows no signs of a reversal for Seamark’s net redemptions, while the end solution is most likely a privatization by Manulife Financial Corp. or a management buyout. Manufacturers Life Insurance Co., a wholly-owned subsidiary of Manulife, is Seamark’s largest shareholder at 31%.

Mr. Aiken estimates that the departing client represents 40% to 50% of private client and wrap account assets under management. The move automatically triggers a review by other wrap program partners, which puts additional assets in jeopardy.

“With the departure of its largest customer (again) and negative headwinds facing Seamark, profitability is likely to take another hit as efficiencies are negatively impacted by additional declining scale,” the analyst said.

He reduced his earnings estimates to 8¢ per share for 2009 and 7¢ for 2010, down from 10¢ and 12¢, respectively. Mr. Aiken also cut his rating on the stock from “neutral” to “sell” and his price target from $1 to 80¢.

Michael Mills at Beacon Securities suggested that based on historical disclosures, BMO Nesbitt Burns is likely the partner in question. He noted that it represents an estimated $250-million to $350-million in assets, while Seamark’s entire wrap AUM at the end of December 2008 stood at $790-million.

“We believe the likelihood of a privatization or take-out of the firm increases with each passing week,” the analyst said in a research note on Monday. “Unfortunately, without sticky assets and a stable investment team, there is little value to be realized, in our opinion.”

Seamark shares are down about 70% in the past 12 months but have risen roughly 10% in 2009.
Financial Post, Jonathan Ratner, 26 March 2009

While insurance companies proved to be sensitive to stock markets on the way down, the same case can be made on the way up during this recent rally. Last fall, this sensitivity increased as off-balance sheet guarantees were assumed to be in the money.

With lifecos in Canada and the U.S. having fallen much further that the S&P/TSX composite index and S&P 500, respectively, there is a growing call for better disclosure about this sensitivity.

“If this information had been better understood before stock markets plunged in the second half of 2008, investors would have had a better sense of potential risks on an absolute as well as relative basis,” Desjardins Securities analyst Michael Goldberg told clients.

He noted that since September 2008, the S&P 500 has fallen by 29% and the TSX by 24%, while U.S. lifecos have declined 64% and their Canadian counterparts 55%. That equates to two or three times the market declines. U.S. and Canadian banks, meanwhile, have lost 54% and 32% of their respective values during the same period, which shows they are less sensitive to equity markets.

While Manulife Financial Corp. appears to be the most sensitive lifeco to equities, Mr. Goldberg still calls Canada the ‘Goldilocks of the insurers.’ “Market movements and sensitivity had explained a large portion of the relative performance of life insurers around the globe in the early 2000s, with the worst performance from European companies, followed by U.S., then Canadian companies, he said.

During the stock market decline and credit downturn of the early 2000s, it was relatively straightforward to understand what was expected from insurance companies in the U.S. and Europe. European insurance companies often had a substantial portion of their investments tied to their surplus capital invested in equities. Mr. Goldberg points out that this time around, European lifecos had equity investments equivalent to 80% to 100% or more of their surplus. “So when stock prices dropped by 30%, a significant chunk of their capital vapourized, which constrained their ability to grow.”

U.S. lifecos got hit because of their investment for income – earning them the label ‘yield hogs.’ They held a significant amount of high-yield debt and insurers who had been downgraded to non-investment grade, the analyst explained, which lead to many credit problems.

But Canadian lifecos, who invest for total return, did not suffer from these extremes. Mr. Goldberg says the domestic landscape is therefore like a bowl of porridge that is neither ‘too hot nor too cold,’ due to its balance of equity and debt investments.

If insurers provided additional disclosure in terms of their exposure to equity investments, he insists the sell-off in their shares would have been less indiscriminate and it would make it easy for analysts to predict these trends.

“This would have provided a more dynamic picture of the market equity exposure of life insurance companies than we currently have,” he added. “Not only would disclosure of this nature have been beneficial for investors for the reasons mentioned above, but also for the companies as they were affected by the indiscriminate sell-off resulting from uncertainty and fear of the unknown.”

02 April 2009

TD Bank Hopes to Maintain Earnings from Falling in 2009

Reuters, Jeffrey Hodgson, 2 April 2009

Toronto-Dominion Bank Chief Executive Ed Clark said on Thursday it would be a "big accomplishment" for Canada's No 2 lender to keep its earnings from falling in 2009, given the pressures of a weak economy.

Clark also said it would take far worse economic conditions before the bank would consider cutting its dividend, although the current outlook means a dividend hike is also unlikely.

"In 2009, our job may be to simply maintain flat earnings per share. And, frankly, that would be a big accomplishment in today's environment," he told investors at the bank's annual meeting, held in Saint John, New Brunswick.

Clark had warned in February that while TD Bank would like to increase earnings this year, this would be "tough."

RBC Capital Markets said in a research note last month that Canadian banks should consider suspending their common share dividends. It said this would increase internal capital generation and reduce the need to raise capital if loan losses and writedowns accelerate.

Clark said that given their wide ownership by retail investors, the banks would be reluctant to cut their dividends and would do so "with agony".

"If the world turned out to be way more dire than any of us are contemplating, then you'd have a responsibility to look at those things. But I think we're a long way away from that," he told reporters after the meeting.

The chief executive had earlier told shareholders that TD has a policy of paying out 35 to 45 percent of earnings as dividends, but could go above this ratio in order to maintain its dividend.

"In the first quarter, we were right at the upper limit, the 45 percent," Clark said.

"If our earnings don't grow or if in fact they decline, as long as the economic environment remains reasonably stable, we can go above that ratio for a period of time, a considerable period of time, and not be in danger because of our strong capital base."

Clark also warned investors attending the meeting that they should not expect dividend hikes any time soon.

"We don't see this year, in 2009, that we will have significant earnings per share growth, so as a consequence of that it's unlikely that we would have dividend growth either."

Clark, who told Reuters early last month the bank was not considering U.S. acquisitions without regulatory assistance, said he was still wary of making big buys in the United States.

"The economic outlook remains sufficiently uncertain that other than deals where we can have significant protection against the assets that we acquired, we'd be reluctant to make a major acquisition now," he told reporters.

The bank is more interested in building out its U.S. branch network in its current geographic footprint, which it could fill out or expand with smaller "tack-on" acquisitions at some point, Clark said.
Bloomberg, Sean B. Pasternak, 2 April 2009

Toronto-Dominion Bank may post earnings this year that are little changed from last year, and is unlikely to raise its dividend as it sets aside more money for bad loans in the U.S.

“In 2009, our job may be to simply maintain flat earnings per share,” Chief Executive Officer Edmund Clark said. “That would be a big accomplishment in today’s environment.”

Provisions for credit losses in the U.S. may be higher than the bank previously estimated as the economy slows, Clark told shareholders at the bank’s annual meeting today in Saint John, New Brunswick.

Canada’s second-biggest bank is expected to post earnings per share of C$4.38 in fiscal 2009, based on a survey of seven analysts by Bloomberg. Net income was C$4.87 a share for the year ended Oct. 31, 2008.

Clark said he sees “enormous potential” in the bank’s U.S. business, and is likely to begin buying assets once it completes the integration of Commerce Bancorp Inc. this year. He may look at “tack-on” purchases, and plans to add 30 branches in the U.S. this year and in 2010.

The Financial Times reported this week that Canadian Prime Minister Stephen Harper urged banks such as Toronto-Dominion to capitalize on their strong balance sheets by buying banks in the U.S. Toronto-Dominion isn’t likely to do so immediately, Clark said.

Reluctant to Acquire

“Other than deals where we would have significant protection against the assets we acquired, we’d be reluctant to make a major acquisition now,” Clark told reporters after the meeting.

Toronto-Dominion has spent more than $15 billion over the past four years expanding in the U.S., buying Portland, Maine- based TD Banknorth and Cherry Hill, New Jersey-based Commerce Bancorp. Toronto-Dominion has more branches in the U.S. than in Canada.

“I think we can create ourselves a franchise, really, from Maine into Philadelphia (where) we are in the top-three slot everywhere in that territory,” Clark said.

In Canada, where the lender has 11 million consumer-bank clients, Clark said the bank is getting about 1,000 visits a week from customers seeking financial advice on mortgages, credit cards and other loans because of job losses.
The Globe and Mail, Tara Perkins, 2 April 2009

Toronto-Dominion Bank chief executive officer Ed Clark says the bank's U.S. loan portfolio will probably sour more than expected, but he stands by TD's decision to make a major U.S. acquisition last year.

“I recognize that some people are worried about our operations in the United States,” he told shareholders at the bank's annual meeting in Saint John on Thursday. “They wonder whether we can actually pull off the integration of TD Banknorth and Commerce.”

TD paid $8.5-billion (U.S.) for New Jersey-based Commerce Bancorp last year, a large acquisition that resulted in roughly half of the bank's branches being south of the border. However, three-quarters of the bank's revenue still came from Canada in its latest quarter.

In the U.S., “we're expecting to take greater provisions for credit losses than originally anticipated,” Mr. Clark told shareholders. But he said that TD's U.S. banking operation is performing better than its American peers, “and we're totally confident that the integration will be a complete success.”

TD's earnings dropped 27 per cent in the first quarter, to $712-million (Canadian), partially because of higher provisions for loan losses on both sides of the border. Its profit margins are also being squeezed by the high cost of raising money to lend. But Mr. Clark said the bank is showing that it's able to successfully attract deposits.

“Just this past weekend, we opened a store in New York City's Chinatown,” he said. “In just three days, we raised the same amount of deposits that other banks in the area would normally take four months to do.”

The bank's chairman assured shareholders at the meeting Mr. Clark deserves more than $8-million for his performance last year.

John Thompson told the annual meeting the CEO and his management team “had the foresight to avoid the U.S. subprime market; we didn't invest in or sell third-party asset-backed commercial paper and other risky financial instruments.”

As a result, Mr. Thompson said, TD avoided billions of dollars in losses and is ranked as one of the safest banks in the world.

The board awarded Mr. Clark $11-million in total compensation for 2008, down 19 per cent from 2007, and Mr. Clark then declined to take $3-million, for a total reduction of 41 per cent.

Mr. Thompson, noting that TD's share price is down by one-third from the start of 2008, said the stock market “hasn't differentiated between the winners and losers at this point in time, but TD is clearly a winner.”

He cited “a populist sentiment” that CEOs are overpaid, but emphasized that “great executive leadership is a rare talent, and obtaining rare talent in any field means that you pay a top price for it.”

Ahead of the annual meeting, TD last month joined the other Canadian banks in announcing that shareholders will get a so-called say on pay vote starting with next year's meeting.

Mr. Thompson said that “while your board fully supports the new shareholder advisory vote on pay, we truly hope that this power will be used judiciously and not become politicized in the future.”

Mr. Clark, who recently had its contract extended until at least 2013, told the meeting that he is “a cautiously optimistic guy” about the economy.

“The world is going to recover,” he said. “And this crisis, like most crises, will create opportunities if we remain prudent and patient and stay focused on our winning strategy.”

He also allayed worries about the 74,000-employee bank's sizable and growing presence in the northeastern United States, saying earnings are up 400 per cent since TD entered that market in 2005.

“The disruption has meant that many U.S. banks aren't lending,” while “our lending volumes have been terrific” and TD's financial solidity is making it “a bank of choice” for anxious Americans, he said.

In Canada, he stressed, TD is expanding its lending to hard-pressed businesses and consumers.

“TD is stepping in and replacing the foreign banks and non-banks that have withdrawn from the market,” he declared.

“For example, in our auto lending business, new loan originations have grown 43 per cent year-over-year.”

He noted that interest rates are at historic lows, and said profit margins are being squeezed as “the reality is that we've dropped our lending prices by more than we've dropped our deposit rates.”

TD is “managing our businesses as if it will get tougher before it gets better,” he added, planning 20 new Canadian branches this year after 30 in 2008.

He repeated that for this year simply maintaining flat earnings per share will be a big accomplishment.

“We can have a good debate about how long this crisis will last and how deep it will go,” Mr. Clark said. “But I think the important message is that things will get better.”

In a press conference following the bank's annual meeting, Mr. Clark said he welcomes Prime Minister Stephen Harper's comments that the government would be supportive if the big Canadian banks made acquisitions abroad, noting that it runs counter to the isolationist sentiment that's increasingly being expressed by some governments.

However, he said that TD has no plans to make another major acquisition in the near future. The bank is still digesting Commerce Bancorp, and will have a better sense toward the end of this year of where the economy lies. Any major acquisition would likely be in the U.S. because there are no significant takeover opportunities in Canada, and TD doesn't plan to do any significant deals outside of North America, Mr. Clark said.

As for dividends, Mr. Clark reiterated that all of the big Canadian banks would be very reluctant to cut them. He suggested that it's easier for U.S. banks to cut their dividends because a larger proportion of their shareholder bases are generally institutional, rather than individual, investors. For Canadian banks, it would be an agonizing move, he said.

“We're all sitting here saying lets try to get through here without doing that,” he said. “But there's no quick answer,” he added. “If the world turned out to be way more dire than any of us are contemplating, then you have a responsibility to look at those things, but I think we're a long way away from that.”

01 April 2009

Canadian Banks Not Rushing to Make US Acquisitions

Bloomberg, Doug Alexander, 1 April 2009

Royal Bank of Canada Chief Executive Officer Gordon Nixon says the worst of the financial crisis may be over.

“The financial services crisis has stabilized,” Nixon said in an interview yesterday in New York. “The worst is over.”

Still, Canada’s biggest lender is in no rush to buy U.S. banks. The Toronto-based bank hasn’t made a U.S. acquisition since its $1.64 billion takeover of Alabama National BanCorporation in February 2008, even as the financial crisis has driven down bank stocks.

Prime Minister Stephen Harper is urging the Canadian lenders to take advantage of their strengths to expand abroad, according to an interview published yesterday in the Financial Times.

“There’s no question that if you believe that companies in your country should be continuing to expand, to grow internationally, it is an opportunity today that wasn’t there previously,” Nixon said. “At the same time, in today’s environment, you don’t want to do things that compromise your financial strength.”

Nixon said there is still too much “uncertainty” in the U.S. market to make acquisitions to add to its consumer bank based in Raleigh, North Carolina and its New York- based investment bank.

“We’re not capable of making decisions in an environment with a significant degree of uncertainty in terms of what regulation rules are,” Nixon said. “Until that uncertainty clears up, we’re going to continue to be fairly conservative.”

Royal Bank’s patience may be rewarded, said Ian Nakamoto, director of research at MacDougall MacDougall & MacTier Inc. in Toronto, which owns Royal Bank shares among about $2.4 billion in assets.

“There still seems to be a lack of confidence in U.S. financials,” he said. “Why should you rush in now and buy something? Those who have gotten in early have paid the price dearly.”

Nixon said the bank is more concerned about the economy than about the crisis in the financial services industry. Rising loan losses led to a 15 percent decline in first-quarter profit, to C$1.05 billion ($830 million).

“What we are watching much more carefully today is Main Street,” he said. “What’s happening to credit cards, what’s happening to consumer loans.”

Nixon said opportunities are emerging to deploy capital in the U.S. at attractive rates of return due to the need for capital.

“We’re certainly spending a lot of time thinking about how we take advantage to some degree of what may unfold in the U.S. marketplace and other parts of the world,” he said. He added that Royal Bank may pursue acquisitions “over the next three years.”

Nixon, 52, wouldn’t say what business areas Royal Bank would target when it resumes acquisitions.

“This is going to sound really boring,” Nixon said. “We have been saying the same thing for the last eight years since I’ve been around, which is that we like our diversified strategy because we think it serves us well through good times and difficult times.”

He said the bank tries to limit its investment-banking earnings to no more than 30 percent of overall profit, with the rest coming from consumer lending and money management.

Royal Bank has spent more than C$2 billion on U.S. acquisitions in the past three years, including Atlanta- based Flag Financial Corp. and Alabama National. The bank also bought RBTT Financial Holdings Ltd. in Trinidad and Tobago for about $2.2 billion in June.

“There are probably going to be significantly better opportunities over the next five years than during the last five years,” Nixon said.
Bloomberg, Doug Alexander, 31 March 2009

Royal Bank of Canada Chief Executive Officer Gordon Nixon isn’t afraid of being called “boring” for not rushing into U.S. takeovers during the worst financial crisis since the Great Depression.

“Being boring is all of a sudden not a bad thing,” Nixon said in an interview today in New York.

Royal Bank, Canada’s largest lender by assets, hasn’t made a significant U.S. acquisition since its $1.64 billion takeover of Alabama National BanCorporation in February 2008, even as the financial crisis has driven down bank stocks and threatened the survival of some lenders.

Prime Minister Stephen Harper is urging the Canadian lenders to take advantage of their strengths to expand abroad, according to an interview with the Financial Times. The country’s six biggest lenders reported less than C$20 billion ($16 billion) in debt-related writedowns since the credit crisis began in 2007, about 2 percent of the $914 billion recorded by banks and brokerages worldwide.

“We’re not capable of making decisions in an environment with significant degree of uncertainty in terms of what regulation rules are,” Nixon said. “Until that uncertainty clears up, we’re going to continue to be fairly conservative.”

Nixon said opportunities are emerging to deploy capital in the U.S. at attractive rates of return due to the need for capital.

“We’re certainly spending a lot of time thinking about how we take advantage to some degree of what may unfold in the U.S. marketplace and other parts of the world,” he said. He added that Royal Bank may pursue acquisitions “over the next three years.”

Nixon, 52, wouldn’t say what business areas Royal Bank would target when it resumes acquisitions.

“This is going to sound really boring,” Nixon said. “We have been saying the same thing for the last eight years since I’ve been around, which is that we like our diversified strategy because we think it serves us well through good times and difficult times.”

He said the bank tries to limit its investment-banking earnings to no more than 30 percent of overall profit.

Royal Bank has spent more than C$2 billion on U.S. acquisitions in the past three years, including Atlanta- based Flag Financial Corp. and Alabama National. The bank also bought RBTT Financial Holdings Ltd. in Trinidad and Tobago for about $2.2 billion in June.

“There are probably going to be significantly better opportunities over the next five years than during the last five years,” Nixon said.

As many as 1,000 U.S. banks may fail in the next three to five years, almost double the one-year tally at the height of the saving-and-loan collapse, as losses mount on commercial real-estate loans, RBC Capital Markets analyst Gerard Cassidy said in a Feb. 9 interview.
Financial Post, Eoin Callan, 31 March 2009

The two men who walked through the doors of the bank branch in Cleveland were both older, neatly dressed and polite.

Claiming to be real-estate brokers, the pair inquired about opening a business account and were given a quick tour.

Suspicion was aroused only after their inquiries strayed beyond the norm to the number of tellers on duty behind the counter.

Then the pair blundered, betraying total ignorance of local geography, before bolting.

"We knew our cover was blown," said one of the men in a recent interview.

While the pair's identity remains a mystery to staff at the branch, the duo were in fact two of the most senior executives of Bank of Nova Scotia, Canada's third-largest bank.

They were casing the joint as they mapped out a plan to knock off all 1,400 branches of National City in a multi-billion-dollar takeover of the regional U.S. bank.

The plot was foiled when the U.S. government unwittingly erected barriers to foreign takeovers with a series of interventions to protect the country's banking system.

Although inadvertent, the U.S. Treasury scared off many buyers of banks when it agreed last fall to inject $250-billion into more than 300 banks through the Troubled Asset Relief Program (TARP).

"The TARP money really slowed down the process of consolidation," said Rob Sedran, an analyst at National Bank Financial.

But things may start to change later this month when the U.S. is expected to give the healthiest banks a green light to start repaying government funds, and to seek strong partners for those on the sick list.

This is seen as one step in a series of developments that could help put acquisitions back on the agenda for Canadian banks, which stand out in the West for having escaped the worst of the financial crisis.

Two of Bay Street's biggest banks -- Royal Bank of Canada and TD Bank -- rank in the top 20 worldwide by market capitalization for the first time, while all of the big five are in the top 50.

The remarkable rise in standing does not reflect a steady increase in the value of Canada's banks, but rather a sudden and stunning plunge in the worth of former giants.

Yet it still puts Canada's banks at the head of a select class of institutions with international experience and an appetite for retail franchises in the vast expanse of middle America.

Prime Minister Stephen Harper has been cheering the sector on, giving his full support to international expansion as he strikes a proud note in the run up to a summit of leaders of the Group of 20 nations in London.

Still, executives up and down Bay Street stress they are using an abundance of caution when evaluating opportunities, and are reluctant to place bets on the direction of the U.S. economy.

They confess to frequent phone calls from U.S. regulators over the last six months testing their interest in shot gun marriages, but have so far demurred.

TD was among the handful of banks that held talks about rescuing Washington Mutual, the large West-coast bank that was acquired by JPMorgan.

But Ed Clark, chief executive, has since said he will concentrate on expanding TD's existing footprint, which is planted in the affluent north east, with toes stretching to the beaches of Florida.

One of the biggest impediments to deals up until now has been the uncertainty over the quality of loans on the books of American banks that has defined the credit crisis.

This is due to be addressed somewhat later in April when the U.S. examiners complete stress tests of the 20 biggest American banks.

The tests are expected to produce a government-certified health report that is a precondition to repayment of capital, though this could drag on for many months.

While the ordeal will reveal some institutions to be in critical condition and in need of capital injections, the process is designed to dispel uncertainty.

Analysts do not expect this to be a panacea, and forecast a long wait before normal merger activity resumes.

Nonetheless, branch managers in select states may not need to be too alarmed if they start encountering pairs of exceedingly neat and polite gentlemen making unusual inquiries.