Financial services companies continued to do well in the second quarter of 2006, with an average 13.9% increase in earnings year-over-year. But this is not likely to continue if the North American economy slows significantly, as some economists expect. Certainly, brokerage firms Canaccord Capital Inc., GMP Capital Trust and Rockwater Capital Corp. are warning shareholders of the possibility of a slowdown in market activity in the second half of 2006.

The earnings gain was particularly strong for the banks and property and casualty insurer Fairfax Financial Holdings Ltd. and was only partially offset by a big drop in Desjardins Group’s net income. Without these companies, the average gain drops to only 3.8%.

Still, 33 of the 50 companies surveyed posted earnings’ gains. Ten had declines in net income and seven were in a loss position. These figures exclude Great-West Lifeco Inc., Northbridge Financial Corp., BluMont Capital Inc., Dundee Wealth Management Inc., IGM Financial Inc. and Cunningham Lindsey Group Inc., whose results are consolidated with parents that are also in the table (see footnotes).

The 14 deposit-taking institutions certainly shone: their $4.7 billion in combined profits accounted for 61% of total profits and 79% of earnings increases for the 50 companies.

Fairfax posted an increase in net income of US$206.3 million, or 900.9%, accounting for another 22% of the total gain. Fairfax’s jump was mainly the result of very high realized gains on investments of US$434.8 million in the quarter ended June 30, vs US$117.9 in second quarter 2005.

Among those with declining profits, Desjardins saw earnings fall 35.6% to $190 million in the quarter, mainly because of a narrowing of the interest rate spread and an increase in operating costs, including higher expenses for employee benefit plans. The company is looking for group-wide financial and operational synergies that will cut costs by more than $100 million a year over the next few years. The firm also hopes to establish shared operational services that will improve productivity and profitability.

A number of the big banks announced acquisitions in the quarter, but TD Bank Financial Group said after the end of the quarter it wouldn’t be making any more large acquisitions in the U.S. because intense competition in the U.S. northeast is impeding earnings growth at 51%-owned TD Banknorth Inc. At the same time, Sun Life Financial Inc. has disclosed it is considering selling all or part of its Boston-based subsidiary, MFS Investment Management. The price-tag: $4 billion. MFS has been struggling since it got caught up in the U.S. mutual fund scandals.

Integrated Asset Management Corp. has proposed taking BluMont private by acquiring the 15.4 million shares, 46.1% of the total, that it doesn’t already own. IAM says this will provide more liquidity for shareholders, cost savings for the company and better access for BluMont to IAM’s resources. BluMont has appointed a committee of independent directors to consider the offer and alternatives.

Here’s a look at the sectors in more detail:

> Banks. Eleven of the 14 banks and financial institutions in the category had increases in net income. The exceptions were FMF Capital Group Ltd., which continues to post big losses; Pacific & Western Credit Corp., which is in growth mode; and Xceed Mortgage Corp., which returned to a normal level of activity from the exceptional volumes and profitability of a year earlier. Xceed has taken a number of initiatives to strengthen its competitive position.

Bank of Montreal, Bank of Nova Scotia, CIBC and Royal Bank of Canada all announced acquisitions. Royal Bank’s is in the U.S. which presumably means that it believes its U.S. troubles are behind it.

Among the smaller FIs, Home Capital Group Inc.’s profit increase slowed to 12.3%, reflecting the size to which Home Capital has grown and the maturity of its business.

> Life Insurers. Industrial-Alliance Insurance and Financial Services Inc. reported a 15% increase in net income in the quarter, which includes its Dec. 31 acquisition of mutual fund firm Clarington Corp. Great-West and Sun Life Growth experienced sluggish growth in net income, while Manulife Financial Corp.’s net income declined slightly. All three have extensive U.S. operations, and the higher C$ reduced earnings at these subsidiaries in C$ terms.

> Property & Casualty. Results were mixed in this sector, with four companies reporting higher net income and three lower.

@page_break@EGI Financial Holdings Inc., ING Canada Inc. and Northbridge Financial Corp., the Fairfax subsidiary that oversees the Canadian operations, all had lower net in–come than in the same quarter a year ago.

There were an unusual number of losses in this quarter for EGI, but the company is still making a good underwriting profit, as witnessed by its 85.3% combined ratio (losses and operating expenses as a percentage of premiums earned). A non-standard auto insurer, EGI notes that standard firms, basking in high profitability, are going into non-standard policies, but says that won’t last as the non-standard business will erode their margins.

Northbridge was hit with a large increase in reserves at Common-wealth Insurance Co., which insures oil rigs in the Gulf of Mexico, as a result of claims arising out of the devastating 2005 hurricanes. That put the company’s combined ratio at a high 113.4%.

ING’s combined ratio remained low at 82.7%. It expects lower revenue growth for the industry but still historically high returns this year. It says auto costs are stable, while the commercial business continues to be competitive — the rising costs of non-residential construction are putting pressure on margins.

Co-operators General Insurance Co., Kingsway Financial Services Inc. and Optimum General Inc. all had strong earnings growth. Kingsway warns the Alberta auto insurance market is very unprofitable and that competition is increasing in Ontario. The company is finding opportunities in the southern U.S., where smaller competitors are having problems with the availability and pricing of reinsurance.

> Mutual Fund And Investment management firms. Six companies had increased earnings, four had lower earnings, and Avenue Financial Corp. and Mavrix Fund Management Inc. had losses.

CI Financial Income Fund was among those with declining profits, due to a big increase in stock-based compensation, reflecting the rise in the price of CI stock. Without this, earnings would have been up 12%.

AGF Management Ltd. ’s profit was down 2.9% to $21.7 million. AGF has turned the corner on mutual funds sales, with only small net redemptions in May and June (poor months for the industry as a whole) and net sales in July and August.

IGM’s net income was up a solid 11.2% to $186.7 million. Net mutual fund sales in the quarter for wholly owned subsidiaries Investors Group Inc. and Mackenzie Financial Corp. were $164.8 million vs $40 million a year earlier for the former and only $32.1 million vs $206.9 million for the latter.

Dundee Wealth Management Inc. had a 120.7% increase but from a low base; it reported net income of $6.4 million. Net mutual fund sales were $714 million in the quarter, offsetting most of the $736 million in market depreciation. Investment-management pre-tax earnings were up 45% to $27.9 million from a year earlier, while brokerages’ loss fell to $3 million from $5.2 million.

BluMont had a big increase in earnings, also from a very low base. Parent IAM’s earnings were down 87.2%; it had virtually no performance fees except from BluMont.

Unfavourable market conditions and the cost of a number of marketing and sales initiatives kept Mavrix in the red, but Saxon Financial Inc. had a 26.7% earnings gain to $3.8 million.

Sceptre Investment Counsel Ltd. , with a 20.4% jump in assets under management and an 85.7% increase in earnings, says the company’s new business potential has increased substantially over the past few months; it anticipates further opportunities in the balance of the year.

Seamark Asset Management Ltd. ’s net income was down 56.5% as it copes with the loss of the ClaringtonFunds mandates. Sea-mark is reorganizing but says it needs more consistent investment performance to meet clients’ expectations.

Struggling Avenue Financial has yet to find its niche. It is closing down its finance business and will focus on the resources sector, in which it plans to acquire properties aggressively.

> Distributors And Suppliers. Nine of the 13 distributors and suppliers had increased earnings. Fairfax subsidiary Cunningham Lindsey — the renamed Lindsey Morden — reported $2.2 million in net income vs a loss of $2.4 million the year before.

The other three companies — Anthony Clark International Insurance Brokers Ltd., Loyalist Insurance Group Ltd. and Northern Financial Corp. — all had losses. Northern Financial is in building mode, but the others have all been struggling for some time.

> Exchanges. Both Montreal Ex-change Inc. and TSX Group Inc. reported big earnings increases.

> Holding Companies. Dundee Corp. had a huge 522% earnings increase, mainly because of very large gains in its real estate and resources investments. Power Financial Corp. benefited from gains at its Great-West and IGM subsidiaries. IE