30 June 2009

Top 1000 World Banks 2009

Dow Jones Newswires, Monica Gutschi, 30 June 2009

Canada's biggest banks may have been rated the world's soundest by the World Economic Forum, but they are still relatively small by global standards.

Not one of the country's leading lenders cracked the Top 25 in The Banker's 2009 survey released Tuesday. The list was led by JP Morgan Chase & Co., which moved up from number four last year.

Royal Bank of Canada came in at number 34, while Bank of Nova Scotia was 40, Toronto-Dominion Bank was 46, Bank of Montreal was 52 and Canadian Imperial Bank of Commerce was 71.

However, two of the banks were included in the Top 25 of largest profits, with Royal Bank ranking 10th and TD Bank at number 24. That list was led by Industrial and Commercial Bank of China, which moved up from number eight last year.

And CIBC fell into the list of Top 25 Largest Losses, at number 15. That list was led by Royal Bank of Scotland, with losses of $59.3 billion.

The Banker, a part of the Financial Times Group, will include the full list in its July edition.

The Top 1000 list has been published since the 1970s and ranks global banks by their capital strength. In a press release, the publication said the survery showed that the world's Top 1000 banks have had "an abysmal year."

It noted system profits fell 85.3% to $115 billion from $780.8 billion, as return on equity dropped to 2.69% from 20%.

The Banker: Top 1000 World Banks 2009.
Financial Post, Theresa Tedesco, 24 June 2009

Canada's vaunted conservative banking culture offers its financial institutions a competitive advantage during economic downturns, but the edge they now enjoy over their global counterparts will likely disappear in about a year, says a top U.S. banker.

Robert P. Kelly, chairman and chief executive of Bank of New York Mellon, told a Toronto audience Wednesday that Canadians "should be proud" of their financial system because the "hard-core reality is that it's a system that works."

However, the 56-year-old head of the fifth-largest bank in the United States with total assets of US$220-billion, cautioned that while Canadian banks have "a huge competitive advantage right now, you have a window that'll probably last 12 to 18 months."

Mr. Kelly's comments were made during a two-hour panel discussion moderated by John Manley, former deputy prime minister, on how Canada and the United States are managing their financial systems in response to the current credit crisis.

Rick Waugh, CEO of the Bank of Nova Scotia, was the other panelist on the panel, sponsored by the Canada Institute of the Woodrow Wilson International Center.

Mr. Waugh told the blue-chip Bay Street audience that the "Canada brand has never been better," and acknowledged that it was a good time for the banks to take advantage of the country's favourable international reputation.

"The American model is broken and the whole world knows that," he said. "The doors are as wide open as I've ever seen. This crisis has created an opportunity and we have a leg up on the Americans."

Mr. Kelly cited three main reasons for the success of Canada's banks during the recent financial meltdown. He pointed to the "mess" in the US$18-trillion mortgage market south of the border, securitization markets that went "out of control," and a "mature, well-run and well-managed financial system" in Canada that does not exist in the United States.

For example, Mr. Kelly, a former vice-chairman at Toronto-Dominion Bank, said the United States does not have a national banking system, and while the regulatory reform package proposed by President Barack Obama last week is "largely a good thing," it still doesn't go far enough to consolidate the number of regulators and players in the industry.

For his part, Mr. Waugh credited Canada's system of "checks and balances" and "good governance" in the public and private sectors.

The head of Scotiabank, the third-largest in Canada by market capital, cited the macroeconomic policies of the Bank of Canada and regulatory oversight of the Office of the Superintendent of Financial Institutions, as well as "good management" practices inside the executive offices of the banks, especially prudent risk and capital management practises, as reasons for the stable financial sector.

"The back-up systems are working even though they may be far from perfect, they are working," he told the crowd of about 125 people. "There was not one regulation that said, ‘Don't invest in subprime and don't invest in toxic assets,' and yet no financial institution here got in over their heads."

Still, Mr. Waugh predicted that shareholders will have to recalibrate their expectations because there is still a lot of deleveraging to occur.

"We are resetting a new norm. That means a lower level of absolute profitability, lower level of savings and growth rates," he warned.

While Mr. Kelly is the latest to heap praise on Canada's financial system – he joins President Obama and the Geneva-based World Economic Forum – he seemed to caution against smugness.

"Canadians are more conservative by nature and that's a competitive advantage in a downturn but it's not a competitive advantage when things are good," he said.

"Over time, don't bet against the U.S.," Mr. Kelly warned, saying there is no greater growth system than U.S. capitalism because it encourages innovation, risk-taking and the rise of the best people to the top of organizations.

"A lot of bad things have happened with the U.S. capitalist system," Mr. Kelly said. "It's good to learn from its mistakes, but what's really hard is to implement the good aspects. Canada is very well-positioned."

23 June 2009

Analysts Cut Manulife's Q2 2009 Earnings Estimates

Scotia Capital, 23 June 2009

Three Separate Unrelated Events

• As expected, Peter Rubenovitch will step down as CFO, and will be replaced by Michael Bell, former CFO at CIGNA. We believe Bell, 45 and an actuary, is keen and very capable, and will fit in well with the MFC culture.

• Completely unrelated is an announcement from MFC that it received a notice from the OSC saying it failed to meet its disclosure obligations with respect to segregated fund VA risks prior to March 2009. The company has the opportunity to respond to the notice before OSC staff makes a decision whether to commence proceedings. This comes as a surprise to us and the company, as we believe MFC has continuously had the best disclosure with respect to these risks (the only North American lifeco to disclose the net amount at risk). Receipt of such notice is not a disclosable event, and it could very well be that other companies have received such notices. It's hard to speculate where this issue might go, but an immaterial fine could be construed to be a worse case scenario.

• MFC announced it expects a significant portion of the QOQ gains it'll make from the equity market rebound in Q2/09 (we had anticipated the gains would amount to $1.50-$1.60 in EPS) would be offset by increase in reserves for various items, namely due to declines in corporate long-term interest rates, increases in reserves for fewer-than-expected lapses on products, and smaller private equity gains. As such, we are taking down our Q2/09 estimate to $0.45 (in line with our Q3/09 and Q4/09 estimates of $0.48 and $0.54, respectively, which on average are a good proxy for an underlying EPS run-rate) from $1.75, essentially removing about 85% of the QOQ gain from equity markets. We suspect MFC will continue to strengthen its balance sheet in these uncertain times, and will continue to bolster its capital position. We estimate the company's MCCSR could be in the 250%+ range at Q2/09, the highest we've seen it.
Financial Post, John Greenwood, 22 June 2009

Shares in Manulife Financial Corp. fell the most in about seven months Monday in the wake of the company's announcement Friday that recent capital markets gains may be offset by increases in reserves that it expects to make against bonds and other investment products.

Manulife shares fell $2.83, or 12.17%, from Friday to close at $20.42, their lowest level since the start of May.

In a note to clients, Credit Suisse analyst Jim Bantis said the sharp drop may be "excessive," adding it has created a buying opportunity for investors.

But Mr. Bantis cautioned that Manulife is facing possible structural changes as it works to boost capital levels that may impact return on equity.

Meanwhile, Scotia Capital analyst Tom MacKinnon slashed his second-quarter earnings estimates for the company to 45¢ a share down from $1.75 following Manulife's announcement that recent capital market gains will be offset by its efforts to bulk up on reserves.

Andre Philippe Hardy, an analyst at RBC Capital Markets, also cut his second quarter forecast following the company's announcements.

The matter with the OSC will likely take some time to be resolved, he said in a note, adding he would be "surprised" if the outcome is detrimental to Manulife's financial condition.

Mr. Hardy lowered his earnings estimate for second quarter of 2009 by more than 40% to $1 a share from $1.83 over concerns that investment gains from rising stock markets would likely be gobbled up by reserve adjustments.

Toronto-based Manulife was hurt by turmoil on equity markets this year as investment values plummeted. With the recent market recovery the company's position improved, but on Friday afternoon it warned investors not to get carried away.

"Manulife has enjoyed great benefit from strengthening equity markets but, at this time, expects a significant portion of this could be offset by actuarial reserve increases," it said in a statement.

Manulife also announced it had received an enforcement notice from the Ontario Securities Commission regarding disclosure of risks the company faced with respect to various guaranteed investment products that it sells.

Manulife, which believes it did nothing wrong, said the enforcement notice reflects a "preliminary" conclusion on the part of OSC staff and that it will have an opportunity to respond before the regulator decides whether to launch proceedings.

Manulife had limited hedging on its guaranteed variable annuity and segregated fund products to protect against market downturns. At issue is the level of information about its hedging strategy the company disclosed to investors.

There is a wide range of opinion on Bay Street, but according to Scotia Capital's Mr. MacKinnon Manulife has "disclosed more than most lifecos on these risks."

Indeed, "receipt of such notice is not a disclosable event, and it could very well be that other companies have received such notices," the analyst said in a note to clients.

17 June 2009

Review of Banks' Q2 2009 Earnings

Scotia Capital, 17 June 2009

Bank Earnings Near Cyclical Bottom

• Canadian banks reported strong second quarter earnings, handily beating consensus estimates. Earnings were driven by robust wholesale banking earnings, loan repricing, and securitization revenue that offset higher credit costs. Mark-to-market writedowns declined and show signs of abating further.

• Operating return on equity was 17.1% despite 83 basis points (bp) in loan losses and some dilution from common equity issues. Bank reported return on equity on a fully loaded basis remained in double digits at 10.6%.

• Second quarter operating earnings declined 7% year over year (YOY) and 10% sequentially, representing the sixth straight decline in quarterly earnings on a YOY basis. We expect the third quarter of 2009 earnings to be the low of the cycle, with quarterly earnings momentum starting to turn positive in Q4/09 and Q1/10.

• Bank second quarter earnings provide some basis for optimism that earnings are near the cyclical bottom based on an improved outlook for the net interest margin, credit cost absorption, and the expected sequential improvement in wealth management earnings based on the major market rebound.

• We believe that BMO reported the strongest results this quarter, followed by NA, BNS, RY, and TD, with CM the weakest. In terms of domestic banking earnings including wealth management, BNS and NA were the most resilient, declining 1.2% and 2.6%, followed by BMO, TD, and RY declining 3.7%, 4.3%, and 6.9%, respectively, with CM the major outlier, down 25%.

Wholesale Earnings Robust

• Wholesale earnings remained extremely robust, driven by strong trading revenue. Trading revenue this quarter at $2.8 billion was down from the all-time record $3.4 billion level in Q1/09 but remained very high, reflecting the Canadian banks’ preferred counterparty status, OTC spreads, and structural expansion in their trading books and platforms. The trend of growing earnings power from wholesale banking is very much intact. The reduction in capacity in wholesale and the major dislocation in this market has created significant opportunities that continue to be more and more evident. There is a structural shift, not just cyclical.

Net Interest Margin Resurgence

• The resurgence in the banks’ net interest margin (NIM) may represent a significant inflection point for the bank group. The banks’ net NIM received some relief in the second quarter, driven by historically high wholesale spreads, aggressive loan repricing (liquidity/risk premium), and steeper yield curve.

• The retail NIM declined 10 bp YOY, with mixed results among the individual banks sequentially. Retail NIMs were positively impacted by securitization, variable rate loan repricing, and attractive transfer pricing, which helped offset the negative impact from the low level of interest rates. BMO, TD, and BNS retail NIMs improved sequentially by 17, 12, and 6 bp, respectively. Conversely, NA, RY, and CM NIM declined 6, 3, and 3 bp, respectively. It appears that the retail NIM has bottomed for some banks and is bottoming for others, after declining for the past eight years. Further margin expansion is likely, aided by the continued repricing of the loan book. The improved outlook for both the overall NIM and retail NIM should be very supportive to earnings going forward.

Higher Capital – Lower Mark-to-Market

• Tier 1 capital ratio for the bank group was an all-time record of 10.7%, driven by internally generated capital, modest capital raises, and some RWA relief via the higher Canadian dollar. TCE to RWA increased to 7.6%. We also expect book value gains as a result of a reduction in the unrealized AFS losses in OCI in the third quarter based on the significant improvement in corporate bond spreads.

• Mark-to-market writedowns were $1.2 billion after tax in the second quarter, down from the $2 billion level in the two previous quarters. We expect mark-to-market losses to continue to decline given the rally in the LCDX Index, tighter CDS spreads, and the significant improvement in corporate bond spreads.

Credit Losses Peaking

• Loan loss provisions (LLPs) this quarter increased to $2.5 billion or 83 bp of loans, 7% higher than our forecast. LLPs are 2.2x higher than a year earlier and reflect the sharp deterioration in the economy and credit quality. Bank LLPs typically peak one year after the economy bottoms. However, with the sharp economic decline in Q1/09 and the havoc that the capital markets debacle had on the real economy, it seems that peak loan losses in this credit cycle are happening sooner. If gross loan formations continue their modest decline experienced in Q2/09 over the next several quarters, this bodes well for credit losses.

• LLPs were mixed among the banks, with NA provisioning remaining low and BMO LLPs actually declining (may have peaked in Q3/08) and BNS, CM, RY, and TD all up sequentially. We believe BMO’s loss ratio may have peaked, with RY, TD, and CM nearing their peak and BNS likely to increase moderately.

• LLPs in the second quarter increased 18% sequentially to $2,470 million or 83 bp. The loss ratio varies, with RY and TD at highs of 107 and 93 bp followed by BMO and CM at 85 and 83 bp, with BNS at 60 bp and NA a continued outlier at 30 bp.

• The highest loss ratios were in the International business segment with BNS Mexico loss ratio of 434 bp, RY U.S. at 308 bp, and TD U.S. at 127 bp. Loan losses in these businesses for BNS, RY, and TD represented 21%, 38%, and 37%, respectively, of the total quarterly loan loss provisions.

• In terms of domestic banking, the lowest loss ratios are being recorded by BMO, BNS, and NA in the 33 to 38 bp range. CM has the highest loss ratio at 73 bp due to heavy weighting in credit cards, with RY and TD at 59 and 52 bp, respectively.

• In terms of wholesale loan loss provisioning as a percentage of total provisioning, for BMO, BNS, CM, NA, RY, and TD they comprise 12%, 25%, 5%, 17%, 19%, and 11%, respectively.

• Gross impaired loans increased 17% sequentially to $14.3 billion, but remain at a relatively low level compared to past cycles at only 1.2% of loans. This ratio is expected to increase further, but to remain significantly below past historical peaks (see our report titled The Credit Cycle, May 2009). Gross impaired loan formations remained high at $5.2 billion but were lower than in the previous quarter. If gross impaired formations continue this trend, it will be positive for the outlook for loan losses.

• We have increased our 2009 loan loss provision forecast to $9.7 billion from $8.5 billion based on the acceleration of provisioning due to the sharpness of the economic decline. However, our 2010 loan loss provision forecast is essentially unchanged at $10.6 billion or 0.78% of loans.

Earnings Power – Dividend Increases

• In summary, we believe second quarter earnings are reflective of bank earnings power and their ability to absorb credit losses and mark-to-market writedowns. The outlook for earnings, with the possibility of net interest margin resurgence, disappearing mark-to-market writedowns, and eventually lower credit costs, is quite powerful. Canadian banks are well positioned to take advantage of the fallout from the global banking crisis. They have significant operating leverage going forward, with revenue growth opportunities as a consequence of banking capacity reduction at the same time they are able to take advantage on the costs side by reducing operating and labour costs. In addition to strong operating leverage, bank capital is worth more, and banks are starting to get paid a major liquidity/risk premium (repricing of loan book) that is higher than in previous cycles. Thus, strong underlying earnings and high capital positions should be conducive to future dividend increases that could occur as early as the fourth quarter of 2009 for select banks.

• The market’s hysteria about the need to raise or preserve capital and the possibility of dividend cuts has reversed itself dramatically. The capital conundrum going forward is likely to be: what are the banks going to do with all that capital? We believe banks have the ability to easily run their Tier 1 capital ratios up to the 12% to 14% range.

• We are a major proponent of bank leadership signalling confidence in their business models to the market by rewarding shareholders with modest dividend increases early. A 5% dividend increase in Q4/09 would consume an insignificant amount of capital but provide a strong signal that would serve to further differentiate Canadian banks from their global peers. Canadian banks have a stellar record of increasing dividends over the past 50 years, with both BNS and TD actually increasing their dividends in fiscal 2008. Banks that are able to increase their dividends through a global crisis would be a powerful statement, but it does require conviction.

P/E Multiple Recovery

• Bank P/E multiples have recovered from valuation contagion that was aided by aggressive selling and the agents of fear. Bank P/E multiples have rebounded to 10.5x from the 6.0x low reached in late February. The current P/E multiple is now more in line with recent past cycle lows. We estimate the valuation contagion overshoot was three to four multiple points. We believe fundamentals support significantly higher valuation, and the market seems to be refocusing on fundamentals. We believe the market is starting to look at earnings power and P/E multiples for valuation versus market to tangible book.

• We continue to expect bank P/E multiples to expand through 2012, similar to that experienced post the 2002 cycle. We expect bank P/E multiples to expand back to 14x in the next few years and eventually reach 16x. Thus with P/E multiple expansion and bank earnings bottoming, this bodes well for continued strong share price gains over the next several years.

Bank Rally – Positive Outlook

• The major bank rally in Canadian bank stocks has happened at breathtaking speed, with the bank group increasing 72% in three months off their February lows. Bank stocks are now significantly outperforming the market with gains of 28% year-to-date versus the market being up 19%.

• It is natural or reasonable to expect a bank share pullback based on the strength of the rally or at least some retracement on a technical basis. However, if we look at the underlying earnings power and valuation, which remains compelling despite the rally, we remain overweight the bank group.

• Bank dividend yields, although down from their lofty heights, are very high at 4.8% and remain in a strong buy range against government bonds or the equity markets. Bank dividend yield relative to 10-year Canada bonds is 3.6 standard deviations above the mean.

• In conclusion, Canadian banks are well capitalized with high-quality balance sheets, a diversified revenue mix, a solid long-term earnings growth outlook, low exposure to high risk assets, and compelling valuation on both a yield and P/E multiple basis. Remain overweight the bank group.

• We have a 1-Sector Outperform rating on Royal Bank, with 2-Sector Performs ratings on NA, BMO, BNS, LB, and CWB and 3-Sector Underperform on TD and CM. Our order of preference continues to be biased towards strong wholesale banks with wealth management earnings momentum expected to pick up. Our order of preference is RY, NA, BMO, BNS, CWB, LB, TD, and CM.
BMO Capital Markets, 2 June 2009

Operating earnings for the bank sector fell 6%, slightly more than the 5% we estimated. Reported earnings for the banks were much weaker than expected, due to another round of asset writedowns and restructuring charges. In response to weak results and price appreciation, we have trimmed our bank weight by 1%.

Ian de Verteuil downgraded CIBC to Underperform. Q1 earnings were weaker than expected, due to larger than expected charges, and the mix of operating earnings was skewed toward low multiple wholesale earnings. Investors will likely remain on the sidelines until there is a cleaner record of profitability or closure on the structured credit front. We have shifted most of our CIBC holdings into larger positions in Royal Bank and National Bank, both of which exceeded our expections on Q1 earnings.
TD Securities, 1 June 2009

Our Views Largely Unchanged Post Quarter - Market-Weight

• Comfortable with Market-Weighting - we see fair returns from here. Following some volatility, the group ended earnings season largely unchanged. We shifted to Market-Weight down from Over-weight on May 8 and remain comfortable with that stance. We see 10-15% average total returns across the group on 12-months.

• Key themes as expected. Trading/Capital Markets revenues were generally strong across the group and in a number of cases masked continued moderation in key operating trends (i.e. volume growth/revenue) and further credit deterioration. Margins were mixed across the names, but commentary suggests that asset repricing and improved funding situation should begin to help restore NIMs.

• Credit deteriorating, but not exploding. Credit conditions and PCLs deteriorated only slightly worse than our expectations while a number of banks made efforts to stay ahead of the curve by building general/sectoral reserves. Credit headwinds should intensify through 2H09 (peaking in 1H10), but we remain comfortable with our standing view that the cycle will ultimately prove manageable.

• Minor changes to our outlook. We made a handful of changes to our estimates. However, on balance we continue to expect a fairly modest 2H09 with easing revenue trends and rising PCLs. We see room for slight growth/recovery in 2010 as PCLs peak, volumes recover and margins firm.

• We moved to the sidelines on CIBC. We downgraded CIBC to HOLD from Buy on Friday, May 29. We still believe progress is being made improving the fundamental business model. However, consistent retail delivery remains a near-term challenge just as rising credit costs loom. At these price valuations/levels we need to be sensitive to these concerns.

• Scotia and TD delivered and hold good outlooks. Both banks delivered decent quarters (broadly inline with our expected themes) and maintain, in our view, solid medium-term prospects.

• More to follow. We will publish our complete Quarterly Key Trends report in the coming days.
Financial Post, 2 June 2009

Scotia Capital took its turn at bat Friday, analyzing second-quarter results from National Bank, CIBC and TD Bank.

Here's a collection of Scotia Capital analyst Kevin Choquette's findings, released Monday.

For CIBC, Mr. Choquette found retail market earnings to be "disappointing" after dropping 21% from the same time last year.

Loan loss provisions and impaired loan formations both increased in the quarter as well.

However, CIBC World Markets earnings rose to $203-million from $80-million a year earlier as the brokerage firm recently took over top trader spot from TD Securities.

TD had held top spot every month since 2003.

Mr. Choquette's 2009 and 2010 earnings estimates remain the same at $6 and $6.30 per share each, and he is keeping CIBC at Sector Underperform while maintaining a 12-month share price target of $68.

The picture at National Bank and TD Bank appears to be rosier as both are considered "wholesale strong" by Scotia.

A 9% increase in operating earnings to $1.53 per share at National Bank is above Mr. Choquette's estimated $1.30 per share, driven by "extremely strong" trading revenue from fixed income.

And TD Bank's overall results and securitization revenue helped offset a spike in U.S. loan losses, as reported a better-than-expected 7% dip in operating earnings.

National Bank also picked up $100-million of securitization revenue in the quarter, up from $58-million the previous year, a 17-cent per share gain.

Mr. Choquette is keeping National Bank's Sector Perform rating, noting "relatively low credit risk" and solid relative retail momentum.

He has also upped TD's 2009 and 2010 earnings estimates to $5 and $5.40 per share from $4.85 and $5.10 per share, but Scotia's share price target of $60 remains static and TD will keep its Sector Underperform.

16 June 2009

Sun Life's UK Acquisition Adds to Existing Run-off Operations

Scotia Capital, 16 June 2009

• Sun Life is buying Lincoln's U.K. operations for C$359 million cash.


• Virtually all of what Sun Life picks up is a runoff block of individual insurance and annuity policies, with nearly £4B of assets, about 60% of the size of Sun Life's current U.K. runoff business (£6.5B of assets, about 8% of SLF's bottom line).

• Sun Life says it's $0.08-$0.10 per share accretive in 2010, which implies the ROE on the Lincoln block of runoff business is a profitable mid-to-high teens, (1. Lincoln, in need of capital, was a bit of a desperate seller, shedding non-core. 2. runoff business, versus ongoing business, can be profitable to a lifeco since there are no commissions and other selling xpenses, and 3. SLF will likely benefit from synergies in combining two runoff operations together).

• Cash for deal might come out of holdco, but if it came out of Sun Life's operating life companies the impact on capital is an immaterial three to five points on the company's MCCSR.


• Good small tuck-in deal. Sun Life's likely not done buying. Reiterate 2-Sector Perform.

10 June 2009

Canadian Lifecos Less Exposed to CRE & Commercial Mortgages than Peers

Scotia Capital, 10 June 2009

• There is no doubt that commercial real estate (CRE) is increasingly becoming an issue for all financial services companies. As well, but perhaps not necessarily to the same degree, commercial mortgages and commercial mortgage backed securities (CMBS) are potential concerns.

• With significantly less exposure, we believe the Canadian lifecos look very good relative to their peers, namely U.S. lifecos and Canadian banks, with respect to these concerns.


• Not only are the Canadian lifecos significantly less exposed than their peers, but at under 9x 2010E P/E (GWO is 8.8x, IAG is 7.7x, MFC is 8.7x and SLF is 9.5x), they are also much more attractively priced. The Canadian lifecos trade at a 20% discount to P/E ratio (consensus 2010E) of the Canadian banks, versus their long-term average of a 2% premium.
Financial Post, 8 June 2009

The news on Friday that job losses in the U.S. are declining at a smaller pace than expected is good for stocks and even better for Canada's life insurance companies, says Desjardins Securities analyst Michael Goldberg.

"With job losses getting smaller and doing better than consensus forecasts, investors are likely to view the jobs data as one of the 'green shoots' they have been looking for that signal pending economic recovery and contribute to improved investor confidence which has driven the stock market recovery since early March," said Mr. Goldberg in a note to clients. "We view this as particularly good news for lifecos,"

He noted that since March 9, when the current rally in North America began, Canadian stocks have outperformed U.S. stocks, Canadian banks have outperformed the market and Canadian lifecos have outperformed the banks.

The catalyst for the banks has been reduced fear surrounding potential dividend cuts, Mr. Goldberg said. Meanwhile life insurance companies owing to their higher beta, have benefited simply from the rally itself.

"What is good for stocks generally is even better for lifecos," he wrote, adding Manulife remains the most sensitive of the lifecos to stock market performance.

Mr. Goldberg was quick to remind clients, however, that while job losses may be moderating, there are now 5.9 million fewer people employed (4.3%) than at the cycle peak 16 months ago.

That means less income to spend, and people, businesses and banks are still vulnerable to bankruptcies, he wrote.

01 June 2009

RBC Q2 2009 Earnings

• CIBC World Markets raises target price from $44 to $47
• Desjardins Securities cuts target price from $50 to $46.50
• Dundee Securities raises target price from $36 to $38
• Genuity Capital Markets cuts target price from $56 to $54
• National Bank Financial raises target price from $43 to $44
• Scotia Capital has a target price of $58
• TD Securities has a target price of $43
• UBS Securities raises target price from $45 to $46
Scotia Capital, 1 June 2009

Q2/09 Solid Operating Earnings - Wholesale Stellar - Higher Credit Losses

• Royal Bank (RY) reported a decline in cash operating earnings of 6% to $0.97 per share, in line. Operating ROE was 18.6%.

• Reported cash earnings were $0.66 per share including net charges of $0.31 per share comprised of: writedowns of $556 million ($296 million after-tax or $0.21 per share) and a general provision of $223 million ($146 million after-tax or $0.10 per share). Reported accrual earnings were a loss of $0.07 per share including a goodwill impairment charge of $1.0 billion after-tax or $0.71 per share (previously announced) and amortization of intangibles of $55 million ($43 million after-tax or $0.03 per share).

• Earnings were driven by very strong earnings from RBC Capital Markets, which increased 80% to $559 million (excluding writedowns) due to very strong trading revenue. Canadian Banking earnings declined 4% to $582 million from a year earlier due to net interest margin decline. Insurance earnings were $113 million, an increase of 9%. Wealth Management earnings declined 25% to $139 million.

• U.S. & International Banking recorded a loss of $97 million due to the continued high level of loan losses. LLPs increased sequentially to $289 million from $200 million in the previous quarter and from $91 million a year earlier.

Canadian Banking Earnings Decline 4%

• Canadian Banking earnings declined 4% to $582 million from $606 million a year earlier due to a decline in retail net interest margin and higher loan loss provisions.

• Revenues in the Canadian Banking segment increased 3.7%, with non-interest expenses increasing 1.3% from a year earlier, resulting in positive operating leverage of 2.4%.

• Loan loss provisions (LLPs) increased 30% to $351 million from $270 million in the previous quarter, reflecting portfolio growth and higher impaired loans.

Canadian Retail NIM Declines 22 basis points

• Retail NIM declined 22 bp year over year and 3 bp sequentially to 2.78%.


• Insurance earnings were $113 million versus $112 million in the previous quarter and $104 million a year earlier.

Wealth Management Earnings Decline 25%

• Wealth Management cash earnings declined 25% to $139 million from $186 million a year earlier due to large declines in AUM.

• Revenues were flat year over year with operating expenses increasing 11.6% for negative operating leverage of 11.6%.

• U.S. Wealth Management revenue improved 11%, with Canadian Wealth Management declining 16% and Global Asset Management revenue increasing 3%.

• Mutual fund revenue declined 19% from a year earlier to $311 million. Mutual Fund assets (IFIC) declined 10% from a year earlier to $97.8 billion including PH&N. U.S. & International Banking Remains in Loss Position

• U.S. & International recorded a loss of $97 million versus a loss of $22 million in the previous quarter and net income of $57 million a year earlier. The loss position was driven by the continued high level of LLPs. LLPs were $289 million in the quarter, up from the Q1 level of $200 million and up significantly from $91 million a year earlier. LLPs are at an extremely high level of 3.16% of loans and are expected to remain high throughout the remainder of 2009 and 2010.

• The weakness in the portfolio is primarily related to the bank's US$2.6 billion U.S. residential builder finance portfolio, of which 40% of loans are impaired. Our rough estimate is that RY has been taking $150-$200 million in provisions against this portfolio quarterly.

The run rate may not subside in the near term but we do not expect significantly more aggressive provisioning.

• Net interest margin increased 17 bp from a year earlier and 27 bp sequentially to 3.67%.

RBC Capital Markets Earnings Stellar

• RBC Capital Markets earnings increased 80% (excluding writedowns) to $559 million, up from $310 million a year earlier due to very strong trading revenue.

Underlying Trading Revenue Very Strong at $1.4 Billion

• Trading revenue was very strong at $1,414 million (excluding writedowns) versus a record $1,748 million in the previous quarter and $786 million a year earlier.

• Trading revenue was extremely high in all products: interest rate, credit, equities, and foreign exchange.

Capital Markets Revenue

• Capital markets revenue was $568 million versus $520 million in the previous quarter and $472 million a year earlier.

• Securities brokerage commissions increased 15% to $355 million from $309 million a year earlier, with underwriting and other advisory fees at $213 million, increasing by 31%. Security Losses Negligible – Large Unrealized Deficit

• AFS security loss was $66 million or $0.03 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.01 per share a year earlier.

• Unrealized security surplus was a deficit of $1,786 million versus a deficit of $2,163 million in the previous quarter.

Securitization Revenue Increases

• Securitization revenue increased to $354 million or $0.16 per share versus $227 million or $0.10 per share in the previous quarter, adding $0.06 per share to earnings.

Loan Loss Provisions Increase

• Specific loan loss provisions (LLPs) increased to $751 million or 1.07% of loans from $598 million or 0.81% in the previous quarter and $349 million or 0.53% of loans a year earlier. LLPs in Canadian Banking increased 30% sequentially to $351 million from $270 million. LLPs in U.S. & International increased sequentially to $289 million (3.16% bp of loans) from $200 million. The bank recorded a $223 million general provision ($146 million or $0.10 per share). Total loan loss provisions were $974 million or 1.38% of loans.

• We are increasing our 2009 LLP estimate to $2,800 million or 0.97% of loans from $2,100 million or 0.70% of loans. Our 2010 LLP estimate is unchanged at $2,600 million or 0.86% of loans.

Loan Formations Decline QOQ

• Gross impaired loan formations declined to $1,800 million versus $2,648 million in the previous quarter but increased from $867 million a year earlier. Gross impaired loans increased 19% quarter over quarter (QOQ) to $4,217 million or 1.46% of loans versus $3,540 million or 1.20% of loans in the previous quarter.

• Net impaired loan formations increased to $1,467 million, up from $737 million a year earlier and from $1,134 million in the previous quarter. Net impaired loans increased to $1,341 million or 0.46% of loans.

Tier 1 Ratio Strong at 11.4%

• Tier 1 capital was strong at 11.4% versus 10.6% in the previous quarter and 9.5% a year earlier due partially to a 3% sequential decline in risk-weighted assets mainly from currency impact.

• Risk-weighted assets increased 7% year over year (YOY) to $265.6 billion. Market-at-risk assets increased a modest 2% YOY and 5% QOQ to $20.1 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 11.2% versus 11.1% in the previous quarter and 9.5% a year earlier.

Additional Disclosure on High-Risk Assets

• The bank provided additional disclosure on its exposure to U.S. sub-prime CDOs of ABS, RMBS and U.S. insurance and pension solutions. The notional and fair value exposures to these areas as well as writedowns are detailed in exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.


• We are reducing our 2009 earnings estimate to $4.15 per share from $4.25 per share due to a higher loan loss provision forecast. Our 2010 earnings estimate remains unchanged at $4.65 per share.

• Our 12-month share price target is unchanged at $58 per share, representing 14.0x our 2009 earnings estimate and 12.5x our 2010 earnings estimate.

• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength-of-franchise and operating platforms, growth prospects from RBC Capital Markets, recovery in Wealth Management and higher than bank group ROE.
Financial Post, John Greenwood, 30 May 2009

According to Gord Nixon, chief executive of Royal Bank of Canada, the world that emerges when the current recession finally ends will be a much happier place for banks, with fatter margins, higher interest rates and less competition from the shadow banking system that in recent years has been muscling in on the lending business.

"I think you're going to see a lot of very positive things for the industry generally," said Mr. Nixon, commenting on a conference call after Royal reported its second quarter yesterday.

"You're going to have a repriced balance sheet and a much better pricing of credit. You'll see margin expansion because you'll naturally see that happen as interest rates start to move up. In addition to that, given all the things that have occurred in the marketplace, competitors have exited, particularly the shadow banking system, the pricing of assets has become more attractive."

But those happy days have not arrived yet. RBC yesterday posted its first lost since 1993 after taking a previously announced $1-billion writedown on goodwill associated with the declining value of loans held by its U. S. operations.

In the three months ended April 30, Canada's largest bank had a net loss of $50-million, or 7¢ a share, compared with a profit of $928-million (70¢) last year.

Excluding the goodwill charge and other one-time items, RBC came out ahead of analysts' expectations with a profit of 97¢ a share.

Royal was the last of the big six banks to post results and, as with its competitors, analysts were concerned about its exposure to the United States, where the economy is slowing more quickly than in Canada.

RBC, like Bank of Montreal and Toronto-Dominion Bank, has been expanding in the United States and in recent years has bought several banks in southeast states such as Alabama which are significantly exposed to the troubled real-estate market.

In April, Royal said it planned to take a $1-billion goodwill charge associated with those deals, but some analysts worry that given the state of the U. S. economy, there could be more writedowns to come.

"Trends continue to worsen," said Jim Bantis, an analyst at Credit Suisse, who noted that the bank's impaired loans had increased considerably over the first quarter and that loan-loss provisions had risen for the third consecutive quarter.

Mr. Nixon conceded that "the environment remains challenging," but said the bank's capital ratios are strong. RBC is prepared for a downturn, he said, and will emerge on the other side in a position to take advantage of the opportunities he expects to be there.

Mario Mendonca, an analyst at Genuity Capital Markets, said the crux of the problem is RBC's operations in the U. S. Southeast, where the housing-market meltdown has been particularly harsh, including the recently acquired AmSouth Bank and Flag Bank.

In the second quarter, RBC's U. S. operation had about US$3.3-billion of mortgages, US$4.6-billion of home-equity loans and a US$1-billion of loans to buy homebuilding lots.

In the event that the downturn in the United States is worse than expected, those assets could prove troublesome, Mr. Mendonca said.

"If U. S. unemployment moves higher, if you're going to see problems down the road, that's the stuff to be worried about," he said.

BMO and Toronto-Dominion both have U. S. branch networks, but most of their operations are not in states that have been hit hard by the housing meltdown.