Desmarias Dynasty

Bloomberg, Lisa Kassenaar, 31 July 2009

Deep among the pine forests of rural Quebec lies a private estate the size of Manhattan, a refuge where French President Nicolas Sarkozy has gone to relax.

Former U. S. presidents George H. W. Bush and Bill Clinton have played golf here, on 18 meticulously groomed holes with a bright-yellow cottage for respite at the 13th tee. Pheasant shoots are orchestrated from the hunting lodge; opera is performed in the music pavilion. An original of Auguste Rodin's The Thinker and a statue of Thomas Jefferson adorn the rough, granite hills.

At the heart of the property is a grand residence surrounded by formal gardens called Cherlieu -- which means beloved place -- that's modeled on a 16th-century Palladian villa. This is the home of Paul Desmarais Sr., a white-haired, Canadian billionaire whose obscurity outside Quebec masks his family's vast connections and influence in global business and politics.

"They keep a very low profile," says Brian Mulroney, who met Mr. Desmarais in 1965 and, as Canada's prime minister from 1984 to 1993, introduced him to president Ronald Reagan and Bush. "That's the way they like it."

Mr. Desmarais, 82, started out with a backwoods Ontario bus line in 1951. Now, he and his family control Power Corporation of Canada, a holding company headquartered in an unmarked, eight-story building on Montreal's leafy Victoria Square. Paul Sr.'s sons, Paul Jr., 54, and Andre, 52, are co-chief executives. Together, the brothers govern a labyrinthine business empire that extends from Denver to Geneva to Hong Kong, with seats on 38 related corporate boards.

Power Corp. owns 66% of Power Financial Corp., a web of North American insurance and asset management companies with 2008 revenue of $36.5-billion. In 2007, the Desmarais bought Putnam Investments, a once mighty, Bostonbased mutual fund company that had been wounded by a trading scandal and weak fund performance.

The US$3.9-billion deal closed two months before the Standard & Poor's 500 Index peaked in October 2007. Power Financial's biggest challenge is to make good on plans to renovate Putnam into a flagship for U. S. expansion, after the mutual fund manager's assets were almost halved by the 2008 plunge in global markets.

In Europe, the Desmarais have been partners with Albert Frere, one of Belgium's richest men, for almost two decades. Together, they hold stakes in Total SA, Europe's third-biggest oil and gas company, based in Courbevoie, France; Paris-based Lafarge SA, the world's biggest cement maker; and Paris-based GDF Suez SA, the world's second-biggest utility. Paul Desmarais Jr. is a director of all three.

In China, the Desmarais own 4.3% of Hong Kong-based Citic Pacific Ltd., a steel, mining and real estate development company with a market value of US$7.2-billion as of July 13. Andre Desmarais joined the board in 1997. His father first ventured into China in the 1970s.

"Power Corp. is like an iceberg -- large and largely invisible," says David Beatty, a professor of strategic management at the University of Toronto.

Those who bet on Power Corp. in the 15 years from 1993 to 2008 earned slightly more than investors in Omaha, Neb.-based Berkshire Hathaway, according to data compiled by Bloomberg. Power Corp.'s average annual return in the period, including reinvested dividends, was 14.5%. Berkshire, which pays no dividend, returned an average of 14.1%.

The Desmarais also run a US$1.6-billion, Paris-based private equity firm called Sagard Private Equity Partners. Investors include companies managed by the Frere family; Bernard Arnault, CEO of luxury goods giant LVMH Moet Hennessy Louis Vuitton SA; and Laurent Dassault of the French aviation family, who's on Power Corp.'s board.

The unit is named for Sagard, Que., a French Canadian hamlet of 260 people that's about 480 kilometres from Montreal and adjacent to Mr. Desmarais's 6,070-hectare estate.

Four years ago, Paul Sr. built the villagers a yellow, wooden Roman Catholic church. In December, he attended Christmas services there with the maids, cooks and gardeners who work on his property.

Some visitors to the estate arrive by helicopter. They come for quiet weekends or for enormous costume parties. Cirque de Soleil has performed there. Guests have included King Juan Carlos of Spain and assorted National Hockey League stars.

"They rank with the best and most generous hosts in the world," says Mr. Mulroney, 70, in an interview the morning after a four-day visit to Sagard. "The only thing they don't do is tuck you in at night."

Paul Sr. also owns a home in Palm Beach, Fla., and another in New York. He was Canada's eighth-richest man in 2008, worth $4.1-billion, according to Canadian Business magazine. That was a slide from fourth in 2007 -- partly reflecting a plunge of 44% in the shares of Power Corp. as the global economy shuddered. Profit fell 41% to $868-million in 2008, the lowest amount since 2002.

At Power Financial, where shares declined 44% last year, net income dropped 35% to $1.34-billion, hurt by lower fee income from its prime holding, Winnipeg-based insurance firm Great-West Lifeco Inc., and $983-million in writedowns and other costs related to Putnam.

Power Corp. and Power Financial's stocks, which trade in Toronto, have rebounded in 2009. Power Corp. stock traded at $29.53 this week, up 26.4% for the year. Power Financial was at $29.98, up 21%.

The family's mystique is fed by its policy of avoiding the press. "No one really knows the full extent of their power," says John Aiken, an analyst at Dundee Securities Corp. in Toronto who covers Canadian banks and insurers. "They are an enigma, and I think they like perpetuating that." The father and sons all declined to comment for this story.

Like Berkshire Hathaway, Power Corp. relies on the insurance business for steady returns. Power Financial's core companies have been built up with numerous small acquisitions. The Desmarais keep cash high and borrowing low. Power Corp. had $5.3-billion in cash on its balance sheet at the end of 2008 and just $6.4-billion in long-term debt, according to Bloomberg data.

Power Corp.'s dividend payout in 2008 was $1.11 a share, up from 91¢ in 2007. That put the Desmarais' dividend cheque at more than $130-million. Paul Sr., directly and through holding companies, controls 48.6 million participating preferred shares of Power Corp., which carry 10 votes each. He also holds 72 million common shares, according to the company.

He doesn't collect dividends from Power Corp.'s other publicly traded units: Power Financial; Great-West; IGM Financial Inc., Canada's biggest mutual fund company; and Geneva-based Pargesa Holding SA, home of Power's European investments.

Power Financial CEO Jeffry Orr sits for an interview in a third floor boardroom of Power Corp.'s Montreal head office. The walls are lined with paintings by Jean-Paul Riopelle, a Quebec-born abstract expressionist. Elsewhere in the building is a collection of 18th-century neoclassical French antiques and a filing cabinet said to have been used by Talleyrand, Napoleon's foreign minister.

While earnings declined in 2008, Power Financial's $36.5-billion in revenue represented a jump of 27%, as receipts from Europe doubled, the company reported. "Our fundamental strategy hasn't changed," Mr. Orr says. He aims to grab market share in life insurance, retirement products and asset management as millions of households in North America and Europe, hurt by falling home and equity prices, set more money aside. "They are going to need to save," he says.

The brothers, who took over as co-CEOs in 1996, go into deep detail at dozens of board meetings a year, Mr. Orr says. "They're very active shareholders with active oversight, but they aren't running the businesses themselves," he says. "It's a very fine line."

Paul Jr. is Power Corp.'s chairman; Andre is deputy chairman and president. The father's only official title is chairman of Power Corp.'s executive committee.

A third generation is in training. Paul Desmarais III, 27, is a banker in the special situations group at Goldman Sachs Group Inc. in New York. His brother Nicolas, 23, has worked at consulting firm Bain & Co. in San Francisco. Both are members of Young Canadians in Finance, which sponsored discussions at a Montreal conference.

Paul Sr., in his ninth decade, now spends most of his time on his estate. He helped design the Sagard mansion, which was finished in 2003. The library is filled with architecture books, says Tom McBroom, the Toronto golf course designer who spent six years working with Desmarais on the meandering loop of fairways and greens strung out through the woods.

"I would stay over, and he would be up late at night in his housecoat going over the plans for the house," Mr. Mc-Broom says. Sometimes in the evenings, he says, Paul Sr. and Jacqueline would sit and talk about the old days -- when they had no high-powered friends and Paul, to save money, would drive one of his buses.

Yet the dynasty was already in the making. Sitting in the back as the bus bumped along were Paul Jr. and Andre, who would grow up to inherit their parents' business empire.

• Power Corp. and the Desmarias Family, 25 May 2006

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Scotia Capital Increases Banks' Target Prices

Scotia Capital, 29 July 2009

P/E Recovery to Continue

• Canadian banks are turning in a spectacular year thus far in terms of share price performance with the bank index up 42% year-to-date and up 90% from the late February lows. The P/E multiple has recovered from the low 6.0x (valuation contagion U.S. pricing of Canadian bank stocks) in late February to the current 11.6x on LTM operating earnings.

• The major bank rally has happened at breathtaking speed and it is natural to expect some retracement in bank share prices or at least a consolidation phase. However, given the attractive dividend yield of 4.4% that is now viewed as safe, the low return from Treasuries, and bank underlying earnings power with operating earnings nearing the bottom for the cycle, we believe the P/E multiple will continue to expand at the same time the earnings outlook is improving. We are therefore increasing our share price targets based on a target multiple of 13.3x our 2010 earnings estimates versus our previous target of 12.6x on 2009E EPS. We expect the P/E multiple to expand into the 13x to 14x range before consolidating similar to post the tech meltdown in 2002.

• We would expect further P/E multiple expansion to the 14x to 16x range after a six to twelve month period of consolidation as the market would likely need further confirmation of the longer term level of profitability and strength of underlying fundamentals. We continue to use the Graham & Dodd P/E Matrix as guide with a 5% long term growth rate and bond yields of 5% to 6% equating to our 14x to 16x target P/E multiple range.

• In the near to medium term we expect bank valuations to be given a boost as the earnings outlook improves based on net interest margin expansion (loan book repricing, steep yield curve) as well as the realization that loan losses are peaking and the descent will be played out over the next several years through the economic recovery.

Increasing Target Prices

• Thus our new 12 month target for the bank index increases 16% to 25,000 based on a 13.3x P/E multiple on our 2010 earnings estimates for total expected one year return of 25%. We are increasing our target prices on BMO, BNS, CM, NA, RY, TD and CWB to $60, $55, $75, $70, $65, $70 and $20, respectively, with LB unchanged. Our revised target prices are highlighted in Exhibit 1.

Earnings Power and ROE Momentum Favours RY and BNS

• In terms of bank fundamentals earnings power has remained strong and capital levels are robust. The bank group return on equity on a fully loaded basis after all mark to market writedowns is 11% year-to-date in 2009 with operating return on equity very solid at 17.7% despite near peak loan loss provisions.

• If we exclude the impact of security gains and the entire positive income statement impact of securization the operating ROE for 2009 YTD slips to 16.3% from 17.7%. If we further adjust the loan loss provisions ratio to an average or normalized loss ratio of 43 bp from 83 bp, the underlying or core ROE would be 18.5% for 2009 YTD for the bank group led by RY and BNS at 21.3% and 18.9% respectively. Thus we believe the level of bank profitability and earnings power is supportive to higher P/E multiples especially given the level of interest rates and supportive dividend yield.

Minimal Regulatory Changes Required

• In addition capital levels are high with Tier 1 ratio of 10.8%, CE/RWA of 11.1% and TCE/RWA of 7.6%. We estimate net earnings after dividends represent a capital build of 90 basis points per annum with Canadian banks continuing to have full access to the capital markets for capital and funding.

• The Canadian banking system is now generally viewed as being among the strongest in the world with no major changes needed in terms of regulation and structure. However Canadian banks will likely be modestly impacted by the global push for lower leverage, higher liquidity, increased amount and quality of capital, pro-cyclicality requirements, and higher capital allocated to various activities.

• Canadian banks profitability or return on equity would be reduced if higher capital requirements were introduced beyond the high levels they already have. The impact of profitability of an immediate 200 bp increase in Tier 1 via common equity bringing the Tier 1 ratio up to 13% (funds held in liquid Treasuries - improving liquidity) would be to reduce ROE by 2% to 3%, thus ROE downside is to the 15% to 16% range (assumes no repricing of products and activities impacted). Thus we believe the highly profitable, low risk Canadian model will continue post the global financial markets reformation.

• Bank valuation remains very attractive on a dividend yield basis, although dividend yields are down from their lofty heights to a still very attractive 4.4% and remain in the strong buy range against government bonds or the equity markets. Bank dividend yield relative to 10 year bonds is 2.9 standard deviations above the mean. If this ratio was to revert to one and two standard deviations, bank stocks would need to increase 55% and 21%, respectively, assuming no dividend increases and a constant bond yield.

Recommendation - Remain Overweight the Group

• 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. We remain Overweight the bank group.

• Our order of preference continues to be biased towards strong wholesale banks with wealth management earnings momentum expected to improve. Our order of preference is RY, BMO, BNS, CWB, NA, LB, TD and CM.

Bank Significant Outperformance

• Thus far in 2009 the bank index has increased 42%, outperforming the S&P/TSX by 24%. This compares to slight outperformance in 2008 of 3% and underperformance of 15% in 2007 (commodity bubble), the third worst year for bank stocks. The other major years of bank underperformance were in 1979 (commodity bubble) and 1999 (Nortel/tech bubble). If bank share price performance remains intact for the remainder of the year this will be the fourth highest outperformance in 50 years on a total return basis.

Third Quarter Update

• Banks begin reporting third quarter earnings with BMO on August 25, followed by CIBC on August 26, NA, TD and RY on August 27, BNS on August 28, and LB and CWB closing out reporting on September 3.

• We are looking for a 14% decline in earnings year over year and 2%, sequentially. Return on equity for the bank group is expected to be 16.5% with mark-to-market writedowns moderating.

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TD Securities, 28 July 2009

U.S. banking results provided some relief for the market relative to mixed expectations heading into earnings season. However, broadly speaking underwriting activity and trading were key sources of strength, while credit and core P&C banking trends continue to reflect ongoing challenges. Issues around troubled assets and related write-downs have moved to the background.

• There remains an inordinate amount of noise in reported results. However, in this report we do our best to summarize the key trends in the U.S. results and draw out some implications for the Canadian banks.

• Credit remains a key focus and we review the U.S. loan books of the Canadian banks. U.S. results appear to support our view that credit conditions are likely to continue to deteriorate (albeit potentially at a slower pace). To date the biggest concerns have been around some specific exposures (largely related to U.S. housing construction). To us, focus will shift to broader deterioration across commercial portfolios going forward.

• We expect U.S. loan books to continue to account for a disproportionate amount of credit costs (up to 50% of PCLs in some cases). All that said, we continue to view aggregate credit costs as manageable for the industry.

• Looking to capital markets, the U.S. results seem to confirm that market conditions remain very favorable for certain trading and investment banking activities. We expect this to continue to carry through the Canadian results and we expect another strong quarter. However, we note that a stellar equity underwriting quarter (driven by recapitalizing the U.S. banking sector) was a key contributor to the U.S. experience.

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Preview of Insurance Cos Q2 2009 Earnings

Scotia Capital, 20 July 2009

Canadian Lifecos – A Noisy Quarter Expected – Focus Remains on Credit – Capital Positions Very Strong

• Lots of moving parts this quarter. A sharp increase in equity markets quarter over quarter (QOQ) combined with continued uncertainty in credit conditions could lead to a noisy Q2/09 for the lifecos. Manulife has suggested that all of the gains from the rebound in equity markets, gains that arise predominantly from the mark-to-marketing mechanics of segregated fund/variable annuity reserving, may not all fall to the bottom line; variable annuity reserves need to be boosted for lower corporate bond rates and increasing persistency, and long-term care reserves need to be boosted for lower interest rates and a few swaps that went offside. While we don’t know what others will do, there could very well be similar reserve adjustments, although not to the same extent as the $1.00 in EPS we expect in the case of MFC. We’re also expecting some “guidance” if any as to what “underlying” EPS is for the quarter. We put underlying EPS in Q1/09 at $0.52 for GWO, $0.57 for IAG, $0.52 for MFC, and $0.72 for SLF. Exhibit 1 outlines the development of our Q2/09 estimates.

• We’ve modestly cut our 2009 and 2010 estimates – largely due to currency. For 2010 we took $0.09 in EPS off each of GWO and SLF and $0.17 off MFC, as we revised our FX assumptions to address what looks to be an increasing Canadian dollar versus foreign currencies. Scotia Economics now forecasts the Canadian dollar will average US$0.86 in 2009 and US$0.96 in 2010, £0.55 in 2009 and £0.56 in 2010, and ¥84 in 2009 and ¥87 in 2009. MFC is the most sensitive to changes in currencies. These revised forecasts also led to a $0.04 EPS reduction in 2H/09 for GWO, a $0.07 reduction for MFC, and a $0.06 reduction for SLF.

• A more measured view on long-term interest rates results in a reduction in EPS for IAG (by far the most sensitive), with little impact on others, apart from MFC interest rate reserve strengthening in Q2/09. After increasing steadily since the start of the year, new money rates have fallen since mid-June, with a 25 bp decline in long-term provincial bond yields (a good proxy, especially Quebec bonds, for IAG’s initial reinvestment rate for reserving or IRR), and a 40 bp decline in Moody’s AA corporate bond yields. For IAG, each 10 bp decline in the IRR results in a $0.30 EPS hit. We’ve decreased our 2009 and 2010 EPS estimates by $0.21 and $0.30, respectively, to reflect a more measured view of long-term interest rates. As MFC has suggested, a drop in corporate interest rates used to discount seg fund/VA liabilities, largely in the U.S., will result in a reserve hit in Q2/09. We suspect that given the recent volatility we’ve seen in these rates, MFC will significantly pad its assumption, and look for a total EPS hit in Q2/09 for interest rates that could be as high as $0.50. While we don’t forecast any reserve hits for interest rates for SLF, there certainly is a chance, and each 10 bp drop in new money rates across the yield curve results in a $0.05 EPS hit for SLF. GWO is the least affected by swings in interest rates, with a 10 bp decline hurting EPS by only $0.01.

• We suspect the lifecos will continue to increase reserves for asset default throughout 2009 as credit conditions remain uncertain. We forecast increases in assumption for credit default, largely given rating agency downgrades, as well as increases in reserves for lapse assumptions (we suspect policyholders will hold onto “lapse-supported policies” longer than expected, to the detriment of lifeco earnings) will translate into EPS hits in the second half of 2009. We estimate these “hits” will be just $0.03 for GWO and $0.01 for IAG, given their limited exposure to both U.S. commercial real estate (CRE) and U.S. commercial mortgages, as well as their modest segregated fund exposure. With relatively higher exposure to U.S. CRE and U.S. commercial mortgages, we expect these hits for MFC and SLF to be slightly higher (although exposures are still significantly below those of the U.S. lifecos) and expect these EPS hits in the second half of 2009 to be $0.17 for MFC and $0.15 for SLF. We must admit that we have a degree of cautiousness around SLF’s estimate, given its less-than-stellar history in terms of credit hits.

• Sun Life most likely to suffer as credit continues to weigh. SLF’s track record in this regard speaks for itself, with a total of $1.64 EPS in credit hits in the past three quarters (excluding LEH/Wamu and AIG) versus $0.21 for GWO, $0.22 for IAG, and $0.43 for MFC. As well, gross unrealized losses on fixed income securities trading below 80% of acquisition cost for more than six months represent 4.9% of fixed income assets for SLF, 5.7% for GWO, 1.5% for MFC, and 1.3% for IAG.

• We see healthy Q2/09 capital ratios. We peg MCCSR ratios at 213% for GWO, 230% for IAG, 255% for MFC, and 230% for SLF, all well above regulatory minimums (120%), regulatory watch-list levels (150%), and comfortably above target ranges (175% or 180% to 200%), although we do expect target ranges to be reset to levels above 200%. IAG can withstand a 32% drop in equity markets from current levels (i.e., S&P/TSX of 7,100) before its MCCSR ratio hits 175%, and a 45% drop (i.e., S&P/TSX of 5,450) before it hits 150% levels. We estimate MFC (on a “do nothing” basis, and without utilizing the $1.0 billion currently sitting at the holdco) can withstand a 30% drop in equity markets from current levels (i.e., to an S&P 500 level of 640) before its ratio hits 185%, and a 40% drop in equity markets (i.e., to an S&P 500 level of 525) before it hits regulatory watch-list 150% levels.

Great-West Lifeco Inc.

1-Sector Outperform – $27 one-year target, based on 1.9x 6/30/10E BVPS and 11.0x 2010E EPS

• We’re looking for EPS of $0.49 for Q2/09, $0.01 above consensus.

• Credit hits could be around $0.07 EPS, some related to U.K. hybrids and some related to other general provisions.

• Cautious on Putnam. We look for net sales of around negative $2 billion. Margins are expected to remain very weak as they have in the past.

Industrial-Alliance Insurance and Financial Services Inc.

2-Sector Perform – $31 one-year target, based on 1.4x 6/30/10E BVPS and 9.5x 2010E EPS

• We’re looking for EPS of $0.62 in Q2/09, $0.02 below consensus.

• "Canada only" likely leads to very modest credit hits - we expect just $0.02 in EPS.

• Keeping a cautious eye on long-term corporate interest rates – particularly Quebec long-term provincials where yields have declined 30 bp in the last seven weeks – IAG is by far the most sensitive.

• Sales will likely remain weak.

Manulife Financial Corporation

1-Sector Outperform – $30 one-year target, based on 1.7x 6/30/10E BVPS and 11.0x 2010E EPS

• We are looking for EPS of $0.45 for Q2/09, $0.25 below consensus.

• A lot of moving parts. We are expecting a noisy quarter, with $1.38 EPS due to the QOQ appreciation in the market (17% weighted average for MFC) offset by $1.22 EPS in reserve hits.

• Focus will be on “core” or underlying EPS. We look for some assistance from management in this regard. We believe core EPS could be in the $0.53 range.

• Update on capital plan - dividend cut unlikely, but remains an option (albeit at the bottom of the pecking order).

• MCCSR we expect to be 255%, well above its 180%-200% target

Sun Life Financial Inc.

2-Sector Perform – $33 one-year target, based on 1.3x 6/30/10E BVPS and 10.0x 2010E EPS

• We are looking for EPS of $0.95, $0.09 above consensus.

• Significant gains from rebound in equity markets should add an additional $0.55-$0.60 to EPS.

• Company track record makes us a little nervous with respect to credit - expect $0.32 in credits, significantly lower than prior run rate.

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Bloomberg, Sean B. Pasternak and Doug Alexander, 21 July 2009

Canadian banks, facing the biggest profit decline in seven years, are expanding their insurance businesses, using the Internet and stand-alone outlets to get around restrictions dating from at least 1923 on insurance sales in bank branches.

Royal Bank of Canada, Bank of Montreal and other lenders are increasing sales online and making acquisitions to skirt the rules and take a bigger slice of the country’s C$115 billion ($104 billion) insurance market.

“Banks are definitely trying to prod areas where there’s not a strict distinction between what a bricks-and-mortar branch is,” said John Aiken, an analyst at Dundee Securities Corp. in Toronto.

With insurance revenue rising by 53 percent last quarter at Royal Bank alone, the business is helping counter the biggest profit decline since 2002 for Canadian lenders. Profit before one-time items at Canada’s six main banks will fall an average of 9.5 percent for the year that ends Oct. 31 on higher loan losses, according to Aiken.

Royal Bank, the country’s largest lender, opened 43 insurance offices adjacent to their bank branches over the last four years to bypass the restrictions, and plans to open more. Bank of Montreal, the No. 4 bank, bought the Canadian life insurance arm of American International Group Inc. in April for C$329.5 million. The purchase may increase the bank’s earnings within a year.

Bank of Nova Scotia, Toronto-Dominion Bank, Canadian Imperial Bank of Commerce and Canadian Western Bank have followed suit, getting around government restrictions by offering life, health and property insurance on their Web sites.

Canada is “the only civilized country in the world that doesn’t allow our banks to sell insurance” through branches, said Larry Pollock, chief executive officer of Canadian Western Bank in Edmonton, Alberta.

The banks’ expansion into insurance is leading to a showdown with the country’s insurance brokers, who say the lenders are violating rules set up by the federal government in 1991. The guidelines state that banks can only promote insurance “outside of a branch.” They previously had been restricted from selling most types of insurance since at least 1923, according to the Department of Finance.

The banks’ insurance outlets should be “separate and distinct” from their branches, and not next door, says Dan Danyluk, CEO of the Insurance Brokers Association of Canada, which represents 33,000 brokers. Bank clients may feel “tied” to an institution that can package insurance together with mortgages and other bank products, he said.

“It’s not about the competitive disadvantage to insurance brokers,” Danyluk said. “The fundamental principle is that consumers are in a very vulnerable position when they’re seeking credit. If banks control that money, consumers aren’t in a strong position.”

Danyluk said that adjacent branches, along with Internet advertising and insurance pamphlets on display in branches, violate the spirit of the Bank Act.

Canada’s financial services regulator gave the banks a boost last month when it clarified that a bank Web site “is not a bank branch.”

“This was exactly what we were waiting for,” said Pollock, 62, who added that Canada’s eighth-biggest bank plans to ramp up its online insurance promotions.

Manulife Financial Corp., the country’s largest insurer, has lost little share to the country’s banks, said Paul Rooney, senior executive vice president for Canada.

Manulife supports the ban on insurance sales in branches because it ensures that clients have more options than just the bank’s own insurance products. The Toronto-based insurer uses a network of 10,000 brokers to sell its policies.

“If you have in-branch selling of insurance, I think it would be difficult for you to see a TD product being sold in a Bank of Montreal branch,” Rooney said in a telephone interview. Independent brokers “are so critically important in ensuring that the consumer gets the right product from the right company at the right price.”

Even with the ban, insurance sales at the banks are growing.

Insurance accounted for 19 percent of Royal Bank’s revenue in the first half of 2009, up from 15 percent a year ago. Premiums and deposits increased 38 percent in the second quarter to C$1.24 billion, helped by higher revenue from annuities and other products.

Royal Bank “cannot provide the value that we believe we bring to the marketplace in the current Bank Act until we do it on the Internet, over the phone and somewhere near the branch,” said Neil Skelding, the bank’s head of insurance.

Bank of Montreal says its purchase of the AIG unit, announced in January, makes it the largest bank-owned seller of life insurance in the country behind Royal Bank, based on direct premiums written. The Toronto-based bank plans to sell insurance through its existing network of brokers and the Internet.

Bank of Montreal had C$222 million in insurance income in fiscal 2008, a 37 percent increase since 2005. The figure excludes the AIG acquisition.

“This is really about accelerating our strategy,” Gordon Henderson, senior vice president of insurance, said in a telephone interview. “We have viewed insurance as a strategic priority for the enterprise for a number of years.”

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Scotia Capital's Analyst Meeting with Manulife CEO

Scotia Capital, 10 July 2009

• Following yesterday's MFC lunch, we met with CEO Don Guloien.

• In our opinion, the lunch did a good job of clearing the air. Guloien mentioned to us in our subsequent meeting he was amazed that a sell-side only meeting held June 25 "produced" everything from a dividend cut to an equity raise when nothing suggesting anything of the sort was ever mentioned (in our opinion, broad market dissemination of a message is a much better way to go).

• What he did say in our meeting yesterday is that nothing has essentially changed over the last couple of months in terms of the company's capital plan, even though the market has rebounded. Priorities remain to build capital through, in order of preference, preferreds, innovative tier 1, medium term notes, reinsurance, and lastly dividend cuts/common equity. In effect, everything is on the table, just as it was a couple of months ago. They're looking at more debt/prefs/innovatives, and with a debt+prefs+innovatives/total capital ratio of 27%, vs. SLF at 29% and GWO at 41%, they still have ample room, possibly another $1.5B to reach 30%. Housing the recent $1B in innovative Tier 1 at the holdco provides lots of flexibility as well.

• With respect to all this dividend talk, Guloien said essentially said nothing has changed. It's a Board decision, it remains the last item in the pecking order in the capital plan, he's very cognisant of investor sentiment (acknowledging though that lifecos are different than banks), and it's not his job to say it will never happen. The payout ratio is a function of "core earnings" (which will be elaborated on when the company reports Q2/09 Aug 6) over the long run and he has suggested growing into the target payout ratio could be a more likely scenario. The target payout ratio is 25%-35%, our 2010 estimate puts them at 38%, and consensus puts them at 41%, which is lower than consensus for SLF of 44% (above their 30%-40% target) and consensus for GWO of 50% (above their 30%-40% target).

• Unlike other CEOs Guloien is very open. He's blatantly honest and will explain both sides of any idea freely and openly with the Street. His style will likely take a bit of getting used to.

• MFC sees plenty of acquisition opportunities down the road and believes that these volatile markets will separate the strong from the weak.

• At 7x 2010E EPS, we believe MFC is good value for an excellent franchise.

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Financial Post, David Pett, 3 July 2009

Manulife Financial Corp. was one of the biggest gainers on markets over the past three months, but thanks to a late June slump, the life insurance giant still remains one of the better buying opportunities heading into the third quarter, says Desjardins Securities analyst Michael Goldberg.

"We believe that the recent decline in Manulife's stock price has been an overreaction by investors, Mr. Goldberg said in a note to clients.

For the second quarter, Manulife shares were up 42%, compared to 19% for the broader TSX benchmark. However, since June 19, the stock has dropped 14%.

The sell off followed news that the OSC is investigating the company's disclosure to investors regarding its segregated funds and annuity business, but Mr. Goldberg believes the real culprit behind the drop was a Manulife statement saying it may need to strengthen its reserves .

"As we have said in the past, we expect any reserve strengthening next quarter to be minimal on a net basis and any expectation of a net reserve release following the buildup of those reserves at a cost of $7-billlion over the past few quarters, would be naive," he said.

He said Manulife is now trading at 7.6x his projected 2010 EPS forecast of $2.80, which compares favourably to his $26.50 price target based on 9.5x 2010 EPS.

"It is time to lessen exposure to Canadian bank positions and start accumulating Canadian lifecos," Mr. Goldberg added.

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U.S. Regulators Could Learn from Canada's Banks

USA Today, David J. Lynch, 5 July 2009

Our northern neighbor sometimes seems so similar to the United States that it's hard to tell where the USA ends and Canada begins. Here's one way: Canada is the place with healthy banks, taxpayers unscathed by megabillion-dollar bailouts and no need to overhaul financial regulation because it was done right the first time.

As U.S. officials scramble to prevent a crisis sequel, the ability of Canadian banks to navigate the current financial storm is earning global plaudits. The World Economic Forum in October ranked the country's financial institutions No. 1 in the world for solvency. U.S. banks came in 40th, two rungs behind Botswana.

Praise for the Canadian regulatory approach has come from former Federal Reserve Board chairman Paul Volcker as well as the head of the National Economic Council, Larry Summers. "Canada has come through this period with much less financial damage than we suffered. ... I think there are some lessons in financial regulation to be gained from what's happened in Canada," Summers told USA Today in a recent interview.

Indeed, Canada's experience is reflected in elements of the Obama administration's proposed revamp of financial industry regulation, the most sweeping set of changes since the 1930s. One example is an increase in the capital buffer required of financial institutions, especially those whose failure would threaten the entire system. Canadian banks must maintain high-quality capital reserves beyond international standards, thus limiting the banks' use of borrowed funds for investments. (Such leveraged financial bets magnify gains if they pay off — or losses if they don't.)

"The proposals the Obama administration have come up with are certainly along the lines of our thinking," says Mark Carney, governor of the Bank of Canada.

But the prospect of congressional turf battles prompted the administration to shy from tackling the fragmented U.S. regulatory system, meaning perhaps the greatest Canadian lesson is being ignored. The administration opted to leave in place multiple financial regulatory agencies rather than mimic Canada's most distinctive feature: a single powerful regulator, the Office of the Superintendent of Financial Institutions, with a mandate to roam across banks, insurance companies and pension plans.

"We see everything. ... If we see something that concerns us, we tell them to fix it," says Julie Dickson, OSFI superintendent.

Along with a consolidated regulatory system, Canada also boasts a more conservative executive-suite culture. Canadian bankers act less like Wall Street's masters of the universe and more like sedate, green-eyeshade types. Regulators aren't the enemy; they're an early-warning system that signals financial problems before they blossom into catastrophe.

In the U.S., some blame the financial debacle on the 1999 repeal of a Depression-era law that prohibited commercial banks from owning investment banks. But Canada notably allowed such mergers for more than a decade without incident before the U.S. scrapped its Glass-Steagall law. Conservative management made the difference.

In 2005, for example, Ed Clark, CEO of TD Bank Financial Group, which operates a U.S. retail subsidiary, grew increasingly worried about the complexity of some of the securities in the bank's portfolio.

Clark didn't fully understand how the derivatives would behave in different market environments, and he suspected no one else did either.

So he did something almost no one on Wall Street had the foresight to do: He ordered his traders to ditch the risky but highly profitable positions. Over the next nine months, TD gradually unwound its derivatives holdings at a cost of more than $200 million in write-offs, which looks like a bargain compared with the $2.2 trillion in losses that U.S.-originated derivatives are expected to incur this year and next, according to the International Monetary Fund.

Still, at the time it was a controversial move, even within TD's own ranks. "I actually said internally, 'I'm not going to be proven right in my career,' " Clark recalled. "I didn't see it blowing up that fast."

Clark is happy to take a little credit for getting a big call right. But he says far less dramatic factors at the core of financial industry operations also explain Canada's stability. Canada's Big 5 banks, which account for about 85% of industry assets, didn't make subprime loans to customers with weak or non-existent credit ratings. And rather than package their mortgages into securities for sale to other investors, as U.S. banks did, Canadian banks held onto the loans. Limits on the banks' use of borrowed money to goose their investment returns further insulated them from the woes suffered by their American counterparts.

While Canada has avoided the more than $1 trillion the U.S. has at risk in its financial industry rescue, it hasn't been able to dodge the economic fallout. Thanks to its close links to the U.S., unemployment is 8.4% and total output in April was 3% less than one year ago.

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