The global credit crunch and the resulting poor performance of equities played havoc with financial services firms’ bottom lines in the final quarter of 2007. Only 40% of 48 publicly traded companies surveyed reported improved earnings in the quarter than in the same period a year earlier.
The big winner in Investment Executive’s quarterly profit survey is Fairfax Financial Holdings Ltd. It had purchased credit default swaps that have produced gains. Fairfax posted net income of US$563.6 million in the quarter ended Dec. 31, 2007, a gain of 380.5% from US$117.3 million in the same period a year prior.
But that gain was small in comparison to the $2.2-billion drop for CIBC, which reported a net loss of $1.4 billion in the quarter ended Jan. 31, vs earnings of $770 million in the same quarter a year earlier. CIBC took $2 billion in charges for the purchase of credit protection to cover its exposure to the U.S. subprime mortgage market. The bank also reported losses of $316 million related to the falling U.S. housing market and $64 million on the sale of some of its U.S. businesses toOppenheimer Holdings Inc. (The latter charge is excluded from the accompanying table because it is an unusual, non-recurring item.)
Xceed Mortgage Corp. was also badly affected by the credit market problems in the quarter. Its earnings dropped by 78%. The company has decided not to write mortgages that fail to conform to mortgage insurers’ guidelines, which has resulted in lower volumes. The company’s board and management are “considering whether to curtail mortgage origination further to preserve capital resources,” its quarterly statement says.
None of the other banks and deposit-taking institutions were burned as badly, although Bank of Montreal took a $324-million net charge related to the deterioration in credit markets. Royal Bank of Canada, National Bank of Canada and Laurentian Bank of Canada had similar if lesser charges of $187 million, $14 million and $2.9 million, respectively.
Of the other companies in the subsector, Canadian Western Bank, Equitable Group Inc., Home Capital Group Inc., Pacific & Western Credit Corp., Rentcash Inc. and TD Bank Financial Group reported higher earnings.
Bank earnings are expected to improve for the rest of this year — but only if the banks do not need to take further charges and the global credit crunch does not worsen. The general view is that the credit crunch will continue until mid-year and then dissipate.
Equity markets are likely to be volatile and weak until the credit situation improves significantly and the U.S. economy shows signs of resumed growth. Many analysts and economists expect this to happen in the second half of 2008.
Banks and deposit-taking institutions weren’t alone in feeling the effects of weak equity markets. Both stock exchanges and brokerage firms reported declining earnings. As well, Coventree Inc. ’s earnings dropped by 93%. A special committee of Coven-tree’s five independent directors, has concluded that the company’s capital markets and administration businesses are “no longer viable” and that no further investments should be made in those units.
In all, for the 28 companies that saw lower net income or reported losses, the average decline was 25%. And that’s with a lower federal corporate tax rate, which reduced taxes for most companies. (The 48 companies exclude Great-West Lifeco Inc. and IGM Financial Inc. , which are owned by Power Financial Corp. , as well as Northbridge Financial Corp. , which is owned by Fairfax.)
However, the 25% drop is distorted because CIBC’s $2.2-billion drop made up for a significant chunk of the financial services sector’s total losses. If CIBC and Fairfax are excluded, the average decline is a much smaller 7%.
Here’s a look at the subsectors:
> Banks And Deposit-Taking Institutions. In addition to charges related to the credit crunch, the Big Six banks are feeling the pinch of slowing economic growth in their core businesses, particularly wholesaling. (See page 32.)
Among the eight others in the category, HSBC Bank Canada, Laurentian and Xceed all had lower earnings, while Canadian Western Bank, Equitable, Home Capital, Pacific & Western and Rentcash had strong gains.
Although Equitable’s earnings were up in the quarter, it took a $3.4-million writedown on its holding of Quebecor World Inc. preferred shares when the printing company filed for bankruptcy protection. If this extraordinary item is included, Equitable would have had an 11% drop in net income. The mortgage financier has no asset-backed commercial paper holdings and has picked up books of mortgage business. It notes, however, that the credit crunch has increased competition in the GIC market and slowed discharge rates for warehoused mortgages.
@page_break@HSBC’s quarterly report says margin compression and strong competition in personal and commercial banking lines are behind its 12.8% decline in net income to $116 million. The bank also took a charge of $30 million after taxes in the quarter related to non-bank ABCP. It has only very small exposure to the U.S. subprime mortgage market.
HSBC does, however, see opportunities for growth across all key business lines and, its report says, “will engineer key processes to further improve the quality and consistency of customer service to achieve this.”
Laurentian considers its results “very satisfactory, considering the prevailing financial market conditions and the uncertain economic environment” and notes “continued growth in loan and deposit volumes as well as effective cost control” in its quarterly report.
Neither Canadian Western Bank nor Home Capital had any ABCP. In fact, Home Capital has picked up some books of mortgages that other institutions had to sell. It has also completed its acquisition of Payment Services Interactive Gateway Corp., which expands its payment processing services for online merchants.
Canadian Western Bank says in its report that it “remains flexible to capitalize on any strategic opportunities” that may emerge from the credit turmoil. It has been benefiting from the booming economies in Western Canada and is happy to pause as those economies slow.
Rentcash’s 82% earnings gain to $3 million comes from increased store-level operating results following a year-long restructuring. It was expected to complete the spinoff of its rental division by Mar. 31.
Pacific & Western continues to look for potential partners and customers for proposed products.
> Life Insurers. Manulife Financial Corp. was the only one of the four life insurers that saw earnings drop, if slightly, in the fourth quarter — by 3% to $1.1 billion. The reason for its decline: the impact of the high Canadian dollar vs the U.S. dollar, which took $163 million off its bottom line. Without that, earnings would have increased by 12%.
The C$ also affected earnings at Great-West and Sun Life Financial Inc. It cost Great-West $38 million, taking net income to $550 million in the quarter; Sun Life, $41 million, taking net income to $573 million. Without the C$’s impact, Great-West would have been up 16.4%; Sun Life, 9.3%. Sun Life was also hurt by financial market movements.
Industrial Alliance Insurance & Financial Services Inc. had strong individual insurance policy and mutual fund sales. Its acquisition of Excellence Life Insurance Co., completed on Jan. 31, enables the company to enter the individual disability and health insurance sector.
> Property And Casualty Insurers. Only Co-operators General Insurance Co. had a higher underwriting profit in the quarter than a year earlier, as witnessed by the drop in its combined ratio (losses and operating expenses as a percentage of earned premiums) to 93.6% from 99%. The increases in earnings at both Fairfax and Northbridge were the result of gains from credit swaps.
EGI Financial Holdings Inc. had a greater drop in earnings (28.3%) than ING Canada Inc. (12.4%) because it’s a non-standard insurer, insuring those who don’t qualify at standard insurers. Many standard insurers have dropped their underwriting standards and prices to get more volume, taking market share from companies such as EGI. ING is a standard insurer, although it doesn’t lower its standards or prices to be competitive.
EGI is “poised to be opportunistic,” its quarterly report says, looking for acquisitions as standard insurers are forced to raise standards and prices as profitability declines. EGI’s quarterly release says that it is “encouraged by recent signs that sellers are adjusting price expectations to more realistic levels.”
ING is strong despite the 12.4% decline in net income from a year earlier to $95.8 million. It expects industry profitability to return to historically lower levels.
Kingsway Financial Services Inc. ’s US$103.5-million loss is the result of the need again to shore up reserves at U.S. subsidiary Lincoln General Insurance Co. — to the tune of US$124.8 million. Kingsway does expects improvement at Lincoln this fiscal year. Besides the increased reserves, underperforming insurance programs at Lincoln are being eliminated or repriced and several operating procedures are being enhanced.
> Mutual Fund And Investment Companies. The sector had an average gain in earnings of 27%, thanks to the big three fund companies: AGF Management Ltd., CI Financial Income Fund and IGM Financial Inc.
AGF’s net income was up by 135.6% to $49.4 million in the quarter ended Nov. 30, 2007, although much of this was due to acquisition of high net-worth firm Highstreet Asset Management Ltd. on Dec. 1, 2006. AGF’s mutual fund assets under management were up 25.7% from a year earlier.
CI’s AUM was also up, by 7.1%, but most of its earnings gain in the quarter comes from paying fewer taxes because it is an income trust. Indeed, CI got money back from the government in the fiscal year ended Dec. 31, 2007.
IGM’s AUM was up only 1.3% year-over-year, but the company remains a steady performer — mainly because subsidiary Investors Group Inc. tends to produce fairly consistent investment performance and its captive sales force keeps redemptions low. Subsidiary Mackenzie Financial Corp.’s investment returns are more volatile, but its strong relationship with advi-sors tends to stem redemptions. Investors Group’s AUM was up 3.4% in the quarter, while Mackenzie’s was virtually unchanged.
CI and IGM did well during this past RRSP season, but AGF and Mackenzie had sizable net redemptions. (See page 1.)
As for the investment-management companies, four — Gluskin Sheff & Associates Inc., Guardian Capital Group Ltd., Sceptre Investment Counsel Ltd. and Saxon Financial Inc. — all reported strong gains in net income in the quarter. But Guardian owed its increase to the lower federal corporate tax rate. Without that, Guardian’s earnings would have been down by 19.1%.
Integrated Asset Management Corp. and Seamark Asset Manage-ment Ltd. both reported lower earnings. Performance fees at alternative investment product manager IAM were only $1.5 million vs $3.9 million a year earlier, while Seamark’s drop is because of the loss of the Clarington funds’ mandates in February 2007.
Mavrix Fund Management Ltd. and Stone Investment Group Ltd. both reported losses. Mavrix had lower AUM, while Stone’s AUM was up a strong 36.6%.
> Distributors And Suppliers. Investment dealers Canaccord Capital Inc. and GMP Capital Trust both reported lower net income as a result of the unfavourable economic and market conditions.
But despite these conditions, Northern Financial Corp. reported its third consecutive profitable quarter. Its core brokerage activities have improved and it generated merchant banking gains in the quarter vs losses a year earlier.
Oppenheimer, which operates in the U.S., also did very well as a result of “strong equity markets, a significant increase in performance fees for managed hedge funds and strong investment banking revenue,” according to its report.
Grey Horse Corp. has “significantly” diversified sources of revenue and added “numerous senior staff to strengthen its operations and to support anticipated continued growth and is focusing on other key aspects of its infrastructure,” says its quarterly report. It does, however, caution that some of the diversified activities are more volatile than its core business as an equity transfer and escrow agent for Toronto Stock Exchange and TSX Venture Exchange companies, and “it will take more time to gauge the ultimate success.” Grey Horse’s other activities are in corporate compliance, foreign exchange and operating as a “limited market dealer.”
Loring Ward International Inc. , another firm with net income vs a loss a year earlier, says its core asset-management business performed well. The company is in discussions with a number of parties that have expressed initial interest in acquiring it.
Western Financial Group Inc. had a 8.6% increase in net income to $3.2 million, thanks mainly to the jump in subsidiary Bank West’s operating income to $841,000 from $218,202.
Anthony Clark International Insurance Brokers Ltd. continues to post losses. Its board is “exploring strategic options to enhance shareholder value.”
> Exchanges. Both Montreal Exchange Inc. and TSX Group Inc. had lower earnings — no surprise, given the state of equity markets during the quarter.
> Holding Companies. Power Financial had a healthy gain, reflecting the positive results at Great-West and IGM.
Desjardins Group, which has exposure to ABCP, reported slightly lower earnings.
Jovian Capital Corp. reported a $1.9-million loss in the quarter. The investment-banking arm of subsidiary MGI Securities Inc. took a loss on warrants acquired in partial payment for services. IE
Losses mount as markets tighten
- By: Catherine Harris
- March 31, 2008 March 31, 2008
- 12:04