Profit Survey: “Paper” gains drive rise in earnings

Companies have been allowed to include changes in the value of their investments since the international financial reporting standards (IFRS) accounting rules were adopted in Canada as of fiscal years beginning in 2011 – and most financial services firms have chosen the option to use fair market value. Previously, investments were held at book value until sold. Thus, the ups and downs of equities and other financial instruments are reflected in net income each quarter – and they’re also reflected in revenue, as that’s where the changes in the value of investments usually are recorded.

Life insurance companies (lifecos) are particularly affected because they hold so many assets to support their insurance and investment contract liabilities – hence, the average 42.2% rise in net income and 494.2% increase in revenue for the five lifecos in Q2 2014.

Three other firms whose results also were inflated by increases in the value of their investments were Fairfax Financial Holdings Ltd., Brookfield Asset Management Inc. and Guardian Capital Group Ltd.

Nevertheless, there were other companies that had big profit jumps from other sources. Fiera Capital Inc., for example, is growing quickly through acquisitions, while Canaccord Genuity Inc. and GMP Capital Inc. finally are seeing strong increases in investment-banking activity.

Of the 41 companies in the survey, 24 had higher net income and seven reported earnings vs a loss in Q2 2013. That left four with lower net income and six with losses. (These figures exclude Great-West Lifeco Inc. [GWL] and IGM Financial Inc., whose results are consolidated with those of Power Financial Corp.)

Six firms raised their quarterly dividends in Q2: Bank of Nova Scotia, to 66¢ from 64¢; Home Capital Group Inc., to 18¢ from 16¢; Royal Bank of Canada (RBC), to 75¢ from 71¢; Manulife Financial Corp., to 15.5¢ from 13.5¢; Fiera, to 12¢ from 11¢; and Accord Financial Corp., to 8.5¢ from 8¢.

Here’s a closer look at the results, by industry:

– Banks. The only deposit-taking institutions that didn’t see higher earnings were Bank of Montreal (BMO), First National Financial Corp. and PWC Capital Inc.

BMO’s decline was small, the result of a drop in its insurance earnings due to unfavourable movements in long-term interest rates.

First National’s much bigger drop also was the result of falling interest rates, which negatively affected the firm’s interest rate hedges. PWC remains in a loss as it continues to struggle to find a viable business model.

All the other 12 firms saw their earnings improve (including Equity Financial Holdings Inc., which had a small loss in Q2 2013). Increases for the other Big Five banks ranged from 2.3% for Canadian Imperial Bank of Commerce (CIBC) to 39% for Toronto-Dominion Bank.

Besides the decline in BMO’s insurance profits, only CIBC’s retail and business banking had lower earnings. All other divisions at the big banks had higher net income.

Among the smaller companies, HSBC Bank Canada had the biggest increase, at 40%. This was mainly because of a big drop in provisions for credit losses, to $27 million from $84 million.

The only other bank to reduce its loan-loss provisions significantly was CIBC, to $195 million from $330 million.

– Life insurers. Only E-L Financial Corp. had a drop in earnings. Most of this was because E-L’s Q2 2013 results were pushed up by large gains when the equity portfolio of its then property and casualty insurer subsidiary, Dominion of Canada General Insurance Co., was liquidated prior to the sale of Dominion on Nov. 1, 2013. But net income at E-L’s lifeco subsidiary, Empire Life Insurance Co., was also down a little.

Manulife’s huge jump of 192.5% was due to a particularly large swing in the value of its investments – an increase of $4.1 billion in Q2 2014 vs a drop of $9.4 billion in Q2 2013.

Among the Big Three, Manulife had increased “core” net income in Canada and Asia but a decline in the U.S. Sun Life Financial Inc. had lower earnings in Canada, the U.S. and Asia but higher net income for its U.S. wealth-management business, MFS Investment Management. GWL’s net income was up in Canada and Europe but down in the U.S.

Industrial Alliance Insurance and Financial Services Inc., which operates only in Canada, “exceeded expectations,” according to the firm’s interim report, in all divisions except group insurance, for which health, dental and disability claims were higher than expected.

– Property and casualty insurers. The key operating statistic in this industry is the combined ratio. If that ratio is below 100, the company is making an underwriting profit. That was the case for four of the five firms this quarter – including Kingsway Financial Services Inc., which helped produce positive net income for this firm for the first time since the Q3 2011.

The one company with a combined ratio higher than 100 was EGI Financial Holdings Inc. The problem was in the U.K. A warm and extremely wet winter increased the frequency of automobile claims by about 30% and there were also negative developments concerning claims started in prior years, mainly in the motorcycle program.

– Mutual fund and investment-management firms. Six firms had higher earnings, three reported positive net income vs a loss a year earlier, not one had a decline and only Matrix Asset Management Inc., whose assets under management (AUM) sank to just $226.5 million, had a loss. But that overview paints too rosy a picture.

AGF Management Ltd. is still making money in most fiscal quarters but remains in substantial net redemptions – at $507 million in Q2 2014 vs $610 million in Q2 2013 – and AUM continues to slide.

Sprott Inc. specializes in investing in gold, so it’s vulnerable to swings in the price of bullion. Even though Sprott’s AUM increased over the past year to $7.8 billion, that’s still well below the $10.3 billion the firm had in Q3 2011.

Then, there are Integrated Asset Management Corp. and Stone Investment Group Ltd., both of which still are trying to establish viable businesses.

Among the other six firms, CI Financial Corp. continues to have strong net sales, $1 billion in both Q2 2014 and in Q2 2013. Still, it’s worth noting that Scotiabank is divesting itself of its 36.8% interest in CI. Scotiabank has sold off 82.8 million of its CI shares and plans to sell the remaining 22 million.

IGM’s net sales aren’t nearly as strong as CI’s, but they are positive at $134.1 million in Q2 2014 vs net redemptions of $533.8 million in Q2 2013.

Brookfield is a major global infrastructure company; Fiera continues to expand; and Guardian’s AUM was up by 20.7%. Guardian also benefits from large holdings of BMO shares.

– Distributors and suppliers. Both Canaccord and GMP saw very strong increases in investment-banking activity, for which revenue was up by 174% and 102%, respectively. Oppenheimer Holdings Ltd.’s investment-banking business was up by 19% and the firm also had $8.4 million in after-tax charges “related to two regulatory matters emanating from transactions in low-priced securities.”

Accord Financial not only had a 29.2% increase in net income, but the firm’s interim report says inquiries from referral sources and potential clients are at “an all-time high.”

– Exchanges. TMX Group Ltd. had a substantial loss due to $106.2 million in non-cash impairment charges related to the goodwill and customer list of its options exchange subsidiary, BOX Market LLC.

– Holding companies. Desjardins Group and Power Financial both had good earnings gains, but Dundee Corp. remained in a loss position. Dundee’s pre-tax share of the loss at Dundee Precious Metals Inc., which is one of its equity-accounted investments, was a substantial $21.8 million in Q2 2014.

All of Desjardins’ divisions had higher earnings this quarter, and Power Financial’s results reflect those of GWL and IGM.

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