25 November 2009

BMO Q4 2009 Earnings

Scotia Capital, 25 November 2009

Q4/09 - Earnings Very Strong - Large Beat

• Bank of Montreal (BMO) reported a 4% decline in cash operating earnings to $1.13 per share, in line with our estimate but significantly above consensus of $0.96 per share. Operating ROE was 14.2% with Tier 1 at 12.2%. This is the first clean quarter since the financial crisis began.

• Fiscal 2009 operating earnings declined 11% to $4.20 per share from $4.70 per share in fiscal 2008. Operating ROE for the year was 13.5%. Reported earnings were $3.14 per share down 18% from $3.83 per share a year earlier. Reported ROE was 10.0% for fiscal 2009.

• Fourth quarter earnings were driven by a 22% YOY increase in P&C Canada with P&C U.S. earnings increasing 55% and Private Client earnings increasing 8%. BMO uses expected loan loss provisions. BMO Capital Markets earnings declined 3% due to lower trading revenue. The loss in the Corporate and Other segment moderated due to lower balance sheet carrying costs. Credit losses were in line remaining below Q3/08 and Q1/09 levels reinforcing our view that they have peaked. Impaired loan formations did increase QOQ due to one large account but remained lower than previous highs.

• Our 2010 earnings estimate is unchanged at $4.80 per share. We are introducing our 2011 earnings estimate at $5.50 per share. Our 12-month share price target is unchanged at $65 representing 13.5x our 2010 earnings estimate. We maintain our 1-Sector Outperform rating based on strong earnings momentum from retail banking as the bank restores its retail brand and franchise. In addition, the bank has a solid wholesale platform, strong capital, and leverage to improving credit.

P&C Canada Earnings Increase 22%

• P&C Canada earnings increased 22% to $394 million from a year earlier, driven by volume growth and improvement in the retail net interest margin (NIM). BMO uses expected loan loss provisions and not actual. If we used actual loan loss experience of $124 million, P&C Canada earnings would have increased 20% versus 22%.

• The retail NIM in Canada improved 34 bp from a year earlier and 5 bp sequentially to 3.22% due to higher deposit growth rate versus loan growth and securitization of low-margin mortgages. The retail NIM improved 29 bp in fiscal 2009 to 3.13%.

• Personal loan growth was strong at 13%, however, market share declined YOY. Personal deposits were also up 13% from a year earlier, resulting in a market share gain from a year earlier.

• Fiscal 2009 P&C Canada earnings improved 15% to $1,395 million from $1,212 million a year earlier.

P&C U.S. Earnings Increase YOY

• P&C U.S. cash earnings increased 55% from a year earlier to $31 million using expected loan loss provisions. If we use actual loan loss provisions of $149 million versus $15 million, P&C U.S. earnings would have been a loss of $60 million.

• The P&C U.S. retail NIM improved 26 bp year over year and 13 bp sequentially to 3.26%.

• P&C U.S. earnings increased 10% in fiscal 2009 to $137 million from $124 million a year earlier.

Overall Net Interest Margin - Flat In Q4/09; Improves in 2009

• The overall net interest margin for the bank was relatively flat at 1.78% versus 1.79% in the previous quarter and 1.77% a year earlier. The net interest margin for fiscal 2009 was 1.69% up 7 bp from 1.62% in 2008.

Private Client Group Earnings Improve YOY

• Private Client Group (PCG) earnings in Q4 improved 8% YOY to $112 million but declined sequentially from $120 million.

• Revenue increased 7.7% YOY, with expenses increasing 0.5%, for positive operating leverage of 7.2%.

• Mutual fund revenue declined 9% YOY to $128 million. Mutual fund assets under management. (as reported by IFIC) increased 9% YOY to $33.6 billion.

• Fiscal 2009 earnings declined 16% to $396 million from $474 million.

BMO Capital Markets Earnings Solid

• BMO Capital Markets earnings declined a modest 3% to $289 million from $298 million a year earlier, and 16% from Q3/09 levels of $344 million. If we used actual loan loss provisions of $93 million versus $41 million, earnings would have increased 7% from Q3/09.

• BMO Capital Markets earnings increased 42% to $1,489 million in fiscal 2009 from $1,049 million a year earlier.

Trading Revenue Declines

• Trading revenue declined to $262 million from $391 million in the previous quarter and from $283 million a year earlier.

• Fixed income trading revenue remained strong at $144 million. Equity trading revenue improved to $81 million in the quarter from $71 million in Q3/09. FX trading revenue was weak at $65 million versus $85 million in the previous quarter.

• In fiscal 2009, trading revenue increased a significant 70% to $1,493 million from $877 million.

Capital Markets Revenue

• Capital Markets revenue was $366 million versus $341 million in the previous quarter and $336 million a year earlier.

• Underwriting and advisory fees increased 76% YOY to $116 million, and securities commissions and fees declined 7% to $250 million.

• Capital markets revenue in fiscal 2009 declined 6% to $1,370 million from $1,458 million a year earlier.

Security Gains

• Security gains recorded in the quarter were a gain of $14 million or $0.02 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.03 per share a year earlier. Security gains for fiscal 2009 were a loss of $128 million or $0.16 per share.

• Unrealized security surplus increased to $655 million versus $381 million in the previous quarter and a deficit of $121 million a year earlier.

Loan Loss Provisions in Line

• Specific loan loss provisions (LLPs) were in line with expectations at $386 million or 0.91% of loans versus $357 million or 0.82% of loans in the previous quarter and $315 million or 0.67% of loans a year earlier.

• Specific loan loss provisions for fiscal 2009 were $1,543 million or 0.92% of loans versus $1,070 million or 0.57% of loans a year earlier. Total LLPs were $1,603 million or 0.96% of loans including $60 million in general provisions versus $1,330 million or 0.71% of loans including $260 million in general provisions.

• Our 2010 LLP forecast is unchanged at $1,600 million or 0.90% of loans. We are introducing our 2011 LLP forecast at $1,200 million or 0.63% of loans.

Impaired Loan Formations Increase Modestly

• Gross impaired loan (GIL) formations increased to $735 million from $549 million last quarter (one large U.S. financial services client, CIT) but remained below levels in Q4/08.

• Net impaired loan (NIL) formations increased to $719 million from $316 million in the previous quarter but declined from $976 million a year earlier.

• Gross impaired loans increased modestly in the quarter to $3,297 million or 1.96% of loans. Net impaired loans were also up slightly to $1,395 million or 0.83% of loans.

• The coverage ratio (ACLs as a percentage of GILs) deteriorated slightly to 58% versus 62% in the previous quarter and 73% a year earlier.

Capital Ratios Strong

• Tier 1 Capital increased to 12.2% from 11.7% in the previous quarter due to a 3% decline in risk-weighted assets sequentially. Tier 1 Capital was 9.8% a year earlier. TCE to RWA was extremely high at 9.2%.

• Risk-weighted assets declined 13% YOY and 3% QOQ to $167.2 billion. Market-at-risk assets declined 42% YOY to $6.6 billion.

• The total capital ratio was strong at 14.9% at the end of the quarter versus 14.3% in the previous quarter and 12.2% a year earlier.

BMO to Acquire Diners Club From Citigroup

• On November 24, 2009, BMO announced its intention to acquire the Diners Club North American franchise from Citigroup. The agreement would give BMO net credit card receivables of US$1 billion (mainly U.S.) and approximately US$7.8 billion in card transactions. These cards are corporate Travel & Entertainment and are accepted by Mastercard merchants. The loss ratio on this platform is relatively low due to nature of cards (corporate T&E). BMO acquired the brand plus travel & entertainment system which presents a cross sell opportunity with U.S. corporates. The details of the transaction were not disclosed. The transaction is expected to close before March 31, 2010 subject to regulatory approval.

SIVs – Exposure Declining

• The pace of asset sales remained slow this quarter. Links and Parkland structured investment vehicle (SIV) market value of assets were largely unchanged at US$5.5 billion and €0.63 billion, net of cash, respectively, versus US$5.6 billion and €0.60 billion in the previous quarter. BMO believes the first-loss protection exceeds future expected losses.

• Liquidity facilities extended by BMO for Links and Parkland as at October 31, 2009, declined to US$6.0 billion and €0.63 billion, respectively, versus US$7.9 billion and €0.69 billion at the end of July 2008.

Credit Protection Vehicle – Apex

• BMO provides a senior funding facility of $1.03 billion. As at October 31, 2009, $112 million had been advanced through BMO’s committed share of the senior facility to fund collateral calls. During the third quarter, BMO hedged the first $515 million of losses on the senior funding facility.

• BMO also has exposure of $815 million through investment in mid-term notes. In the fourth quarter BMO entered into an agreement to hedge its total exposure to the notes.

• BMO recorded $50 million of charges, comprised of a one-time $25 million cost to enter into the hedge on $815 million of notes and $25 million mark-to-market loss on the hedge on $515 million of exposure on the loan facility.

• BMO believes the credit quality of the trust is sound, with over 70% considered investment grade and a substantial first-loss protection in place. First-loss protection for the 10 tranches ranges between 13.0% and 29.4%, with a weighted average of 23.5%. Only two tranches have first-loss protection lower than the others.

Fairway – U.S. ABCP Conduit

• Fairway is a BMO-sponsored U.S. ABCP conduit. At the end of October, backstop liquidity facilities were US$5.7 billion, down from US$6.1 billion in the previous quarter.

Monoline Exposure

• BMO has direct notional exposure to monolines and credit derivative counterparties of $3.8 billion, with $256 million mark-to-market exposure. Counterparties: 28% rated AAA or better.

06 November 2009

Manulife Q3 2009 Earnings

Scotia Capital, 6 November 2009

Q3/09 Misses but Underlying EPS in Line

• A miss on larger reserve hits than expected (interest and lapse related) - but underlying EPS in line. As expected Q3/09 was noisy. Details are outlined in Exhibit 1. We were relatively impressed that the underlying EPS was in line with our estimate, and was 4% higher QOQ than the underlying EPS of $0.48 in Q2/09. Credit hits continue to be low and very manageable.

• Economic backdrop improves for Q4/09 - could finally be a "noiseless" quarter. With an annual detailed assumption review behind us (proactively putting the lapse issue to bed), long term interest rates rising (corporate yields are up 20 bp since Sep 30), equity markets generally less volatile, and credit hits diminishing ($0.07 EPS in Q3/09, versus $0.13 in Q2/09 and $0.29 in Q1/09), Q4/09 is shaping up to be a much welcomed "quieter" quarter, something all lifecos need to improve earnings visibility.

• Sales were mixed as MFC de-risks and rebalances product mix - we were encouraged by rebound in individual insurance sales - suggest brand and franchise remains strong. Individual insurance sales regained momentum, especially in the U.S., with sales up 19% QOQ (peers up 8%) and down 4% YOY (peers down 10%). In Canada momentum returned as well, with individual insurance sales down 2% YOY (top 4 up 7%) but up 5% QOQ (top 4 up 3%). Asia remains impressive with Japan individual insurance sales up 22% YOY and Asia (ex Japan) individual insurance sales up 11%. YOY. Wealth management sales excluding variable annuities were impressive, up 51% YOY in Asia and down just 2% YOY in Canada (slightly better than the industry). The U.S. and Japan VA sales remain weak as MFC de-risks its portfolio, down 63% YOY in the U.S. and down 68% YOY in Japan.

• 30% of total VA book is now hedged. MFC took advantage of attractive terms and hedged another $3.8B (in Canada), as the percentage of the total VA book now hedged climbed from 20% at Q4/08 to 30% as at Q3/09. We believe a 100% hedge undertaking is far too costly in this current environment, and essentially throws a lot of money at what could possibly be yesterday's problem. We believe the company is providing a far less costly and more shareholder friendly solution through de-risking the product mix, opportunistically hedging, and minimizing sensitivity of its capital base through a subsidiary reorganization. Maybe somewhere down the road up to 70% of the book may be hedged, but certainly not at these market levels.

• Sub-reorg reduces capital sensitivity. We estimate that after the sub-reorganization, the consolidated MCCSR would be 226% (including $1B at holdco), with each 10% move in equity markets hurting the MCCSR by 11 points. That means this consolidated MCCSR will not fall below 200% unless the S&P500 falls to 790.

• Decreasing 2010E EPS by $0.10 to reflect credit a modest expected $0.10 EPS credit hit. We've made similar credit adjustments across all the big three Canadian lifecos, as we're moving to a more conservative stance. Exhibit 2 outlines the development of our 2010E $2.20 EPS estimate. We essentially see a 2% quarterly increase in underlying EPS each quarter (conservatively less than the 4% in Q3/09) commensurate with a 2% quarterly increase in equity markets, with net experience gains of $0.05 in EPS, in part due to equity markets expected to be up 10% next year. Experience gains/assumption changes have generally averaged $0.59 annual EPS since 2004.

Sun Life Q3 2009 Earnings

Scotia Capital, 6 November 2009

Q3/09 Misses on Credit - Significantly lowering EPS

• A miss, once again on larger credit hits than expected. A noisy quarter, with credit hits $0.10 higher than expected and the gain from equity markets $0.07 less than expected.

• Underlying EPS somewhere between $0.67 and $0.72 - our estimate was $0.72. Details are shown in Exhibit 1. SLF management suggests the underlying may be closer to $0.72, claiming an investment underperformance of $0.05 in EPS, that should be made up in the near term as SLF enhances yield.

• Credit woes continue. EPS hits for credit continue to disappoint, but the pace declines, totalling $0.35 in Q3/09, down from $0.78 EPS in Q2/09 and $0.44 in Q1/09. Of concern is a $4.4B structured products portfolio (just 4% of invested assets) which accounted for about half the credit hits in the quarter. This portfolio was 96% investment grade in Q1/09, falling to 95% in Q2/09 and 90% in Q3/09, with a 5% decline in overall market value. Slippage is largest in the non-agency RMBS portfolio (MV $931 million, 83% investment grade, down from $1B and 89% investment grade in Q2/09), and the CDO/Other ABS portfolio (MV $749 million, 76% investment grade, down from $796 million and 85% at Q2/09).

• Significantly reducing 2010E EPS in light of a more conservative credit outlook and management's view of 2010 "normalized" EPS. Management's $2.50-$3.03 2010 "normalized" earnings exercise (which excludes experience gains and assumption changes, which together have averaged about $0.30 EPS annually since 2004) will likely force down consensus from its $3.10 level (in line with our estimate). We outline our approach to a $2.80 2010E EPS estimate in Exhibit 2, which assumes equity markets will end 2010 at S&P 500 of 1,150, up 10% over 2009. We've assumed experience losses of $0.30, primarily credit driven, and no assumption

• U.S. sales were strong - but expect U.S. VA sales momentum to decline as company de-risks product - Canadian sales mixed, but momentum improving. SLF's momentum continued in the U.S. with U.S. domestic VA sales up 128% YOY and 32% QOQ (we expect momentum to turn negative in Q4 as the company de-risks the product, Q3/09 sales were likely strong in anticipation of a price cut), and core U.S. individual life sales up 23% YOY. Canadian sales were somewhat mixed, but momentum is improving, with individual insurance sales flat YOY (top 4 were up 7%) and down 10% QOQ (top 4 were up 3%), and wealth management sales down 13% YOY and down 14% QOQ.

• Solid quarter for MFS. $7.7B in net sales ($1.9B retail and $5.8B institutional) and margins, at 28%, were up from 23% at Q2/09 and 21% at Q1/09.

• Capital position remains strong. We estimate the MCCSR for SLF's Canadian subsidiary, at 219%, can withstand a 35%-40% drop in equity markets before it hits 200%. That said, we can't say the same with confidence about SLF's U.S. subsidiary (about 1/4 the company's total capital and 40% of the company's total equity market risk) which required $1B in capital in late 2008/early 2009. We expect the holdco has some capital, although it will likely decline by $400 million in Q4/09 to pay for Lincoln's U.K. block.

Great-West Lifeco Q3 2009 Earnings

Scotia Capital, 6 November 2009

• EPS of $0.47, vs. our $0.43 estimate. In line with consensus of $0.48.


• Unlike the other big lifecos, GWO's limited equity market sensitivity and minimal interest rate sensitivity once again resulted in a fairly steady quarter - $0.04 above our estimate and $0.01 below consensus - underlying EPS at $0.49 in line with our estimate.

• Sales momentum continues in U.S. Financial Services, as several new cases propel the top line 50% YOY and 57% QOQ. As well, sales momentum continues in Canada, with individual insurance sales up 13% YOY and individual wealth management sales down just 3% YOY (better than prior quarters). Sales in the U.K. were down sharply (40%), but not as bad as the market (down 50%).

• While Putnam net sales, at negative US$1.8B, were much better than previous quarters, they were slightly worse than our negative US$1B - US$ 1.5B estimate. Putnam margins, at negative 11%, remain weak.


• With a much lower risk profile, significantly less EPS volatility, an excellent track record, attractive 10.6x multiple and 5.2% yield, we reiterate our 1-Sector Outperform rating.

02 November 2009

Barron's Article on Canadian Banks

Barron's, Dimitra Defotis, 2 November 2009

A Canadian native likes to give this quiz to his u.s. friends: What's the most boring word in investing? Answer: "Canadian." How can you make it even more boring? Put the word "banks" behind it.

But boring can be beautiful, especially when trouble erupts.

Yes, the shares of banks in the Great White North were badly bruised during last year's global meltdown, but they deserved better. Thanks to strict regulation, Canada's banks don't make subprime loans, and a typical mortgage term is only five years, greatly moderating balance-sheet risk. The largest banks have a virtual monopoly, controlling their regional markets for residential mortgages, credit cards, retail deposits and brokerage services. With their stout balance sheets and conservative bent, Canada's banks look healthy. Indeed, a recent World Economic Forum report rated the Canadian banking system as the world's soundest. In comparison, Switzerland was No. 16. The U.S. limped in at No. 40, just behind Germany (at No. 39) and ahead of the U.K. (at No. 44).

This isn't to say that Canada's financial system weathered the 2007-2008 financial debacle unscathed. Combined, the five largest banks -- Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank of Montréal, along with No. 6 National Bank of Canada -- have had more than $22 billion in write-downs in their securities and trading businesses since early 2007. But their American and European counterparts have fared far worse, and none of the Canadians has needed a government bailout. And now, RBC analyst André-Philippe Hardy argues, they are even less exposed to credit risk than in the past because loans make up 40% of assets, versus 45% in 2008 and 70% in the 1980s and 1990s.

Another positive: In Canada, when someone defaults on a mortgage, lenders have more recourse than do mortgage lenders in the U.S. What's more, RBC research views Canadian banks as well-insulated from some of the troubles to the south, even though they operate in the States. Through October 2008, the Canadians had only $16 billion in U.S. residential mortgages on their balance sheets -- a mere 3.5% of their total residential loans.

In some ways, anyone who invests in one of the five biggest Canadian banks -- all of which trade in both New York and Toronto -- pays a premium; in other ways, the stocks are bargains. Royal Bank of Canada, Toronto-Dominion and Bank of Nova Scotia are the group's most attractive members because they boast the most potential to boost profits through foreign growth. Each sells at more than two times book value, while some of their U.S. peers fetch less than book. But they all boast substantial dividends, rack up higher returns on assets and sell at lower multiples of current and expected earnings than their south-of-the-border rivals. The largest Canadian banks trade at an average of about 12 times estimated 2010 profits, compared with 13.7 times for JPMorgan Chase, 19.9 for Bank of America and 72 for Citigroup.

The northern banks are benefiting from a robust Canadian dollar that makes it easier to expand by buying foreign companies; operations abroad already account for about a third of their earnings. And they are being helped by the fact that Canada's recession has been somewhat milder than those in the U.S. or much of Europe.

"The next 12 months still look good," Rohit Sehgal, a money manager at Toronto's Goodman & Co. Investment Counsel, says of the Canadian banks, which he thinks should be helped by cost-cutting, a more favorable yield curve and a likely decline in nonperforming loans.

Based on normalized earnings projections, RBC estimates that TD and Scotiabank shares could rise more than 18% over the next year. Wall Street analysts see the pair climbing by a more modest 14% and 8%, respectively, and Royal Bank advancing by 10%. Add dividends, and the potential total returns look juicier.

Royal Bank of Canada, with a stock- market value of $70 billion, is Canada's titan. The bank also has the highest Tier 1 ratio -- a measure of capital ad- equacy -- at 12.9%. Royal Bank gets about a third of its earnings from the capital-markets division, which includes investment banking, trading and underwriting in the U.S. and Canada, and trading operations in London.

Dominic Grestoni, a money manager for Winnipeg-based I.G. Investment Management, says the bank is an accomplished asset manager and has had success selling mutual funds through its branches.

At its recent price of 51.81 (all the figures in this story are in U.S. dollars), Royal Bank is the group's most expensive member. But the stock historically has traded at a premium, and RBC's 15% return on equity is a bit above the group's average of 14%.

Analysts expect Royal Bank to earn $4.02 for its fiscal 2010 year, which ends next October, according to Thomson Reuters. That would be a decline of 3% from the $4.14 expected for fiscal 2009. (Twelve analysts surveyed by Bloomberg are looking for $4.35 next year.) Still, profit is expected to jump 18% in 2011, assuming the recession eases, global investment banking expands and U.S. operations recover. "Royal Bank globally [has] the opportunity to do better than the other banks," says money manager Sehgal. "You pay the highest multiple [see table on previous page] and get the lowest yield, but I am willing to do that because it ranks extremely well on any criteria."

Royal Bank's CEO, Gordon Nixon, tells Barron's that any large acquisition is likely to be in the company's wealth-management business, already the largest among its domestic peers. The bank has forked over $7 billion since 2000 to pick up U.S. retail banks, though its returns on acquisitions have been low. It has more than 430 branches in the States and, Nixon says, a U.S. acquisition is unlikely, "given balance-sheet weakness."

Toronto-Dominion Bank is likely to report only a slight increase in fiscal 2010 earnings, to $5.11 per share from the $5.07 expected for fiscal 2009, which ended in October. The company, which owns the TD Waterhouse and TD Ameritrade discount and online brokerages, has made a big push into the U.S., where it has more than 1,000 locations, about as many as it has at home.

Its Tier 1 ratio, at 11.2% as of the end of the third quarter, is in line with the average for U.S. competitors, and its return on equity, at 13.2%, is strong, but slightly below the average for the big Canadian banks. Since 2005, Toronto-Dominion has spent $20 billion on acquisitions, including Commerce Bancorp, whose U.S. branches are known for a high level of service.

Bank of Nova Scotia, in contrast, has been focused on Latin America in its global operations, which generate more than a third of its profits. Scotiabank, as it's known, has made retail-oriented acquisitions in the Caribbean, Mexico, Chile, Peru and other locales and is Canada's most international bank. The bank's return on equity, at 17.5%, is second only to National Bank's 20%. While its core business is retail banking, Scotiabank is expanding its wealth-management, brokerage and investment-banking operations. This year, it's likely to earn $3.30 a share. The figure should rise to $3.35 in 2010 and to $4.24 in 2011.

As for the other big banks, Canadian Imperial has made a foray into the Caribbean, while Bank of Montreal has expanded in Chicago and Milwaukee.

Grestoni, the I.G. Investment Management money manager, has made the three largest Canadian banks his largest holdings. He's sold some of his Bank of Montreal stake; he considers it a laggard in retail businesses, including mutual funds and wealth management. While the Montreal bank moved into the U.S. early, buying Harris Bank in Chicago more than a decade ago, and community banks also in the Chicago area, those operations struggled during the credit crisis.
In sum, if the markets sell off, Canadian bank shares won't be immune. And if the global economy doesn't recover as strongly as analysts expect, 2011 profits might not be as robust as forecast. But, at the least, boring can help investors sleep better, especially when it pays a nice dividend.

The Bottom Line: Shares of Canada's three largest banks offer potential upside of 8% to 18% over the next 12 months. And that doesn't count the substantial dividends that they offer.