As the news goes from bad to devastating, the bottom lines of financial services companies showed the effects of the credit crunch and global economic slowdown in the most recent quarter, as earnings turned downward. Nor is there much confidence that conditions will improve significantly for the balance of the year.
Only 19 of 53 publicly listed companies surveyed by Investment Executive in the quarterly profit survey improved their earnings in the second quarter of 2008 from the same quarter a year earlier, with 16 reporting higher net income and three reporting a profit in the quarter vs a loss a year earlier. That leaves 27 firms with lower earnings and seven in the red.
(The 53 companies exclude four whose results are consolidated with their parent firms in the survey: DundeeWealth Inc., majority-owned by Dundee Corp.; Great-West Lifeco Inc. and IGM Financial Inc., owned by Power Financial Corp.; and Northbridge Financial Corp., owned by Fairfax Financial Holdings Inc. )
The average decline for the 53 companies was 17.4%, but that was skewed byCIBC’s results. The bank reported net income of just $51 million in its third quarter ended July 31, down from $835 million in the same quarter a year earlier — a substantial $784-million (93.9%) decline. If CIBC were factored out, the average decline would have been a lower but still sizable 9.7%.
Among those 19 companies with earnings gains, eight were financial institutions, including First National Financial LP, which reported a profit in the quarter ended June 30 vs a loss a year earlier.
The other 11 reporting higher earnings were life insurer Industrial Alliance Insurance and Financial Services Inc.; investment-management firms Integrated Asset Management Corp., Sceptre Investment Counsel Ltd. and Sprott Inc.; distributors/suppliers Accord Financial Corp., Coventree Inc., Loring Ward International Ltd. and Western Financial Group Inc. ; exchange TMX Group Inc.; and holding companies Desjardins Group and Power Financial.
All these companies are in good shape, with the exception of Coventree, which was so badly hurt by the ABCP mess that it is winding up its business.
Some of the most dramatic declines in earnings were at the investment banks and brokerages. Of the six surveyed, four had declines in net income of more than 50%. Northern Financial Corp. and Thomas Weisel Partners Group Inc. reported losses. (See page 53.)
There were also big declines in earnings among the property and casualty insurers, averaging 58.6%. Four of the six had underwriting losses, while Northbridge’s underwriting profit was very small. Only ING Canada Inc. managed to keep its combined ratio (operating expenses and losses as a percentage of earned premiums) significantly below 100.
The P&C firms with losses include Fairfax, which didn’t make the big gains on the credit-default swaps in the second quarter that it had recorded in the previous three quarters; it also had losses on other investments. Fairfax still has the potential to profit from its credit swaps, which had a fair market value of US$819.3 million as of June 30 with a cost base of US$291.4 million.
Consolidation continued in the quarter, with IGM subsidiary Mackenzie Financial Corp. announcing the acquisition of Saxon Financial Inc.; Bank of Nova Scotiaannouncing the purchase of E*Trade Canada from its U.S. parent; and Loring Ward being sold to a private U.S. company.
Here’s a look at the various sectors:
> Banks. The Big Five banks all reported lower net income in the quarter ended July 31, while their smaller brethren — with the exception ofLaurentian Bank of Canada, Pacific & Western Credit Corp. and Xceed Mortgage Corp. — did well. This emphasizes the fact that the current credit crunch is primarily a U.S./global phenomenon. It has been subprime mortgage problems in the U.S. that have spurred the ABCP crisis in Canada rather than any domestic event.
The six smaller financial institutions in the sector had no exposure to Canadian asset-backed commercial paper. As a result, they have already benefited or expect to benefit from the credit crunch by picking up books of business being sold by their larger peers. They will also benefit from less competition in the mortgage market.
The problems at the big banks were concentrated in their investment banking/brokerage arms, with the rest of their businesses generally doing well.
@page_break@Scotiabank reported the smallest decline in earnings among the Big Five in the quarter, just 2.1%, and continues to expand internationally. It increased its ownership in Scotiabank Peru to 98% from 78% in the quarter and established an agreement with HDFC Bank in India aimed at serving immigrants in Canada from India and providing referrals to those doing business in that country. Scotiabank had relatively low exposure to the subprime debacle.
TD Bank Financial Group, which hasn’t had to take any subprime mortgage charges, had a drop of 7% in the quarter, mainly because of the need to correct “incorrectly priced financial instruments.”
Royal Bank of Canada’s 9.5% decline in earnings was the result of it taking an additional $263 million in charges related to writedowns of subprime mortgages and other assets.
Bank of Montreal’s lower earnings were because of a big increase in loan-loss provisions, mainly as a result of the impairment of two corporate accounts involved in the U.S. housing market — to the tune of $247 million.
CIBC, of course, is the bank hardest hit by the credit crisis. The only positive is that it was able to report a profit in the quarter, albeit a small one, despite a $596-million after-tax loss on structured credit run-off activities.
Laurentian reported a 33.2% increase in net income but that included a $11.1-million net gain on the sale of Montreal Exchange Inc. shares when the latter merged with TSX Group Inc. IE excludes unusual and non-recurring items, so, without that, Laurentian earnings were down by $3.4 million in the quarter to $19.8 million, because of an increase in loan-loss provisions.
Pacific & Western’s loss is the result of a $2.5-million impairment charge related to preferred shares.
Xceed, which formerly originated uninsured mortgages that were securitized, was directly involved in the ABCP mess. It has changed direction and is now originating insurable mortgages, a business that has lower margins.
Loan-loss provisions for the retail banking sector totalled $1.5 billion in the quarter, about twice the $742 million taken a year earlier. For most of the companies, the big increase in loan-loss provisions was taken in the second half of fiscal 2007, ended Oct. 31, 2007. Only BMO had a big jump in this quarter a year ago.
Among the smaller companies, Home Capital Group Inc. is entering the mainstream insured mortgage market; Pacific & Western has also identified an opportunity to enter that market.
> Life Insurers. Great-West Life and Industrial Alliance had modestly higher earnings in the quarter, while Manulife Financial Corp. and Sun Life Financial Inc. both reported lower earnings than a year earlier.
Great-West Life sold off its U.S. health-care business in the quarter, gaining $649 million after taxes. But that unusual gain has been excluded in IE’s calculations.
Both Great-West Life and Sun Life have large U.S. mutual fund operations — Putnam Investments Trust and MFS Investments, respectively. Putnam remains in net redemptions, to the tune of US$2.3 billion in the quarter, but MFS had US$1 billion in net sales following four quarters of net redemptions. Great-West Life has put in new management to try to turn Putnam around.
Both Manulife and Sun Life note the negative impact of U.S. and Asian equity markets in their quarterly financial statements.
Industrial Alliance experienced higher than expected death claims in individual insurance, abnormally high insurance claims in auto and home due to poor weather, and the default of a security in its bond portfolio.
> Property & Casualty Insurers. Five of the P&C companies reported declines in net income in the quarter, and Northbridge reported a loss.
Most of this is the result of higher claims, thanks to poor weather, and lower investment returns as a result of weak equities markets.
But Kingsway Financial Ser-vices Inc. ’s problems go deeper. Kingsway has been struggling to turn around its U.S. subsidiary, Lincoln General Insurance Co. Lincoln has been moving claims management in-house over the past few years and says this has resulted in improved pricing and claims management. The company has also strengthened management at the corporate level, including appointing a vice president of claims, realigning responsibilities and broadening the group involved in developing corporate strategy.
On a positive note, Kingsway had a big increase in the quarter in motorcycle premiums, as consumers move to more efficient vehicles.
> Mutual Fund And Investment-Management Companies. Most of the firms had lower earnings, and Mavrix Fund Management Inc. and Stone Investment Group Ltd. reported losses.
Out of the 14 companies in the category, there were five companies reporting improved earnings year-over-year, although DundeeWealth’s and IGM’s gains were small. Sceptre had a decent increase of 8.7%, IAM was up by 2.5% and Sprott, which went public on May 8, reported positive earnings vs a loss the year before.
DundeeWealth, Brookfield Asset Management Inc., Gluskin Sheff & Associates Inc., IAM, Saxon, Sceptre, Sprott and Stone all had increases in assets under management — with Sprott up by 50% and Brookfield and Stone up by more than 20%.
But the three big mutual fund companies all had lower AUM. AGF Management Ltd. experienced net redemptions from March through to August. IGM had net redemptions in every month but June in the April-August period; more of the outflows were from Mackenzie funds than Investors Group funds.
CI Financial Income Fund, on the other hand, has had net sales since February. CI has benefited from its strong family of segregated funds, SunWise, and its relationship with 37% shareholder Sun Life. Investors tend not to redeem seg funds.
Mackenzie’s acquisition of Saxon will add $13.4 billion to its (and IGM’s) AUM. Mackenzie had $43.4 billion in AUM as of Aug. 31, so that will bring it close to sister company Investors Group Inc.’s $59 billion in AUM.
Brookfield’s assets include housing and timber operations, which are negatively affected by the weak U.S. housing market.
Guardian Capital Group Ltd. says its big decline in net income is mainly because of much lower capital gains on its investments in this quarter vs the same period a year ago — $292,000 vs 1.9 million.
> Distributors And Suppliers. Outside of the investment banks and brokerages — which make up six of the 11 companies in this group — the companies in this category had generally good earnings. Anthony Clark International Insurance Brokers Ltd. continues to be the exception; it has been in a loss position since 2002. As for investment dealers, none of them expect a significant improvement in financial markets during 2008.
Accord was proud of its results, particularly in the U.S., given the economic conditions. It believes it can continue to overcome the challenges during the rest of this year.
Grey Horse Corp. bought Toro FX Inc. in July to enhance the foreign exchange services it offers its clients.
Western Financial puts its strong increase down to organic growth, low loan-loss provisions and a widening of margins.
> Exchanges. This is the first quarter that TMX Group Inc., resulting from the merger of TSX Group and Montreal Exchange, has reported earnings. Most of the increase was due to the merger, but the $49.2 million in TMX earnings in the second quarter was 7% more than the $46 million in combined earnings of the TSX and the MX a year ago.
> Holding Companies. Desjardins and Power Financial both had higher earnings in the quarter. Strong personal and commercial banking were responsible for the gains in Desjardins’ case; earnings from its life and P&C insurance, securities, brokerage, asset-management and venture-capital divisions were all lower. Power Financial’s results reflect those of Great-West Life and IGM.
Dundee had lower returns from resources, real estate and other investments, while the earnings gain at DundeeWealth was small.
Jovian Capital Corp.’ s $2.8-million loss in the quarter was bigger than its $54,000 loss in the same quarter a year ago but much smaller than the $11.4 million loss in the previous quarter. Jovian’s AUM was up 20% to $6.6 billion because of sales at 60%-owned BetaPro Management Inc. IE
Most companies profitable, but earnings have declined
Loan-loss provisions escalate and companies expect more of the same in the next two quarters
- By: Catherine Harris
- October 1, 2008 October 1, 2008
- 09:43