Fi­nan­cial ser­vices firms re­ported healthy earn­ings to be­gin 2018.

Investment Executive - - FRONT PAGE - BY CATH E RI N E HAR­RIS

earn­ings rose for the ma­jor­ity of fi­nan­cial ser­vices com­pa­nies in the most re­cent quar­ter for which data are avail­able, and six com­pa­nies i ncreased their quar­terly div­i­dends. How­ever, prospects are much dim­mer now, due to the de­te­ri­o­ra­tion in Canada/U.S. re­la­tions and the pos­si­ble com­mence­ment of a trade war that could push Canada’s econ­omy into re­ces­sion.

Twenty-six of 44 com­pa­nies in In­vest­ment Ex­ec­u­tive’s quar­terly profit sur­vey had higher net in­come, while 13 had lower earn­ings and five were in a loss po­si­tion in the fis­cal quar­ter ended be­tween Feb. 28 and April 30. ( These fig­ures ex­clude GreatWest Lifeco Inc. [GWL] and IGM Fi­nan­cial Inc., as the re­sults of both are con­sol­i­dated with those of Power Fi­nan­cial Corp.)

The av­er­age in­crease in earn­ings for the 44 firms was 21%, but that fig­ure is some­what mis­lead­ing be­cause two large com­pa­nies — Fair­fax Fi­nan­cial Hold­ings Inc. and Brook­field As­set Man­age­ment Inc. — had very sig­nif­i­cant gains. In dol­lar terms, Fair­fax re­ported a US$962.7-mil­lion in­crease in net in­come, while Brook­field had a gain of $1.3 bil­lion. If Fair­fax and Brook­field are ex­cluded, the av­er­age in­crease would be only 6.6%.

Among the in­dus­tries, only two had lower earn­ings as a group: fi­nance com­pa­nies, down by 24.6%; and life in­sur­ers, down by 8.8%. Just two com­pa­nies in each group had higher net in­come.

Four banks in­creased their quar­terly div­i­dend: Bank of Mon­treal (BMO), to 96¢ from 93¢; Equitable Group Inc., to 27¢ from 26¢; Lau­ren­tian Bank of Canada, to 64¢ from 63¢; and Na­tional Bank of Canada, to 62¢ from 60¢. The re­main­ing firms that in­creased their quar­terly div­i­dends were: Sun Life Fi­nan­cial Inc., to 47.5¢ from 45.5¢; and TMX Group Ltd., to 58¢ from 50¢. Canac­cord Ge­nu­ity Group Inc. is pay­ing a spe­cial div­i­dend of 11¢ on top of its 1¢ quar­terly di­vided, and In­te­grated As­set Man­age­ment Inc. (IAM) in­tro­duced a quar­terly div­i­dend of 2¢.

In­ter­est­ingly, both Equitable and Sun Life in­creased their div­i­dends de­spite re­port­ing lower earn­ings in the quar­ter, as

the firms em­pha­sized their op­ti­mism about the fu­ture.

Ac­qui­si­tions also con­tin­ued. Bank of Nova Sco­tia was the busiest: the bank com­pleted its $950-mil­lion ac­qui­si­tion of Jaris­lowsky Fraser Ltd. on May 1; ex­pects to com­plete its $2.6-bil­lion pur­chase of MD Fi­nan­cial Man­age­ment by the end of Oc­to­ber; and also made pur­chases in Chile, Columbia and Peru — the big­gest was a $2.2-bil­lion deal for 68.2% of BBVA Chile, which is ex­pected to close in the next few months.

There were other firms mak­ing ac­qui­si­tions, in­clud­ing BMO, ECN Cap­i­tal Corp., GWL, In­dus­trial Al­liance In­sur­ance and Fi­nan­cial Ser­vices Inc. (IA), Fiera Cap­i­tal Corp., Sprott Inc. and Canac­cord. How­ever, these pur­chases were mainly smaller add-ons.

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

banks. Nine of the 12 de­posit-tak­ing in­sti­tu­tions, in­clud­ing the Big Six banks, had earn­ings in­creases in the quar­ter. The three banks with lower net in­come were Equitable, Home Cap­i­tal Group Inc. and HSBC Bank Canada.

Equitable’s 7.4% drop in net in­come was the re­sult of higher ex­penses while rev­enue re­mained rel­a­tively flat. HSBC’s de­cline was only 1.6%. Home Cap­i­tal is a dif­fer­ent story, as it’s still strug­gling from the scan­dal re­lated to in­come ver­i­fi­ca­tion for mort­gages. That has re­sulted in much larger drops in rev­enue than in ex­penses.

Loan-loss pro­vi­sions are key to the health of these com­pa­nies. In this quar­ter, which for most of the banks is the sec­ond fis­cal quar­ter ended April 30, the com­pa­nies had a to­tal of $1.9 bil­lion in loan­loss pro­vi­sions. That’s sim­i­lar to the lev­els in the pre­vi­ous seven quar­ters.

How­ever, loan losses could soar if there’s a trade war. There’s also vul­ner­a­bil­ity from a Bar­ba­dos gov­ern­ment debt de­fault.

Says Robert Colan­gelo, se­nior vice pres­i­dent, Cana­dian bank­ing fi­nan­cial in­sti­tu­tions, with DBRS Ltd. in Toronto: “It would be likely for Cana­dian Im­pe­rial Bank of Com­merce and Royal Bank of Canada to have some ex­po­sure given their Caribbean op­er­a­tions and re­quire­ments to hold debt in cer­tain re­gions.”

fi­nance com­pa­nies. Only Ac­cord Fi­nan­cial Corp. and MCAN Mort­gage Corp. had higher earn­ings. Cal­lidus Cap­i­tal Corp. was in a loss po­si­tion and the other four firms had de­clines in net in­come.

The $153.2-mil­lion loan-loss pro­vi­sion that Cal­lidus had to take at the end of 2017 con­tin­ues to cast a shadow on the com­pany, as fur­ther pro­vi­sions re­main pos­si­ble.

ECN and El­e­ment Fleet Man­age­ment Corp. — new en­ti­ties cre­ated by a split of El­e­ment Fi­nan­cial Corp. in Oc­to­ber 2016 — still are sort­ing out their busi­ness mod­els.

life in­sur­ers. GWL and IA, both with re­cent ac­qui­si­tions, had higher earn­ings, while E-L Fi­nan­cial Corp., Man­ulife Fi­nan­cial Corp. and Sun Life each had a drop in net in­come.

Ac­count­ing for life in­sur­ers is com­pli­cated be­cause changes in the fair value of the large amount of as­sets needed to back up their in­sur­ance con­tracts is in­cluded in rev­enue. In this quar­ter, all the firms had drops in the value of their in­vest­ments, hence the de­clines in rev­enue.

The ge­o­graph­i­cal mix of earn­ings among the com­pa­nies dif­fers con­sid­er­ably: E-L and IA op­er­ate pri­mar­ily in Canada; GWL is mainly in Canada and Europe, al­though it has a sig­nif­i­cant U.S. busi­ness; Man­ulife earned more in Asia and the U.S. than in Canada; and Sun Life’s Cana­dian busi­ness is big­ger than its U.S. and Asia op­er­a­tions, as well as the firm’s global as­set-man­age­ment busi­ness, which was the sec­ond-high­est source of earn­ings.

prop­erty & ca­su­alty and mort­gage in­sur­ers. Re­sults were mixed in the quar­ter. Ech­e­lon Fi­nan­cial Hold­ings Inc.’ s and Fair­fax’s net in­come soared by more than 1,000%, and Gen­worth MI Canada Inc. had a 20.1% gain. Mean­while, In­tact Fi­nan­cial Corp.’ s earn­ings de­clined by 18% and Co-op­er­a­tors Gen­eral In­sur­ance Co. was in a loss po­si­tion.

Fair­fax is by far the largest among the five com­pa­nies in this cat­e­gory, and marches to a dif­fer­ent beat. For the other four firms, in­sur­ance op­er­a­tions are the main de­ter­mi­nant of prof­itabil­ity, but Fair­fax fo­cuses on in­vest­ing to gen­er­ate much of its earn­ings. In this quar­ter, Fair­fax had a US$934.2-mil­lion in­crease in the value of its in­vest­ments vs a loss of $18.4 mil­lion in the cor­re­spond­ing quar­ter in 2017.

Co-op­er­a­tors’ loss came di­rectly from in­sur­ance losses, while In­tact’s in­sur­ance prof­itabil­ity shrank. Ech­e­lon’s in­sur­ance earn­ings also were a bit smaller, but no longer have the drag of losses on the com­pany’s dis­con­tin­ued Euro­pean busi­ness, which was sold in Fe­bru­ary 2017. Gen­worth, the sole mort­gage in­surer in the cat­e­gory, con­tin­ued to in­crease its in­sur­ance prof­itabil­ity.

m u t ua l fund and in­vest­ment man­age­ment com­pa­nies. Most of the nine com­pa­nies had in­creases in net in­come. The ex­cep­tions were Fiera, with a sub­stan­tial 86.9% drop in net in­come, and Guardian Cap­i­tal Group Ltd. and Stone In­vest­ment Group Ltd., both of which re­ported losses.

Fiera con­tin­ues to grow through ac­qui­si­tions, and earn­ings can take time to catch up. Much of Guardian’s earn­ings come from a large hold­ing of BMO shares, which lost al­most $30 mil­lion in mar­ket value dur­ing the quar­ter. In con­trast, Stone is still strug­gling to es­tab­lish a vi­able busi­ness model.

Among the three big mu­tual fund com­pa­nies, IGM had pos­i­tive net sales in all three sub­sidiaries: In­vestors Group Inc., Macken­zie Fi­nan­cial Corp. and In­vest­ment Plan­ning Coun­sel Inc. How­ever, both AGF Man­age­ment Ltd. and CI Fi­nan­cial Corp. re­ported net re­demp­tions.

bro­ker­ages. Canac­cord had lower net earn­ings, while GMP Cap­i­tal Inc.’ s rose and Op­pen­heimer Hold­ings Inc. re­ported pos­i­tive net i ncome com­pared with a loss in the cor­re­spond­ing quar­ter a year ear­lier.

ex­changes. TMX Group had higher earn­ings, mainly be­cause of its ac­qui­si­tion of Tray­port Inc. in De­cem­ber 2017.

hold­ing com­pa­nies. Des­jardins Group and Power Fi­nan­cial both had earn­ings in­creases, but Dundee Corp. recorded a $25-mil­lion loss, pri­mar­ily be­cause of lower values for its in­vest­ments.

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