Financial services companies continued to perform well in the second quarter, but that was before financial turmoil struck in August. Although most companies are not directly affected, there will be those whose next quarter will show the effects of the market turbulence.

Of the 56 publicly traded companies in Investment Executive’s quarterly profit survey, the most hurt by the collapse of the asset-backed commercial-paper market is Coventree Inc. It warned on Aug. 23 that if market turmoil continues, that will have “a material adverse effect” on its business, operations, assets and future revenue. In mid-September, Coventree significantly reduced its workforce. (See page 24.)

Another company hit hard is Xceed Mortgage Corp. , which uses ABCP to fund the mortgages it originates. As of the ABCP pricing in mid-September, it is losing $1 million a month in cash flow. It has suspended its dividend.

Then there’s DundeeWealth Inc. It is selling its Dundee Bank, which was holding ABCP, to Bank of Nova Scotia in a deal which will also see Scotiabank pick up 18% of DundeeWealth as well as the right of first refusal on any future sale of a controlling interest in the company. DundeeWealth expects to take a $70-million loss on the sale of the bank. (See page 14.)

The major banks are also affected, but they are big enough to weather the storm without much impact on the bottom line.

A few lucky firms see the ABCP mess as an opportunity. Besides Scotiabank’s coup in getting a foothold in DundeeWealth, Home Capital Group Inc. is picking up mortgages that have been securitized into ABCP and thinks it may also attract good personnel departing affected companies.

As for the second quarter, the average increase in net income was 17.6% for the 49 companies in the IE survey that had reported year-earlier results and whose results are not consolidated with a parent’s. Those excluded are Stone Investment Group Ltd. , which went public last December; Gluskin Sheff & Associates Inc. , which doesn’t have comparable year-ago figures; Great-West Lifeco Inc. and IGM Financial Inc. , which are owned by Power Financial Corp.; Northbridge Financial Corp. and Cunningham Lindsey Group Inc. , part of Fairfax Financial Holdings Ltd. ; and DundeeWealth, which is owned by Dundee Corp.

Of the 49 companies, 33 had higher earnings than in the same period a year earlier; Pacific & Western Credit Corp. and Northern Financial Corp. reported net income vs a prior net loss. Ten others saw profits decline, while Anthony Clark International Insurance Brokers Ltd. , Coventree, Jovian Capital Corp., Loyalist Insurance Group Ltd. and Mavrix Management Inc. reported losses.

Among the subsectors, property and casualty insurers had an average decline of 13.7% while distributors and suppliers were down 26.6%. The other groups all had double-digit earnings gains — except the exchanges: Montreal Exchange Inc. gained only 7% and TSX Group Inc. , 2.6%.

Among the companies with earnings’ declines is Bank of Montreal, which continues to have commodity-trading losses. BMO has been grappling with this issue for three quarters now. It reports it has “significantly reduced our proprietary positions, the amount of profit and loss volatility and the complexity of the portfolio, as well as the fair market value of the assets.”

Fairfax, too, saw net income decline — by 26.7%. Although its underwriting profit was higher in the quarter and the sale of subsidiary Hub International Ltd. provided a US$220.5-million gain for Fairfax — as well as a $100.2-million gain for Northbridge -— investment gains were US$236.7 million in the quarter ended June 30, barely half the US$434.8 million for the same quarter a year earlier.

Rentcash Inc. saw a 55.9% decline but is seeing positive results and upward momentum as a result of the year-long restructuring of its brokerage operations. Early in the new year, it expects to spin off its rental division, which has been running at a loss.

Behind Optimum General Inc. ’s 68.3% decline in net income is lower underwriting profit and investment income vs results for the quarter a year ago. Co-operators General Insurance Co. and ING Canada Inc. reported insignificant drops in net income.

Seamark Asset Management Ltd. ’s 32% decline in net income reflects the continuing impact of the loss of the Clarington funds mandate. The company is pleased with its investment performance but says business conditions “remain challenging.” Seamark plans to launch its own family of mutual funds.

@page_break@Cunningham Lindsey was down compared with the year before because last year’s net income was pushed up by a tax recovery. In the recent quarter, the firm experienced significant claims growth in Britain yet benefited from appreciation of the British pound vs the Canadian dollar.

A closer look at the sectors:

> Banks And Deposit-Taking Institutions. Eleven of the 14 companies in the sector had increases in net income, all of them double-digit gains except for HSBC Bank Canada, up 7.1%.

But market turmoil and a less buoyant economic environment have caused most of the banks to increase their loan-loss provisions. Excluding Rentcash and Xceed, which don’t make these provisions, the remaining 12 reported combined provisions of $742 million in the quarter, up from $652 million the previous quarter and $512 million in the same quarter a year ago — still way below the loan-loss provisions of $2 billion-plus of 2001-02.

In addition to Scotiabank’s acquisition of a piece of DundeeWealth, another interesting news item in the sector is Home Capital’s decision to start a family of mutual funds. It has appointed a chief investment officer and plans to start with a fund supported by a dozen investors. Home Capital believes its core customers — people who can’t get credit at most other financial institutions — will be very interested in this offering.

Home Capital is also taking over Payment Services Interactive Gateway Corp., which will help grow the Home Trust VISA card services division by offering payment services to Internet-based merchants.

With these initiatives, Home Capital expects to deliver annual earnings growth of 20%-plus for the foreseeable future.

Pacific & Western reports renewed interest in its receivables-purchase program. It has signed one client to provide a $150-million line of credit and expects more substantial contracts to follow. It also announced a partnership with EllisDon Corp. to provide infrastructure financing to Ontario hospital projects.

> Life Insurers. The four insurers all had strong earnings growth, despite significant declines in revenue. Those declines are not related to the insurers’ core businesses but rather reflect losses on assets held for trading, which have to be included in investment income as of Jan. 1 this year.

Great-West’s acquisition of Boston-based Putnam Investments closed Aug. 3. Financing for the US$3.9-billion deal will come from internal resources plus an issue of common shares for up to US$1.2 billion, the issuance of debentures, hybrids, a bank credit facility and an acquisition tax benefit securitization.

In June, Industrial Alliance Insurance & Financial Services Inc. increased its ownership of FundEX Investments Inc. to 100% from 91.75%.

> Property & Casualty Insurers. This is a mixed bag. Because of the large amounts of assets the companies keep on their balance sheets, investment income can play a key role. This quarter, lower investment gains meant lower earnings at Co-operators and Fairfax, despite better underwriting results; at Kingsway Financial Services Inc. , higher investment gains made up for lower underwriting results.

In general, the subsector continues to perform well, with underwriting profits above historical norms. In some cases, increasing competitive pressures are causing declines from year-earlier levels.

Kingsway has been struggling because of one of its U.S. subsidiaries: although Lincoln General Insurance Co. has improved its underwriting performance, it is still posting losses. Nevertheless, Kingsway continues to expand in the U.S. with the acquisition of Mendota Insurance Co. in the recent quarter, which is already making a contribution to earnings.

Northbridge’s results are much improved from a weak quarter a year ago, when its subsidiary, Commonwealth Insurance Co., which had been insuring oil rigs in the Gulf of Mexico, was badly affected by hurricanes. Commonwealth has sold most of its non-Canadian energy and international businesses. The rest of Northbridge’s business is Canadian-based.

> Mutual Fund And Investment Management Companies. With the exception of Seamark and Mavrix, companies in this sector performed very well. The question is what impact the current market turmoil will have on the third quarter.

It should be noted that AGF Management Ltd. ’s big increases in assets under management, revenue and earnings are partly due to its acquisition of 80% of Highstreet Asset Management Inc. late in 2006.

> Distributors And Suppliers. This subsector, too, is a mixed bag. Canaccord Capital Inc., GMP Capital Trustand Oppenheimer Holdings Inc. all reported significant gains in net income, while Northern Financial reported a profit vs a loss in the same quarter a year earlier. Again, third-quarter results for these companies may be affected by the current market turmoil.

Among the others in this sector, Accord Financial Corp. ’s revenue declined because its deals are becoming larger, which means lower yields. And Loring Ward International Ltd. reports significant reduction in corporate costs.

> Exchanges. The TSX plans fee changes in the fourth quarter as part of its move to a volume-based fee model. Says the TSX: “[It is] consistent with our commitment to reduce the overall cost of trading Canadian equities.”

> Holding Companies. Desjardins Group cites “effective cost control” as part of the reason for its 65.8% earnings increase. Power Financial’s results reflect increases at Great-West and IGM Financial. IE