Investment Executive July 2018 page 6

Earnings rose for the majority of financial services companies in the most recent quarter for which data are available, and six companies increased 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 Great-West 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 loan-loss 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.

Financial Services Profit Survey July 2018

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.

Mutual 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 income 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.