26 October 2009

Where Do Bank Stocks Go From Here?

Financial Post, John Greenwood, 26 Octber 2009

Like their peers around the world, Canadian banks got clobbered on stock markets as the financial crisis raged. But as the gloom cleared, their shares -- unlike those of many foreign banks that had the misfortune of owning toxic credit investments -- rocketed skyward, leading the way in one of the most spectacular stock market rallies in decades.

By early August, they had regained nearly all the ground lost since the storm broke in September 2008, collectively rising about 65% from the lows of March.

But for nearly three months since then, bank shares have mostly treaded water -- the sole exception Royal Bank of Canada, which peaked at the end of August instead of the beginning. As the broader Toronto market ploughed ahead, investors have been left wondering if that's all there is for the bank rally.

Brad Smith, an analyst at Blackmont Capital Inc., said he's not surprised.

"More than anything else, what you are seeing is a natural period of consolidation that you would expect to occur after a significant advance driven by improved earnings multiples going forward," said Mr. Smith. "So it's not surprising we are seeing this temporary lull."

Shares in Royal Bank last week closed at $53.39, down 59¢. Bank of Montreal ended at $52.03, down $1.01. Canadian Imperial Bank of Commerce was $1.09 lower at $64.36. Toronto-Dominion Bank was down 67¢ at $64.97, while Bank of Nova Scotia finished at $46.34, down 53¢.

Mr. Smith said the market is still trying to decide if the early optimism around the Canadian banks and their lack of exposure to subprime mortgages justifies the spectacular rise in shares, arguing that the upcoming forth-quarter earnings --due in early November -- will provide a lot of the answers.

One concern is that much of the good news that analysts are expecting has already been factored into the shares, so unless the results include some positive surprises, it could be bad news for investors.

"The banks are trading at roughly 13 times expected 2010 earnings but the reality is that, historically, the range is between eight and 15 times earnings, so we are much closer to peak multiple levels than troughs," said Mr. Smith.

Another issue that will likely affect the banks is proposed new regulations that have come out of Group of 20 nations discussions. In recent weeks, the focus has been on executive bonuses but the rules are expected to cover everything from how much capital banks are required to hold to the amount of leverage they can take on.

"These are the kinds of things that really do affect profitability," said an analyst who asked not to be identified. "No one knows [what the regulations will ultimately look like], so until you get some clarification you just have to hold your breath."

For its part, the federal government has argued that since banks in this country didn't get mixed up in the kind of toxic investments and reckless risk-taking that brought down so many of their global peers, Canadian regulations aren't in need of the kind of overhaul they're getting in the United States and Europe.

But critics say that unless Ottawa follows suit with its fellow G20 countries, it risks upsetting the global balance and becoming a magnet for foreign firms that want to sidestep the rules in their home jurisdictions.

"Capital markets is a global business," said Mr. Smith. "You can't have pockets of regulation that are different from the rest because all the capital will tilt into those jurisdictions."

Another explanation for why bank shares haven't moved is that investment dollars are being drawn toward more attractive sectors such as energy.

At a time when there is so much uncertainty over financial services, the logic around oil and gas is simple. Against the backdrop of an improving global economy, oil prices have been moving steadily higher over the past few months.

"At the end of the day, a guy pulling oil out of the ground [in today's economy] has less risk than a guy sitting on a bunch of loans."

24 October 2009

TD Canada Trust Tests New Branch Format

The Toronto Star, Rita Trichur, 24 October 2009

Inside Toronto-Dominion Bank's corporate headquarters, its secret code name is "Bravo." But on the streets of Brampton, folks are calling it the "branch of the future."

Canada's second-largest bank has chosen this fast-growing GTA city as the testing ground for a daring new experiment that is set to revolutionize personal banking in this country.

Its new prototype branch, at 135 Father Tobin Rd., features an ultramodern design that could eventually become standard fare at all TD locations across Canada. The new "Bravo" branch resembles a cross between Starbucks and Ikea with plenty of high-tech banking gizmos.

Borrowing a page from those venerable retailers, TD's goal is to make its new branch a destination for consumers by giving them a trendy place to hang out with their family and friends.

Its open-concept layout includes marketing gimmicks like a lounge area with complimentary coffee-based beverages, a special kids' zone, a community room and a free coin counter that are also available to non-clients.

Executives are hoping that fresh approach to customer service will translate into more sales of financial products like mortgages, lines of credit and mutual funds. It is an unconventional business strategy made famous by Commerce Bancorp, the New Jersey-based bank that TD bought in 2007.

For the Canadian banking industry, however, the approach marks a dramatic shift from the late 1990s when banks were actively pushing consumers out of branches to lower-cost platforms like online, telephone banking and automatic teller machines.

Tim Hockey, president and chief executive officer of TD Canada Trust, says the new pilot branch is designed to take the "stress" out of branch banking for consumers.

"There was a concept that Starbucks used that I always thought was kind of interesting. And that is `the third place,'" Hockey said.

"And the concept there is you've got your home, you've got your work (but) everybody needs a third place. A place to go where, just like that old Cheers sitcom, `Everybody knows your name.'"

Old-fashioned relationship-building not only makes clients feel appreciated, but it also makes it easier for banks to sell them a wider range of products and services.

And while clients continue to use the Internet, telephone and ATM channels, nearly 85 per cent of TD Canada Trust's revenues "are still generated at the branch level," BMO Capital Markets analyst John Reucassel said in a report this week. He noted the "key" to TD's financial performance is its "focus on service and convenience."

TD's new pilot branch attempts to take customer service to the next level. There are state-of-the-art videophones that can be used to connect customers to live investment experts.

Clients can also use free computers to surf the web or relax in its lounge to catch up on their reading. The bank supplies a range of high-end magazines in addition to local community newspapers.

"You can just sit and have a coffee," said branch manager Nupi Dhillon, as she gestured to the free beverage machine. Children, meanwhile, are free to explore the adjacent kids' area that features an array of books, toys and a pint-sized computer.

In an effort to build stronger ties with the local community, both customers and non-customers alike are invited to use the branch's high-tech community room to hold meetings. The no-cost service is expected to be a hit with non-profit groups and small-business owners.

Other signature items include a document shredder and a free coin counter – an idea inspired by the Commerce's wildly popular Penny Arcade coin machine.

Commerce, established in 1973, based its business model on a stable of Burger King outlets also owned by its founder, Vernon Hill. Its banking strategy was based on a "Wow" culture that often included free treats for children and dogs.

TD has often mused about importing those ideas to Canada. It hopes its new branch experiment will succeed in generating priceless word-of-mouth advertising to attract new clients.

"Quite frankly, the average Canadian consumer doesn't feel all that warmly disposed to their average bank,'' Hockey said. ``So, we're trying to change that, one customer at a time."

Other banks also appear to be sharpening their focus on luring customers back to branches at a time when the recession has taken a bite out of their investment banking profits.

For instance, larger rival Royal Bank of Canada opened 25 new branches this year, while renovating and remodelling more than 100 others. Another 20 new branches are planned for 2010.

Canadian Imperial Bank of Commerce, Canada's fifth-largest bank, has accelerated its branch strategy. CIBC originally said it would open, expand or relocate 70 branches by 2011. It now plans to complete all 70 by the end of next year, with 41 of those branches ready by the end of 2009.

Christina Kramer, CIBC's executive vice-president of retail markets, said the bank has invested $280 million in its strategy. It is the biggest branch investment in CIBC's history.

"Clients do like coming into a branch to have a face-to-face discussion with an adviser," Kramer said. "It helps establish a relationship. It also helps us spend some quality time really understanding their personal goals and needs."

It is an industry about-face from the late 1990s when banks, especially those in concentrated markets, had an incentive "to lower branch-service quality" in order to steer consumers toward lower-cost online banking, suggests research from the Bank of Canada.

"Between 1998 and 2006, the top eight Canadian banks have on average reduced the number of retail branches they operate by 23 per cent, despite a 37 per cent increase in deposits," says the working paper authored by Jason Allen, Robert Clark and Jean-Francois Houde.

Customers, it seems, pushed back. While Canada is one of the "most developed" online banking markets in the world, banks are facing the stark reality that many older customers still prefer traditional teller service, according to ComScore Inc. That repudiation has helped make bricks-and-mortar branches all the rage again, proving the Internet has yet to render old-fashioned branch service obsolete.

"In the 1990s, everybody in the industry believed that branches – because the Internet was so hot – everybody believed that nobody would want to go in the branch anymore," Hockey said.

"Here we are 10 years later easily, and they're never more popular."

19 October 2009

Preview of Life Insurance Cos Q3 2009 Earnings

Scotia Capital, 19 October 2009

Canadian Lifecos – Another Noisy Quarter – Economic Backdrop Improving – Valuations Remain Very Attractive

• Another quarter with a lot of moving parts. As was the case in Q2/09, we expect the continued rebound in equity markets in Q3/09 will be offset to some extent by reserve increases, primarily related to declining long-term corporate rates, but also due to increasing policy persistency on lapse-supported products. Some have pre-announced, suggesting in Q2/09 earrnings releases that, given the pronounced market volatility, Q3/09 results would be affected by prospective actuarial assumption changes. In particular, MFC suggested in its Q2/09 release that preliminary information suggested a change in lapse assumptions for variable annuity/segregated fund guarantee business may result in a Q3/09 charge not to exceed $500 million ($0.30 EPS). MFC also suggested that changes in assumptions for other factors, which could not be estimated at that time, could result in additional charges to earnings. Our best guess is these charges, which we estimate to be $0.62 EPS, will be interest rate driven, as long corporate bond yields continue to fall. SLF also “pre-announced” at Q2/09, suggesting the company expects to take a Q3/09 charge of $350 million to $450 million ($0.80-$0.98 EPS) as it updates its stochastic economic scenario generator in accordance with updated professional guidance – guidance which we can gather applies only to SLF’s stochastic methodology, all others using a deterministic approach to which the revised guidelines do not apply. We’re somewhat uncertain as to whether IAG, the most sensitive of all the lifecos to interest rate changes, will book a charge for lower bond yields, in particular as they relate to long-term Quebec bonds (which generally support actuarial liabilities). However, our guess is that IAG will not, since it generally reviews this assumption at Q4, and the yields on these bonds have started to climb since the end of Q3/09. GWO, the least sensitive to changes in equity markets and interest rates, will likely have the least amount of noise in its results. Finally, we expect the Q3/09 to be marked with credit hits (although not nearly as high as in previous quarters) as companies continue to increase default provisions as bonds are downgraded and credit conditions – at least in the eyes of the rating agencies (often the last to move) – remain uncertain.

• Focus will be on underlying earnings. For Q3/09, we expect this to be $0.49 for GWO, $0.60 for IAG, $0.50 for MFC, and $0.72 for SLF. We expect SLF to provide some sort of clarification as to what the underlying earnings are/will be going forward.

• Modestly trimming 2010 EPS estimates – largely due to currency. We reduced our 2010E EPS estimates by $0.05 for MFC and SLF and $0.04 for GWO, largely to reflect the impact of currency. In keeping with Scotia Economics’ recent move, we bumped our average Canadian dollar estimate for 2010 to US$0.98 (from US$0.96) and £0.59 (from £0.56), and are keeping it at ¥87.

• While it could be argued to wait on the group until we get a quarter with good earnings visibility that further reinforces that underlying earnings are not only achievable, but more importantly beatable, we think it’s better to be early. We know lifecos are complicated enough as it is, and noisy quarters make it worse. And while it can be argued we need to wait for good earnings visibility, one could argue it’s better to be early, especially given the fact that equity markets continue to climb, and, perhaps even more importantly, long-term interest rates are climbing, which is clearly a positive for the group. In the last two weeks, U.S. long-term corporate A and AA yields have increased 25 basis points (bp), Canadian long-term provincial bond yields have increased 16 bp, and Canadian and U.S. long-term treasury yields have increased 20 bp. There are signs of momentum in the group as well. While Canadian lifecos have underperformed the U.S. lifecos and the Canadian banks by 30% and 5%, respectively, in the last three months, they have outperformed in the last 30 days, bettering the U.S. lifecos by 2% and the Canadian banks by 6%. And finally, they’re still very attractive relative to these other financials. There’s still a significant discount between the Canadian Lifecos (10x 2010E EPS) and where they historically trade vis-à-vis the U.S. lifecos (Canadian lifecos currently at a 4% premium on a P/E basis, well below the average 13% premium) and the banks (Canadian lifecos are at a 20% discount, well below the 1% discount average).

Great-West Lifeco Inc.
1-Sector Outperform – $31 one-year target, based on 2.3x 9/30/10E BVPS and 12.2x 2010E EPS
• We’re looking for EPS of $0.43 for Q3/09, $0.05 below consensus, with underlying EPS of $0.49. Our 2010 EPS estimate is $2.30, $0.02 below consensus.
• Should be a relatively clean quarter – unlike the other lifecos. GWO is the least sensitive in the group to changes in equity markets and interest rates
• Still some minor credit hits (we estimate $0.09 in EPS), largely related to U.K. hybrids, but should be of less concern as market values of these securities continue to climb.
• Good sales momentum in Canada likely to continue.
• Putnam margins likely to remain under pressure, but net sales could be encouraging (expect them to be negative US$1B-$US1.5B, the best they've been since early 2008)

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $33 one-year target, based on 1.5x 9/30/10E BVPS and 10.3x 2010E EPS
• We’re looking for EPS of $0.61 in Q3/09, $0.05 below consensus, with underlying EPS of $0.60. Our 2010 EPS estimate is $3.00, $0.16 above consensus.
• No credit hits expected, primarily based on IAG’s “Canada only” asset portfolio.
• Expect no Q3/09 EPS hit from declining interest rates (IAG is the most sensitive by far) – but keeping a close eye particularly on long-term Quebec bond yields – which have declined 28 bp in Q3/09. The fact that these rates have climbed 18 bp since Sep 30 is encouraging, but if they remain flat through Dec 31/09 we'd expect a $0.30 EPS hit.
• Sales likely to remain weak but could be plateauing.

Manulife Financial Corporation
1-Sector Outperform – $28 one-year target, based on 1.7x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for EPS of $0.34 for Q3/09, $0.04 below consensus, with underlying EPS of $0.50. Our 2010E EPS estimate is $2.30, $0.11 above consensus.
• A noisy quarter. We expect an estimated $0.81 EPS gain from equity markets will be offset by $0.92 EPS charge due to actuarial reserve assumption adjustments, which include $0.30 EPS in pre-announced lapse rate assumption changes on VA business and an estimated $0.62 EPS in reserve assumption changes related to declining interest rates
• The recent rise in long term Corporate rates (Corporate A rates up 23 bp since Sep 30) is very positive for MFC.
• We expect to hear more about steps the company is taking to mitigate the sensitivity of the company’s capital to changes in equity markets. The new structure we believe will reduce MCCSR sensitivity such that a 10% drop in equity markets will reduce the MCCSR ratio by 13% (new structure) as opposed to 20% (old structure).
• Sales will likely remain mixed. Strong in Asia but weak in the U.S.

Sun Life Financial Inc.
2-Sector Perform – $37 one-year target, based on 1.3x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for Q3/09 EPS loss of $0.06, $0.05 above consensus, with underlying EPS of $0.72. Our 2010E EPS estimate of $3.10 is in line with consensus.
• Another messy quarter – a lot of moving parts. We estimate a $0.90 EPS hit for reserve assumption changes related to new actuarial guidelines (affect SLF only), $0.06 EPS hit for declining interest rates, $0.25 EPS credit hits, offset by $0.36 EPS in equity market gains and $0.07 EPS gain from narrowing credit spreads.
• Company track record continues to make us a little nervous with respect to credit – we look for $0.25 EPS in credit-related hits.
• Looking for some “guidance” as to what is sustainable EPS.
• U.S. sales momentum likely to continue.

08 October 2009

Canadian Banks Rebound From Crisis Ahead of Rivals

Bloomberg, Matt Walcoff and Sean B. Pasternak, 8 October 2009

For Canada’s banks, it’s almost as if the financial crisis never happened.

The Chart of the Day shows bank stocks in Canada’s Standard & Poor’s/TSX Composite Index have recouped almost all of their losses since Aug. 8, 2007, the day before credit markets began seizing up. The nine stocks in the bank index trade at 91 percent of their level on that day, rebounding from a six-year low on Feb. 23. That compares with 53 percent for the MSCI World Bank Index and 35 percent for the S&P 500 Banks Index.

“It’s easier to be comfortable in the banking sector in Canada, because while they all have different strategies, they are all relatively conservative,” said Todd Johnson, who helps manage C$125 million ($115 million) at BCV Asset Management in Winnipeg.

Canada has the soundest banking system of the 133 countries surveyed in the Global Competitiveness Report of the World Economic Forum, which runs the Davos meetings of world leaders. The U.S. ranks 108th. No Canadian bank has failed since the early 1990s, and none of Canada’s 21 domestic banks has asked for a government bailout.

Royal Bank of Canada, the country’s largest lender, surpassed its August 2007 stock price on Aug. 27, and last week reached the highest price since July 2007. National Bank of Canada, the nation’s sixth-biggest bank, only needs to rise 1.3 percent to reach its Aug. 8, 2007, level. National Bank has surged 88 percent in 2009, the most among lenders in the S&P/TSX and S&P 500.

Analysts are betting the surge isn’t over. Canadian bank stocks with at least five analyst recommendations have an average rating of 3.49, with 5 as the top ranking. The average U.S. bank stock has a rating of 3.22 and the average European bank is at 3.03, according to Bloomberg surveys.