Wednesday, February 15, 2006

Scotiabank's Acquisition of Mortgage Business

RBC Capital Markets, 15 February 2006

Event Scotiabank acquired the mortgage business of Maple Financial Group for $233 million or 1.5x book value.

Set to Close Next Month. While subject to full regulatory approvals (OSFI, Minister of Finance and the Competition Bureau) the deal is expected to close by March 31, 2006. Integration is expected to take 9 to 12 months.

Financially Incremental. This deal is expected to impact Tier 1 capital by only 10 to 15 basis points, barley interrupting a half quarter’s normal growth in capital. The deal is expected to be accretive to earnings by the end of year two, however slightly, in our estimation, roughly break-even in the early going, and contributing on the order of 2-4¢ by and during 2008.

Strategically Most Interesting. This moves Scotia firmly into the highgrowth broker channel. Scotia is doing the deal for the existing and prospective customer base and is betting retail product cross-sell will accelerate using Scotia’s much broader suite of consumer deposit and homeequity lines of credit, to name just two. The deal also increases Scotia’s high ratio mortgage business, where spreads are wide for what may be perceived to be high-risk credits. We say ‘perceived’ because credit loss experience has actually been lower than Scotia’s own normal mortgage business, broadly priced to be lower risk on average. The Maple portfolio in part performs so well because it is 94% government-insured – this also requires zero regulatory capital, therefore offering excellent risk-based returns.

The Business. The majority of Maple Trust’s 42,000 customers are located in Ontario, Alberta and British Columbia. Maple Trust has $7.5B in mortgages under administration, but only $1.6B on the balance sheet as at December 31, 2005 with the rest of the book securitized. Given its excess capital position, Scotia will likely opt for funding this book internally, and in our view, the more the better for Scotiabank’s prospective EPS accretion.

• Valuation. Our price target of $51 is set at 13x our 2007 cash EPS estimate of $3.92. Our target P/E is in line with the target P/E multiple for the group and slightly above Scotia’s five-year average discount of 2%. We believe Scotia’s excess capital position, estimated at $2.8 billion at the end of Q4, and fast-growing international growth platform offset BNS’ lower leverage to wealth and higher corporate loan exposure. Our price target is also indicated at ~2.9x our projected book value of $17.68 (as at Oct. 31/06).