Monday, June 30, 2008

3 of Top 10 North American Banks are Canadian

  
Financial Post, Zena Olijnyk, 30 June 2008

“Don’t hold your breath” is the verdict from Desjardins Securities banking analyst Michael Goldberg when it comes to mergers in the Canadian financial services sector, despite last week’s recommendation from the Competition Policy Review Panel that the ban be removed.

Among the 65 recommendations in the report from the committee was the removal of the de facto ban on bank, insurance and cross-pillar mergers of large financial institutions, but Mr. Goldbeg says in a research note that “investors should not expect its implementation for the foreseeable future.

Why? Well Mr. Goldberg cites two reasons. For starters, he notes that the ban was “politically motivted,” and the constituencies that oppose the idea of mergers are “still stronger and better organized” than those that favour them.

Secondly, Mr. Goldberg argues that the business case for the combinations is not compelling. While the argument for bank mergers has been made on the basis of greater scale,” the committee says that “reaching the scale of the world’s largest institutions will depend on how well Canadian banks fare in the contest to acquire foreign banks.”

He also points out that Canadian banks are once again showing up in the list of top 10 North American banks, based on market capitalization – Royal in fifth place, with TD and Bank of Nova Scotia in seventh and eighth spots, respectively - something that hasn’t been the case in well over a decade. (In 1989, the top 10 included TD, Royal Bank and CIBC. By 1998, just before the proposed merger or BMO and Royal - not one Canadian bank appeared on the list.)

While the rise in the rankings has come as a result as a great erosion in the valuation of US banks, thanks to the recent credit crunch, Mr. Goldberg notes that Scotia and TD have grown their banking businesses outside of Canada significantly through acquisitions and organic growth. “We believe that this history demonstrates the Canadian banks' ability to compete for foreign acquisitions has been more a function of business acumen, vision, courage and patience than it has been about scale,” he says.

So while he doesn’t rule out the possibility of Canadian bank mergers, Mr. Goldberg concludes: “The only merger scenario we can foresee for now is a bank bailout, described for public consumption (to protect public confidence) as a merger. Are any of the major banks in a position now where they need to be bailed out? No.”
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Wednesday, June 25, 2008

CIBC & RBC Likely to Increase Markdowns on Hedges with Financial Guarantors

  
RBC Capital Markets, 25 June 2008

Problems facing financial guarantors worsened recently as rating agencies downgraded several large players.

• We believe further large write-downs are likely as credit default swap spreads have widened considerably since the end of Q2/08.

• Banks have not been valuing their hedges with financial guarantors solely on credit ratings, but have also taken into consideration credit default swap spreads on the financial guarantors in determining valuation allowances on hedges.

• We also expect continued pressure on the valuation of hedged assets, which will increase the exposure to financial guarantors.

CIBC and Royal Bank have the largest exposures to financial guarantors among Canadian banks

• Due to the ratings actions, CDS spread widening and continued pressure on the value of CDOs of RMBS, we are increasing our write-down estimates at CIBC (from $1 billion to $1.5 billion) and Royal Bank (from $0 to $500 million).

• We have summarized our sensitivity analysis on the Tier 1 ratio of CIBC and Royal Bank in this report. We believe that each bank's Tier 1 ratios will remain above 9% using our expected write-down amounts in Q3/08E, and that the banks have enough capital even if we assume the hedges with financial guarantors are worthless.

• The other Canadian banks have much smaller exposures, if any.

Lowering 12-month target price for CIBC and Royal Bank

• We maintain our Underperform rating on CIBC's shares. We have lowered our 12-month target price for CIBC from $64 to $62 per share due to our higher write-down estimate. Our target price is based on a P/BV multiple of 2.0x, versus the current 2.1x multiple, and it implies a P/E on 2009E EPS of 8.4x, whereas the stock currently trades at 8.3x 2008E EPS.

• We maintain our Sector Perform rating on Royal Bank's shares. We have lowered our 12-month target price for Royal Bank from $50 to $49 per share, due to our higher write-down estimate. Our target price is based on a P/BV multiple of 2.3x, versus the current 2.5x multiple, and it implies a P/E on 2009E EPS of 10.8x, whereas the stock currently trades at 10.8x 2008E EPS.
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RBC Capital Markets, 24 June 2008

We prefer Manulife's stock ($36.60, Outperform, $41 price target) to Scotiabank's ($48.79, Sector Perform, $49 price target). BNS is not our least favourite bank stock but it shares many similarities with MFC that reduce basis risk. The reasons why we would take money out of Scotiabank and allocate it to Manulife stock are:

• MFC trades at a more attractive valuation relative to historical averages than BNS.

• MFC trades at 11.5x NTM EPS, in line with BNS. Over the last 7 years, MFC has traded at an average premium of 1.4x.

• MFC trades at a 1.3x P/E premium to the lowest valued Canadian lifeco, while BNS trades at a 3.3x premium.

• On a P/B basis, MFC's current 2.2x multiple is in line with its 7-year average, while BNS current 2.7x multiple is higher than its 7-year average of 2.5x.

• We expect greater core EPS growth from MFC in 2008 and 2009 (5% and 13%) than we do for BNS (4% and 2%).

• The macro environment is shifting in a way that advantages MFC.

• The Canadian dollar has settled in a range of about $0.97-$1.03 since mid-November. The rising Canadian dollar had been more negative for MFC than BNS, as it generates 75% of its earnings from outside of Canada versus 45% for BNS.

• The economic and credit quality outlooks continue to deteriorate, which we believe will have a greater negative impact on BNS's loan book than MFC's bond portfolio in 2009. For BNS, we are expecting a 9% earnings growth drag from increasing provisions for credit losses. MFC's investment portfolio has a conservative allocation to riskier bonds (13.8% in BBBs and 2.6% in BBs and below).

• Long term interest rates are up from their lows on rising concerns about inflation. MFC and other insurers benefit from higher interest rates as the duration of their liabilities is longer than that of their assets.

• New business momentum is better at MFC. Sales of insurance products are less dependent on the economy than is loan growth, in our view. We expect loan growth to slow for banks and pressure on retail margins. MFC's Q1/08 value of new business was up 35% YoY, driven by sales of both insurance and wealth management products.

We believe that a pairs trade between MFC and BNS reduces basis risk as these two companies match up well.

• Both companies are best established outside of Canada among their Canadian peers.

• Both management teams are willing to make acquisitions.

• We view both companies as having a "quality" perception among their peers, which should help their stocks in turbulent times.

Details

We have an Outperform rating on Manulife shares as the company has a well-established record of consistent earnings growth and embedded value growth, and has become a world leader among insurers. We believe that Manulife deserves a premium valuation to Canadian financial services companies and life insurers worldwide, based on the company's sales and earnings growth track record, excess capital holdings, growth prospects in Asia, and a lower credit risk profile versus U.S. lifecos and Canadian banks.

• Diversity of operations limits downside earnings risk, in our view, and reserves appear conservative, with large provisions for adverse deviations relative to reserves and a track record of booking experience gains.

• Our 12-month price target of $41 is a combination of our P/B, P/E, and embedded value methodologies. Our P/B target is 2.4x, our target P/E multiple is 12.0x 2009E earnings and our target multiple on embedded value is 1.8x.

We have a Sector Perform rating on Scotiabank shares to reflect our expectations for benign credit deterioration near term, strong domestic retail momentum coming out of Q2/08 results and continuing strong asset growth in international banking, which are offsetting rising loan losses in Mexico, and the negative impact of currency.

• We continue to believe that deterioration in business lending and lower recoveries will lead to a material increase in loan losses in 2009 but to reduce our exposure to the stock today on that basis only is premature in our mind, especially since the retail division is performing well.

• Our 12-month target price of $49 is based on a P/BV multiple of 2.3x, versus the current 2.6x multiple, and it implies a P/E on 2009E EPS of 11.5x, whereas the stock currently trades at 11.8x 2008E EPS.
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Monday, June 23, 2008

Review of Banks' Q2 2008 Earnings

  
Scotia Capital, 23 June 2008

Earnings Resilience Continues - Grinding It Out

• The Banking Siege is now into its 11th month and still counting, although it continues to show signs of easing. The bank index has rebounded 16% from the lows reached on March 17, The Bear Stearns Rescue, which we believe is the beginning of a major bull market in bank stocks.

• The Canadian banks, except for CM, have avoided the carnage that has besieged many of the global banks. Canadian banks cumulative writedowns as at Q2/08, including BMO’s natural gas trading losses, have totalled $10.9 billion, with CM representing 60% of these writedowns. Thus excluding CM, Canadian bank cumulative writedowns represented less than one quarter of earnings or 3% of book value. TD and RY have stood out from their global peers and Canadian competitors with cumulative writedowns at 0% and 4% of book value, respectively. We expect this quarter will be the last quarter of noticeable mark-to-market (MTM) writedowns with recoveries not out of the question over the next few years.

• The earnings performance of Canadian banks has been relatively resilient in a very difficult environment as they have been grinding it out. On an operating basis after a five-year run of successive 15%+ growth, we expect earnings to decline a modest 2% in 2008 before growth returns to 11% in 2009. On a quarterly basis Q2/08 represented the second straight quarter of modest negative earnings growth, with -2% in Q1 and -5% in Q2, with Q3 expected to be - 7% before earnings momentum is expected to turn positive in Q4 with growth estimated at 6%. Thus the bank group is grinding through three quarters of modest negative earnings momentum while maintaining strong capital positions and near-record profitability. Retail banking earnings have remained very strong with wholesale earnings tumbling, especially in Q2/08.

• The banks earnings performance is actually quite admirable given the 15% year-over-year appreciation of the Canadian dollar, which impacts approximately one-third of bank earnings and the 10 to 15 basis points (bp) year-over-year decline in the retail net interest margins, as well as the difficult wealth management and wholesale banking operating environment.

• The solid underlying earnings for the bank group have resulted in at least one Canadian bank increasing its common dividend in every single quarter since the credit crisis began. Although the increases have been modest, it bodes well. The dividend payout ratio is 46% on 2008 operating earnings and 42% on 2009 earnings estimates. We expect Q4/08 positive earnings momentum to be a catalyst for broad-based dividend increases for the bank group.

• Canadian bank market capitalization declines have been extreme compared with writedowns and relatively low exposure to high-risk assets. Canadian bank market capitalization has declined $40 billion (excluding CM) on writedowns of $6.7 billion after tax, for a market capitalization decline ratio (MCDR) of 15.9x. MCDR is market capitalization decline as a multiple of after-tax writedown. We believe the MCDR at 15.9x is high versus the modest 8.4x MCDR for a group of global banks, especially when Canadian banks have much lower residual risk in their balance sheets. The MCDR is also high compared to levels of 1.8x to 2.3x during the LDC and CRE crisis of the 1980s and 1990s.

• The Banking Siege has presented one of the best buying opportunities in decades to participate in the major bull market in bank stocks. Canadian bank stocks have been impacted, not surprisingly, by the negative sentiment towards the financial services sector. Investors have a heightened awareness of systemic risk and are pricing for it.

• We believe sentiment, although negative, is beginning to shift, as global players are taking major writedowns and shoring up capital positions. We believe Canada has a structural advantage versus U.S. banks and other global players. The solid fundamentals in our residential mortgage market set Canada apart from many countries. The dominance of Canadian banking franchises in a number of business lines and the extremely low penetration from monolines presents a competitive advantage.

• Higher loan losses, we believe, through an economic downturn are absorbable. We expect loan loss provisions to peak in the 65 bp or $7 billion range in 2010/2011 versus our 2008 and 2009 forecasts of $4.6 billion and $5.3 billion, respectively. The earnings drag is expected to be 8% over a two- or three-year period, which we believe is readily absorbable. The retail net interest margin is arguably a more important earnings variable as a 10 bp shift in the retail margin impacts earnings 3%. Interestingly, the retail net interest margin has declined from 3.65% in 2001 to the recent level of 2.88% for a significant 77 bp decline. Thus bank earnings would have been over 20% higher today all things being equal, which of course they are not. The margin decline was driven by loan and deposit mix shifts, competition, deposit cost floors, and spikes in wholesale funding costs. Of the positives from Q2/08 earnings was the firming up of the retail net interest margin, which actually increased 2 bp sequentially although it was down 12 bp year over year. We expect a firmer to perhaps expanding margin to be a catalyst for positive earnings surprises in 2009.

• Bank valuations in our view are already discounting a recession. Bank P/E multiples are at extremely attractive levels at 11.2x, 11.2x, and 10.0x, trailing, 2008 and 2009 operating earnings estimates, respectively. The bank P/E multiples appear to have bottomed at 9.4x trailing, on March 17 (Bear Stearns Rescue), slightly above the 9.0x level during the Asia crisis in 1998 and below the 10.9x bottom during the Telco/Cable/Power crisis in 2001. We believe the trend line for bank P/E multiples continues to be 16x, and the current stress testing (credit crisis and recession) is in fact needed to push the multiple through previous highs. The 16x target multiple is based on a 5% ten-year government bond yield. If bond yields were to increase to 6% based on inflation concerns, the target multiple would be in the 14x range, 25% higher than current valuation.

• Canadian bank P/E multiples relative to U.S. banks have improved to a 7% premium versus a discount of 5% to 10% since the credit crisis began. We continue to believe Canadian banks should trade at a 10% to 15% premium based on lower balance sheet risk, high profitability, and a less volatile and risky banking system.

• The bank P/E multiples relative to the TSX are 63%, in line with the historical mean but below our 80% to 90% target, which is based on periods of similar bank fundamentals.

• Bank dividend yields relative to bonds remain at unheard-of levels (until the current credit crisis) at 109% or 4.6 standard deviations above the mean. The peak was 7.0 standard deviations above the mean on March 17, when fear and panic were at their highest. The market was beginning to discount a total global financial collapse. We continue to believe dividends are safe and broad-based dividend growth will begin in Q4/08.

• Bank dividend yield versus the overall equity market is an astounding 2.3x versus a historical mean of 1.4x and not far off the spike to 2.8x from the Nortel/High-Tech bubble in 2000. Bank dividend yields are also at record levels versus Pipes & Utilities and Income Trusts.

• We continue to recommend aggressively buying bank stocks at these levels. As fear subsides, we expect share prices to move up sharply. We expect the negative drag from flow of funds to reverse. Flow of funds has not been helpful for bank share price performance as $12.7 billion has gone into money market funds in the first five months of 2008, with domestic equities recording net redemptions of $3.4 billion and domestic balance inflows anaemic at $207 million. In addition, the resource sectors have been red hot attracting funds, which is not expected to last forever. The short interest in Canadian banks that peaked in late 2007 and early 2008 continues to decline, removing some downward share price pressure.

• In terms of stock selection we continue to favour RY and TD, which we consider to be the high-quality banks with the strongest operating platforms, and which consistently and continually reinvest in their businesses. These banks have the highest profitability, strongest balance sheets, and growth prospects. These three banks substantially outperform over the long term.

• They have also performed exceptionally well through the recent crisis operationally and share-price wise. TD, and RY share prices are down 11%, and 18%, respectively, from their all-time highs. CM, BMO, and NA share prices have declined 40%, 37%, and 19%, respectively, from their all-time highs.

• We continue to recommend maximum allowable weightings in bank stocks based on overall fundamentals and valuation. Even the weakest bank looks compelling from an investment perspective. We have only BUYS and STRONG BUYS in the bank group with no SELLS or HOLDS on an absolute return basis. High-quality balance sheets, strong funding and liquidity, high profitability, compelling valuation, and the major structural advantages from our banking system and economy support our very bullish stance towards bank stocks.

• We maintain our 1-Sector Outperforms on RY and CWB, 2-Sector Performs on TD, NA, and CM, with 3-Sector Underperforms on BMO and LB.

• Our order of preference is: RY, CWB, TD, NA, CM, BMO, and LB.

RY 1-Sector Outperform – Canadian Banking Earnings Momentum; U.S. & International Represents 5% of Earnings

• RY reported solid domestic banking results up 15% year over year. Insurance earnings doubled from a year earlier while banking-related earnings increased a respectable 7%. U.S. & International earnings were disappointing this quarter, declining 30% due to increased loan loss provisions related to the banks' Builder Finance portfolio. Although U.S. & International earnings were disappointing, the segment only represented 5% of the bank’s total earnings. We believe that RY will continue to achieve above-average profitability based on the strength of its retail and wealth management platform, and that increases in LLPs will be absorbable.

CWB 1-Sector Outperform – High Growth Prospects – Lower Premium

• CWB continues to have a high growth profile, generating loan and deposit growth of 20%+ in the high growth economies of Alberta and British Columbia. Despite the high growth profile, CWB’s P/E premium has narrowed versus the bank group. In fact, CWB’s relative valuation is the most attractive it has been in five years.

TD 2-Sector Perform – Wholesale Represented 9% of Earnings; ROE Dilution from CBH Acquisition

• TD is well positioned with its strong domestic retail banking platform, nominal exposure to high-risk assets, and low reliance on wholesale earnings. The Commerce Bancorp acquisition is dilutive to return on equity with some integration risk, although we expect the company to manage through the integration and difficult U.S. operating environment. We maintain a 2-Sector Perform on the shares of TD as we expect higher earnings growth from RY and BNS. TD also has a significantly lower Tier 1 ratio pro forma fiscal year-end 2008.

NA 2-Sector Perform – Reliant on Wholesale

• NA remains heavily reliant on wholesale earnings. In Q2/08 wholesale earnings represented 34% of total earnings, the highest of the bank group. Growth in retail and wealth management has been modest. Asset quality remains relatively strong with very low impaired loan formations.

CM 2-Sector Perform – Retail Earnings Decline

• We believe the second quarter represented the last quarter of meaningful writedowns on U.S. sub-prime CDOs. However, after the dust settles we are concerned about the earnings power of CIBC World Markets and to a lesser extent CIBC Retail Markets. CM’s restructured wholesale platform has contributed a modest 10%-15% over the last two quarters versus 20%+ prior to Q1/08. CM’s retail banking earnings were disappointing this quarter despite a higher retail net interest margin and slightly lower loan losses.

BMO 3-Sector Underperform – Off-Balance Sheet Risk High; Low Profitability

• We maintain a 3-Sector Underperform on BMO based on the bank’s lower earnings growth outlook, lower profitability, higher off-balance sheet risk, and relatively weak operating platforms. BMO’s loan loss provisions have recently spiked to 36 bp of loans and are expected to remain at these elevated levels. Impaired loan formations also spiked. We believe a 15%-20% discount to the bank group is warranted.

LB 3-Sector Underperform – High Securitization Gains; Underlying Earnings Weak

• We maintain a 3-Sector Underperform on LB based on the bank’s lower profitability, moderate loan growth outlook, and relatively high P/E multiple versus the bank group. Year-to-date, LB has had very large securitization gains representing 22% of earnings. We believe earnings growth from securitization gains is not sustainable at these levels and that earnings momentum is slowing after a number of years of recovery.
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Financial Post, Duncan Mavin, 23 June 2008

Canadian Imperial Bank of Commerce may be forced to raise more capital after another of the bank’s monoline counterparties ran deeper into trouble, said Blackmont Capital analyst Brad Smith.

CIBC has already taken $6.7-billion in writedowns on structured products linked to the U.S. subprime mortgage market. It will likely take another $1-billion hit in the third quarter of 2008 after XL Capital Assurance was downgraded by rating agency Moody’s, Mr. Smith said.

XLCA is a subsidiary of monoline SCA, with which CIBC has about $3.3-billion in exposure. In addition, the bank has about $25-billion in structured products that are not related to the subprime mortgage market.

Mr. Smith notes that the bank can withstand further losses on its remaining subprime exposure, and has a strong balance sheet after raising $2.9-billion in dilutive equity earlier this year. But additional losses in its $25-billion book of of non-subprime investments could push the bank to go back to the market for more capital, he said.

Blackmont Capital rates CIBC stock “hold” with a 12-month target price of $74.00
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TD Commerce Bank Investor Day

  
Financial Post, Duncan Mavin, 23 June 2008

Toronto-Dominion Bank has achieved critical mass in the U.S. with the acquisition of Commerce Bancorp, and although TD is now significantly more exposed to the weakening U.S. economy than its Canadian peers, there is plenty of upside from the deal, says National Bank analyst Rob Sedran.

The combination of Commerce and TD’s existing platform, TD Banknorth, will see TD rank in the top ten for deposit market share in eight states in the U.S., including New York, New Jersey and Massachusetts. It also increases TD’s existing branch platform from 626 branches to 1,071 branches, and positions the bank to do more deals.

“As a result of this larger footprint, future acquisitions are more likely to carry expense synergies, allowing TD to compete for assets on a more equal footing with the large U.S. banks,” Mr. Sedran said in a note.

The National Bank analyst also points out that TD appears to be committed to Commerce’s high-service level culture — what executives call the “wow” factor — which is a strong source of competitive advantage. The bank has already done a lot to bring Banknorth up to the high-service level model, he notes. Also, although TD now has more at stake in the U.S., it is mostly located in the northeast, where recent negative trends have not been as dramatic as in other parts of the country.

TD’s capital position is looking tight after the Commerce deal, but unlike its Canadian rivals, “the fact TD’s balance sheet has been stretched not by writedowns and losses, but by deployment, is a crucial distinction,” Mr. Sedran said.

Although all the Canadian banks have suffered a fairly lacklustre performance so far this year, that outlook could brighten in 2009 for TD at least. If TD hits or even beats its targeted earnings from the U.S. of $1.2-billion in 2009, there is potential upside to earnings estimates, Mr. Sedran said.

National Bank rates TD “outperform” with a $77.00 target price.
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Financial Post, Janet Whitman, 21 June 2008

Commerce Bank customer Corey Singer was a little worried when he heard Toronto-Dominion Bank was taking over. But he soon got some reassurance after the newly named TD Commerce sent him a letter and an e-mail saying his bank-- which has built up one of the most powerful customer-centric U. S. brands with its free red lollipops, coin-counting machines and Sunday hours -- won't be changing.

"I trust Commerce," Mr. Singer, who works in public relations, said one recent evening outside a Commerce branch in Manhattan's East Village. "It appears that all of the major benefits are going to be the same--at least I hope."

Investors and analysts aren't so sure.

Since Cherry Hill, N. J.-based Commerce Bancorp agreed to accept a US$8.5-billion takeover offer from TD in October, the chief concern among analysts and investors has been whether the charismatic, customer-first culture at Commerce will slip.

"The $64,000 question of the Commerce transaction is what percentage of customers are at risk of losing should they scale back certain services to make an attempt at lowering expenses," said Gerard Cassidy, an analyst with Royal Bank's RBC Capital in Portland, Me. "Instead of opening up at 8 in the morning to capture commuters, they could, in certain locations, say now we're opening at 9:30. It's really a balancing act: how to increase the profitability of Commerce while at the same time lowering costs and not alienating their customer base."

Analysts don't doubt TD will be looking to cut costs.

For every dollar it takes in, Commerce lavishes around 75¢ on its customers. TD, which has built up a strong reputation for customer service in Canada since its 2000 acquisition of Canada Trust, spends only about 50¢.

Ed Clark, TD chief executive, and Bharat Masrani, TD Commerce CEO, acknowledged at TD's annual investor day in suburban New Jersey on Thursday that expenses at Commerce are high.

But they added that the free ballpoint pens, lollipops and dog biscuits handed out at the Commerce branches account for very little of that spending.

A big chunk of the expenses goes toward opening new branches, which, down the road, should fuel profits.

Aggressive growth has been a cornerstone of Commerce Bancorp's success since Vernon Hill II founded the bank in 1973 at the age of 27.

Mr. Hill, who owned Burger King retail franchises and modelled the bank on retail outlets such as Starbucks and Home Depot, had expanded to 470 branches before he was ousted last year amid a scandal over regulatory scrutiny involving deals with his family members and other company insiders.

Speaking with reporters following the investor meeting, Mr. Clark and Mr. Masrani said they'd be loath to slow the pace of opening new branches.

"If we stopped new branch growth, we could get our expenses way down, but that's not our strategy," said Mr. Masrani. "Commerce has shown it can go into markets and take share."

The executives pointed to the bank's foray into Manhattan's Chinatown as an example. When Commerce opened in the neighbourhood, it gave away rice cookers and offered 7,500 safety deposit boxes built around the number eight, considered a lucky number by many Chinese. Commerce opened a whopping 10,000 accounts there in the first month, a rate unheard of in the U. S. banking business.

The TD executives noted that they've already found a way to lower costs considerably -- without skimping on services -- by spending 25% less money on building each new Commerce branch.

"We can source materials cheaper and we've modified certain aspects," said Mr. Masrani.

The executives also said they can improve profitability at Commerce by selling new services to customers at higher profit margins.

Throughout Thursday's meeting, which included a tour of a local bank and call centre and five hours of powerpoint presentations, executives took pains to assure analysts and investors that they see the value in protecting and expanding the "wow-the-customer" cul-ture at Commerce. The bank's slogan, "America's Most Convenient Bank," is "not just a tagline," said Mr. Masrani. "It is the essence of our brand and who we are as a company."

TD, which began its foray into U. S. retail banking in 2005 when it took a stake in Banknorth, faces a lot more competition down here than in Canada, where five banks dominate the landscape.

Nevertheless, TD executives said they expect to dominate the "hassle-free" convenience banking space from Maine to Florida when its 1,100 Commerce and Banknorth branches are converted to the TD Commerce brand in 2009.

"As you well know, in the financial-services industry, products and price can be matched in a millisecond," Mr. Masrani told the dozens of investors and analysts gathered for the investor day at "Commerce University, " a training ground for bank employees in Mt. Laurel, N. J. "But providing a legendary 'wow' customer experience -- founded on unparalleled convenience -- cannot be easily replicated by our competitors who simply do not have the locations we do, the customer conveniences we offer, the people we have, or, frankly, the hours we keep -- including seven-day banking across much of our network."

This year, TD plans to replace the prominent red "C" logo at Commerce with its new green TD Commerce colour scheme. The TK Banknorth branches will be converted next year.

The rebranding effort hasn't come without hiccups.

In parts of Massachusetts, a federal judge blocked some Banknorth branches from switching to the TD Commerce Bank name after another Commerce bank -- Commerce Bank & Trust Co. -- filed a lawsuit arguing the name change would confuse customers.

Beyond the dozen branches held up in the legal spat, the naming rights of the sports arena where the Boston Bruins and Celtics play is in limbo. The arena, sponsored by TD Commerce, is currently called TD Banknorth Garden.

Mr. Masrani said the dispute is giving him more grey hair. "Our name is TD Commerce. It has the globally known TD shield in front of it. We think that's a significant differentiator."
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RBC Capital Markets, 20 June 2008

Integration on track

The integration of Commerce Bancorp is underway with the leadership team announced and legal entities consolidated under one national charter. The bank has also started to close overlapping branches while continuing to open others in optimal locations, and still intends to meet its systems conversion target in H2/09 and cost synergy target of $310 million.

The bank reiterated its guidance for TD Commerce to contribute at least $750 million to earnings in 2008 and $1.2 billion in 2009 despite the tough economic environment and an expected increase in loan losses. Initiatives to grow earnings from the Q3/08 estimate of $250 million include organic balance sheet growth, improved spreads on loans and securities, expense initiatives and synergies from integrating TD Banknorth and Commerce. Total U.S. earnings currently make up about 20% of total earnings, and management expects this to grow to up to 25-30% of total earnings in upcoming years.

A smooth integration is key to TD's stock price since our forecast Tier 1 ratio of 8.1% at the end of Q4/08 gives TD very little room for slippage against profitability estimates, particularly when considering ratios based on tangible equity. TD's Tier 1 ratio of 9.1% is lowest of its peer group and the excess capital the bank generates between now and Q4/08 will be offset by a negative impact of 1.3% on the bank's Tier 1 ratio (given changes to the way the bank accounts for its investment in TD Ameritrade). However, if the year goes as management plans for TD, then we believe it can improve the ratio quickly after Q4/08 because TD generates about 20-30 basis points of Tier 1 capital per quarter.

Management reiterated that its #1 priority is integration related, but that a compelling acquisition would be considered. We believe this is reflective of the environment in U.S. banking, which may lead to banks being sold at attractive prices. We do not believe that TD could execute two integrations at the same time and any acquired bank would have to be left alone for a few years while the integration of TD Banknorth and Commerce Bancorp continues. We understand management's reluctance to categorically state that it will not participate in acquisitions, but do not believe that a transaction would be initially well received by investors.

We are still concerned about U.S. credit quality

TD Commerce has not yet seen major problems in its loan portfolio as some other U.S. banks have, and management believes that TD Commerce will be a positive outlier relative to peers. TD's management acknowledged the worsening economic environment but believes that it has adequate reserve coverage, and even if loan losses were higher, it would still expect to meet its earnings guidance unless the U.S. entered into a deep recession.

We are not as concerned about TD's loan losses as we are with other banks in the U.S., but we expect credit quality deterioration in the U.S. will continue especially in HELOCs, credit cards, automobile lending, construction lending, commercial real estate and leveraged lending.

• We believe TD's U.S. exposures (26% of total loans) are worth paying attention to, but we believe that issues are more likely to arise in 2009 than 2008 as TD fair valued Commerce Bancorp's loan book as at the acquisition closing date. The bank would have had a fair bit of visibility on potential near term impairments, in our view, and would have fair valued the loans that had the potential to become impaired in the near term.

• TD has been a positive outlier so far from a credit perspective, which management attributes to a focus on in-market lending, underwriting to hold, not participating in loans originated by brokers, avoiding the sub-prime market and exotic types of real estate lending, not having had to "reach for assets" to generate earnings growth since deposit growth was more rapid than average, and being located in a geographic segment that has held up better than other areas of the U.S.

• Provisions for credit losses have so far exceeded write-offs.

• Non-performing loans of 68 bps in Q1/08 compared to an average of 116 bps for retail banks with assets of $50-$250 billion while non-performing assets of 33 bps compared to an average of 83 bps. Both measures improved slightly from Q4/07 to Q1/08, although we expect deterioration in the upcoming year given the moribund state of the U.S. economy and broadening of credit losses to sectors other than those tied directly to residential real estate..

• The U.S. commercial lending portfolio has $29.7 billion outstanding as at March 31, 2008.

• Management believes it has adequate reserves as long as the U.S. avoids a deep recession.

• Geographic exposures are concentrated in the U.S. Northeast (Massachusetts 22%, New Jersey 18%, Northern New England 17%, Metro New York 14% and Metro Pennsylvania 14%) with only 2% exposure in Southeast Florida.

• Sector exposures included Investment real estate (36%, of which appears to be diversified by property type and geography), Manufacturing (8%), Health care (8%, Retail trade (7%), Wholesale (6%), Finance/Insurance (5%) and Other.

• The U.S. consumer lending portfolio has $15.9 billion outstanding as at March 31, 2008.

• The average FICO score is 745, and the bank states that rising delinquencies are within acceptable levels.

• The geographic distribution is mixed in the Northeast with only 1% in Florida.

• The product mix is 31% home equity 2nd lien, 30% residential mortgage, 17% home equity 1st lien, 14% indirect auto, 4% credit card and 4% other.

• Average loan to value in the HELOC portfolio is 62% while it is 67% in the first mortgage portfolio.

TD will maintain the core attributes that made Commerce Bancorp successful

Management spent a considerable amount of time conveying the importance of preserving many of the attributes that made Commerce Bancorp successful and taking advantage of its convenience advantage. Prior to the merger, both TD Bank and Commerce Bancorp had "owned the convenience space" and we expect them to leverage the brand further to maximize customer loyalty and to grow business.

• The high standards for customer service lead to an expensive model to execute but it leads to a high level of employee engagement and customer satisfaction, and ultimately attractive profitability in mature branches.

• Commerce Bancorp has ranked first in JD Power's customer satisfaction survey in recent years, and TD Banknorth's customer surveys showed satisfaction results that were comparable to TD Canada Trust.

• Commerce Bancorp has higher deposits per branch than its peers ($110 million versus an average of $71 million in spite of having many "immature" stores in its network while deposit growth has also outpaced the competition).

Successful features that the bank intends to maintain and leverage include:

• Longer branch hours and open 7 days per week / 360 days per year in many metro markets;

• Timely service on the phone and in the branch (Commerce completes 6,095 monthly transactions per teller, almost double its peers while its call centers are less automated than the competition's);

• Fast turnaround on account openings including on site issuing of debit cards;

• A refined product suite with fees that are lower than the competition's

• Upgrading legacy TD Banknorth branches with customer friendly designs and in branch services such as penny arcades for free coin counting and a friendly environment for kids and pets. The bank will initially target the branches in areas where there was overlap between Banknorth and Commerce;

• Building distinct "cookie-cutter" retail branches in key metro markets. TD believes it can open 300+ branches in Long Island, Metro Boston and New York/New Jersey, although we believe that the pace of expansion will be muted until the integration of TD Banknorth and Commerce is completed in H2/09. Management stated that 33 stores are set to open in 2008, with another 22 projected in 2009.

TD highlighted multiple growth initiatives

TD management acknowledged the tough operating and economic environment in the U.S., but it does not appear that it will slow down initiatives to add customers and share of wallet. The following are highlights of some opportunities and initiatives underway at TD Commerce.

• The commercial banking group will leverage TD Securities resources by providing new products for legacy Commerce's 150+ clients such as foreign exchange, interest rate derivatives and trade finance. With over 3,000 potential client prospects, it will look to add more debt capital markets, investment banking and private equity products and services. TD has shown that it can successfully bring some of TD Securities' expertise to U.S. banking clients in TD Banknorth.

• The retail banking group is focusing on:

• Cross-platform referrals. For example, insurance referrals, which are not limited by regulatory constraints in the U.S., rose 8% at TD Banknorth after TD introduced new sales practices and incentives, of which 36% were sold products;

• Extended branch hours in the legacy TD Banknorth branches to strengthen the convenience brand. TD Banknorth extended hours in 253 of 580 stores since early 2007, which helped increase the number of chequing accounts by 21,000 versus stores that maintained their operating hours;

• Sales initiatives. In addition to brand and marketing campaigns, TD Commerce is implementing sales revenue tracking to improve employee engagement, and surveys customers to continue improving products and services.

• Management intends on leveraging the best of both Commerce and Banknorth models. For example, penetration of home equity loans are 50% higher for TD Banknorth customers than Commerce Bancorp. The bank has already run pilot programs that showed similar results can be accomplished in Commerce branches. Growing credit cards is also something the bank plans on doing in the early years as a relatively easy way to take advantage of existing customer relationships.

• Retail deposit growth opportunities via new household origination and cross-sell initiatives. TD Banknorth's new household origination rate was 10.7% versus 21.7% at Commerce Bank (November 2006 – 2007). Conversely, the average deposit balance per household at Commerce Bank was $9,459 as at November 2007 versus $19,074 at TD Banknorth. Marrying the deposit growth capabilities of Commerce Bancorp as well as some of the attributes of TD Banknorth, and the maturing of recently opened Commerce Bancorp stores would lead to above-industry deposit growth.

• The business banking group intends to leverage product and distribution in order to grow its customer base and deepen relationships. For example, TD Commerce has a 16% share of 2.2 million potential customers in its footprint and would like to improve penetration to 20%. In addition, opportunity exists to increase the penetration rate of loan balances per business customer (6% penetration at Commerce and 19% at TD Banknorth) and deposit balances per business customer (99% penetration at Commerce and 92% at TD Banknorth). Initiatives to achieve these goals include enrolling more clients in BusinessDirect online banking and streamlining and automating underwriting processes.

• Other divisions such as wealth management, insurance and TD Ameritrade are also working on initiatives to leverage TD Commerce's distribution infrastructure and client relationships.

Valuation

TD (Sector Perform, Average Risk): Our 12-month price target of $69 is based on a price to book methodology. Our P/B target of 1.7x in 12 months is slightly lower than our target for banks given a lower ROE offset by its relatively lower exposure to headline risks and leading domestic retail franchise. It implies an approximate P/E multiple of 10.9x 2009E earnings, compared to the 5-year average forward multiple of 12.2x.

Price Target Impediment

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment and greater than anticipated impact from off-balance sheet commitments. Additional risks include an unexpected acquisition, integration risk with Commerce Bank, TD Ameritrade and TD Banknorth, pricing pressure in the discount brokerage industry, a rising Canadian dollar, litigation risk and a worse than expected impact from Enron-related litigation (although it appears that risk has declined, given a court ruling in another Enron trial).

Company Description

TD Bank Financial Group is Canada's second-largest bank by market capitalization. TD currently has more than 1,110 retail branches in Canada, 1110 branches in the U.S. and 250 retail brokerage offices. Our estimated 2008 earnings mix is as follows: TD Canada Trust (54%), US Personal & Commercial (16%), TD Securities (13%), TD Wealth Management (10%), and TD Ameritrade (7%).
__________________________________________________________
Scotia Capital, 20 June 2008

TD Commerce Bank Integration On Track

• The TD Commerce Bank Investor Day was positive as the bank reaffirmed its earnings target from TD Commerce Bank at $750 million and $1,200 million for fiscal 2008 and 2009.

• The bank indicated that integration is on track. Cost synergies of $310 million were affirmed.

Systems conversion is scheduled for the last half of 2009.

• Multiple state and federal charters were merged into one national charter. The bank emphasized its focus on successfully integrating its two legacy brands into TD Commerce Bank (green).

Strong Market Presence in Attractive Markets - Strong Brand

• TD Commerce Bank highlighted its strong market presence in attractive markets of metropolitan NY, Boston and Philadelphia. The bank's competitive advantage is branch location, branch design, customer service and brand.

• High customer service is driven by efficient tellers, free services such as a Penny Arcade, branches open seven days a week and branch experience.

• The bank is positioned for organic growth with market turmoil providing growth opportunities.

Minimal Real Estate Exposure Outside North-East U.S.

• Real estate exposure is 98% in the North-East U.S. and only 2% in Florida. The bank expects to be a positive outlier in credit quality and loan losses. Very little lending was done out of the bank's footprint.

Recommendation

• The Investor Day tone was very positive. We believe TD Commerce Bank has positioned itself for growth and has a high probability of being successful in the U.S. market.

• Our 2008 and 2009 earnings estimates remain unchanged at $5.70 per share and $6.60 per share, respectively. Our share price target is unchanged at $95 per share representing 16.7x our 2008 earnings estimate.

• We maintain a 2-Sector Perform on share of TD.
__________________________________________________________
Reuters, Lynne Olver, 19 June 2008

TD Commerce Bank, the U.S. unit of Toronto-Dominion Bank, has its hands full in integrating its recent Commerce Bancorp purchase, but would be "foolish" to ignore potential acquisitions along the East Coast, its chief executive said on Thursday.

"Obviously integration is our top priority," Bharat Masrani, president and CEO of TD Commerce Bank, told analysts at an investor briefing in New Jersey. "We're busy right now."

But if a "compelling" acquisition opportunity popped up because of turmoil in the U.S. banking market, "we'd be foolish not to look at it seriously," Masrani said.

He noted that this was the same answer he had given a year earlier, but stressed that TD has "a big integration" on its plate -- merging New Jersey-based Commerce Bancorp, which it acquired in March, into TD Banknorth, creating a larger retail bank with 1,100 U.S. branches, or "stores."

"From my perspective, in the U.S. we have now got scale, we think we can expand the model we have," Masrani said.

Ed Clark, president and chief executive of Canadian parent TD Bank, said that asset quality would be a big worry in any U.S. acquisition right now.

"I'm more inclined to see the knife bounce off the floor than try to catch it before it hits the floor, because I'm not a hedge fund manager," Clark said.

He also said TD would not go to the effort of building a customer-focused U.S. bank and then "dismantle it" by adding a new culture that did not fit.

Asked whether TD would try to increase its stake in 40 percent owned discount brokerage TD Ameritrade, Clark said it was "probably not" economically attractive to do so, given the capital the bank would have to put up

He called the existing Ameritrade set-up "a wonderful relationship" that was working well.

And executives said there is plenty of scope to cross-sell products and services between customers of Ameritrade and TD Commerce, to the benefit of both businesses.

Bank clients will be encouraged to open Ameritrade brokerage accounts, while Ameritrade customers will be encouraged to open new deposit accounts at the bank.

"We really believe there's a significant opportunity by leveraging the scale and distribution strengths of each other's businesses to reach these new audiences," said David Boone, TD Commerce's corporate development executive.

TD Commerce will put Ameritrade kiosks in various Boston-area branches as a pilot project this month.

During the investor briefing, executives highlighted TD Commerce's customer-friendly ways, including long branch hours, Sunday openings in urban areas, free pens and piggy banks, pet treats, and a coin-counting service known as Penny Arcade.
__________________________________________________________
Reuters, Phil Wahba, 17 June 2008

TD Ameritrade Holding Corp on Tuesday said it expected earnings in the current quarter to be at the high end of its previous forecast, as the discount brokerage also reported that average daily trading volume in May had risen by 3 percent from the previous month.

TD Ameritrade had previously said it expected to earn 27 cents to 33 cents a share in the quarter, up slightly from 26 cents in the year-ago period.

Growth in the company's monthly volume numbers was in line with that reported by Charles Schwab Corp last week. That led some analysts to attribute the gains, which came amid stagnant equity markets, to resilient retail investor trends than efforts by specific retail brokerages.

Analysts had expected industry volumes to decline in April and May with lower market volatility.

TD Ameritrade has said that asset management is now the focus of its business development. It reported client assets rose 9 percent in May from the previous year to $326 billion, a gain of 2 percent over April. Some of that growth came from its acquisition of Fiserv, completed in February.

In May, average fee-based investment balances shot up 55 percent to $79.2 million from a year ago.

Analysts say developing asset management is more important for the company's growth prospects than trading volumes.

"The market for online equity retail trading is not a high growth market given high penetration rates and Ameritrade needs to evolve its model more in terms of serving the investor versus being a place to trade," said Michael Hecht, an analyst with Banc of America Securities.
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Wednesday, June 18, 2008

Subprime Writedowns & Credit Losses Top U$396 Billion

  
Bloomberg, Yalman Onaran, 18 June 2008

The following table shows the $396 billion in asset writedowns and credit losses at more than 100 of the world's biggest banks and securities firms as well as the $302 billion capital raised in response.

All the charges stem from the collapse of the U.S. subprime-mortgage market and reflect credit losses or writedowns of mortgage assets that aren't subprime, as well as charges taken on leveraged-loan commitments. Capital raised includes common stock, preferred shares, subordinated debt and hybrid securities which count as Tier 1 or Tier 2 capital, depending on local regulations and the amount of each that's already on the bank's books.

All numbers are in billions of U.S. dollars, converted at today's exchange rate if reported in another currency. They are net of financial hedges the firms used to mitigate losses.


Firm Writedown & Loss Capital Raised

Citigroup 42.9 44.1

UBS 38.2 28.6

Merrill Lynch 37.1 17.9

HSBC 19.5 3.5

IKB Deutsche 15.9 13.1

Royal Bank of Scotland 15.2 24

Bank of America 15.1 20.7

Morgan Stanley 14.1 5.6

JPMorgan Chase 9.8 7.8

Credit Suisse 9.6 1.5

Washington Mutual 9.1 12.1

Credit Agricole 8.3 9.1

Lehman Brothers 8.2 13.9

Deutsche Bank 7.6 3.2

Wachovia 7 10.5

HBOS 7 7.8

Bayerische Landesbank 6.7 -

Fortis 6.6 1

Canadian Imperial (CIBC) 6.5 2.9

Barclays 6.3 9.7

Societe Generale 6.2 10.1

Mizuho Financial Group 6 -

ING Groep 6 4.9

WestLB 4.9 7.7

LB Baden-Wuerttemberg 4 -

Goldman Sachs 3.8 0.6

Dresdner 3.4 -

Natixis 3.4 0.8

E*Trade 3.3 1.8

Wells Fargo 3.3 4.1

Bear Stearns* 3.2 -

National City 3.1 8.9

Lloyds TSB 2.7 -

Landesbank Sachsen 2.7 -

BNP Paribas 2.7 -

HSH Nordbank 2.5 -

Nomura Holdings 2.4 1.2

ABN Amro* 2.4 -

DZ Bank 2.1 -

Bank of China 2 -

Commerzbank 1.9 -

Rabobank 1.7 -

Bank Hapoalim 1.7 2.6

Royal Bank of Canada 1.6 -

Mitsubishi UFJ 1.6 -

UniCredit 1.6 -

Alliance & Leicester 1.4 -

Fifth Third 1.4 2.6

Dexia 1.3 -

Caisse d'Epargne 1.2 -

Hypo Real Estate 1 -

Gulf International 1 1

Sovereign Bancorp 0.9 1.9

Sumitomo Mitsui 0.9 3.1

Sumitomo Trust 0.7 1

Keycorp 0.6 1.7

DBS Group 0.2 1.1

European banks not 6.1 2.4
listed above (a)

Asian banks not 4.5 6.4
listed above (b)

North American banks 3.8 1.3
not listed above (c)
____ ____

TOTAL** 395.8 302.1

* These banks have been acquired. Writedowns reflect figures
announced prior to their acquisition.
** Total reflects figures before rounding. Some company names
have been abbreviated for space.


(a) European banks included in this group: Allied Irish Banks, Bradford & Bingley, Aareal Bank, Deutsche Postbank, Standard Chartered, Northern Rock, NordLB, HVB Group, Sachsen LB, Intesa Sanpaolo, Landesbank Hessen-Thueringen, SEB AB, Erste Bank, DnB NOR, Anglo Irish, KBC Group, LB Berlin, NIBC Holding.

(b) Asian banks included in this group: Shinsei, Aozora Bank, Australia & New Zealand Banking Group, Abu Dhabi Commercial, Arab Banking Corp., Fubon Financial, Industrial & Commercial Bank of China, Citic International, BOC Hong Kong, Bank of East Asia, China Construction Bank, ICICI Bank, State Bank of India, United Overseas, Wing Lung, Macquarie, Maybank.

(c) North American banks included in this group: Bank of Montreal, National Bank of Canada, Bank of Nova Scotia, Canaccord Capital, BB&T Corp., PNC Financial Services Group, SunTrust Banks, South Financial Group, First Horizon.
;

Friday, June 13, 2008

Will Banks Buy in the US?

  
Reuters, Lynne Olver, 13 June 208

Canada's big banks have weathered the credit crunch in relatively good shape and should swoop in to buy some ailing U.S. banks, observers say.

Royal Bank of Canada, the country's largest bank, and Bank of Montreal, the fifth largest by market value, are best positioned to make U.S. acquisitions, CIBC World Markets analyst Darko Mihelic said on Friday in a research note entitled "Fish or Cut Bait."

The banks have excess capital to use and relatively clean balance sheets, Mr. Mihelic noted.

"Perhaps now is the time to think big," he wrote.

U.S. banks have taken a beating, with the KBW Bank index down by more than 40% in the past year. Over the same period, the S&P/TSX banks index of large Canadian banks is down 17%.

Considered another way, the Canadian bank stocks trade at about 2.1 times book value, while the median of seven U.S. large-cap regional bank stocks is right at book value, according to RBC Capital Markets.

Eric Bushell, chief investment officer of Signature Advisors within Toronto-based CI Investments, told a conference this week that Canadian banks will come out of the credit crunch episode as bigger and more global players.

"The Canadian banks came into this situation extraordinarily well capitalized and have essentially twice the amount of return on weighted assets as the U.S. banks," Mr. Bushell said at a Toronto conference organized by research firm Morningstar.

"I think they're in a position to really pick over the carcasses," said Mr. Bushell, who runs the $4.2-billion CI Signature Select Canadian fund.

Dennis Gartman, the Virginia-based author of investment newsletter The Gartman Letter, said at the same conference that Canadian banks would be "in the driver's seat" for the next decade.

"They're going to come around buying everything in the United States ... they're in great condition."

Royal Bank of Canada, which acquired Alabama National Bancorp earlier this year for $1.6-billion, has ample targets and its stock carries a hefty premium multiple, CIBC analyst Mihelic said.

U.S. banks in the U.S. Southeast, where RBC operates, and in the Midwest, where BMO runs Harris Bank, have seen their premiums to core deposits plummet to single digits in the past year, while these two Canadian banks' premiums to core deposits have held in much better, at 15%, Mr. Mihelic wrote.

He crunched numbers on possible RBC acquisitions of Regions Financial, and BB&T, saying Regions would add slightly to Royal's earnings in 2009, while cost savings of 5% would have to be found in a BB&T buy to avoid diluting earnings.

Before Alabama National, RBC's biggest U.S. purchase was the $2.3-billion buy of Raleigh, North Carolina-based Centura Banks in 2001.

As for Bank of Montreal, it has made a string of small U.S. purchases in the last few years, but paid less than $300-million in each case.

Mihelic said buying Huntington Bancshares would add to BMO's earnings without any cost savings, while Associated Banc-Corp would be a better geographic fit but more difficult financially.

BMO's management has said it will continue to look at acquisitions, while RBC's top executive has expressed caution about making a big U.S. move.

"Either they have the fortitude to make a deal and the capability to execute a deal or they need to re-evaluate their respective U.S. strategies," Mr. Mihelic said in his report.

As for other big Canadian names, Toronto-Dominion Bank just swallowed New Jersey-based Commerce Bank, and Bank of Nova Scotia, which has a strong presence in Latin America, has so far stayed out of U.S. retail banking.

However, Scotiabank's CEO said in May that U.S. bank valuations were "intriguing."
__________________________________________________________
Financial Post, Duncan Mavin, 13 June 2008

According to numerous reports, the best chance for Canada's banks to go on a spending spree in the U.S. is right now.

American bank stocks are beaten up, even more than Canadian shares. As well, the Canadian banks are armed with a supercharged loonie and anyone who has done any cross-border shopping in the past twelve months knows what a great boost to buying power that means.

The Canadian banks should "Fish or Cut Bait," said CIBC World Markets bank analyst Darko Mihelic. He's not the only one.

But surely there's more to this picture than meets the eye. While there are bargains to be had, the top executives of Canada's big banks didn't get where they are today by deviating too far from long term strategy, and that means acquisitions will have to fit the plans of the banks or they just won't happen.

Take a couple of recent cases. In April, Bank of Nova Scotia kicked tires at National City Corp., a struggling Cleveland lender. But that deal fell through, in part because Scotiabank which doesn't have a U.S. banking plan isn't going to start one by spending billions of dollars on a bank with a dodgy balance sheet.

Another case: Toronto-Dominion Bank's purchase of Commerce Bancorp — which closed in March and has been valued at US$7-billion — fits the bill much more neatly because TD already has a U.S. strategy and the Commerce footprint ties in nicely with TD's existing U.S. geography. There's also the fact both banks — TD and New Jersey-based Commerce — have a strong commitment to high-service levels, which should make for better integration.

No doubt Canada's top banks are looking closely at their U.S. counterparts. But they are unlikely to buy a bank south of the border just because its cheap, and the targets they are scouting are much more likely to be bolt-on acquisitions that complement existing plans.

The Wall Street Journal said Friday that Royal Bank of Canada was a possible bidder for Lehman Brothers, whose stock has fallen markedly because of concerns about its exposure to the credit crunch. An RBC spokesperson was quoted in the story refusing to talk about the speculation. But if RBC really is looking at Lehman — one of the world's biggest brokers — it would be quite a departure for the leading Canadian bank that has turned in record profits in recent years in large part by improving its domestic retail bank. Spending billions of dollars on an acquisition that would essentially be a switch in strategy would surely be a tough sell to shareholders.
;

Citigroup Lowers Rating & Raises Target Price of Scotiabank

  
Citigroup, 13 June 2008

• Lower Rating to 2M Driven by Valuation — At nearly 3x book and 11.2x forward earnings estimates, BNS is trading at a significant premium to its peer group of Canadian banks. Historically, the share price has traded at a premium ranging from 2.5% to 9% based on book and 2% to 5% based on earnings. Currently, the bank is trading at a 20% premium to book and 11% to earnings.

• Raising Target Price to C$52 — We are raising the target price to C$52 from C$50 reflecting the slight reduction in capital costs. Similar to all financials, the bank’s funding costs increased as a result of the credit/liquidity crisis in the market, but as the market turbulence begins to subside funding costs are beginning to normalize.

• Valuation likely Reflects Geographic Diversification — The premium valuation/share price likely reflects the bank’s growth potential via geographic diversification. The bank operates in emerging markets where growth is anticipated to outpace that of the Canadian market. BNS is the most international of the Canadian banks.

• Price Performance Relative to Peers — Since our initial 1M Rating on 2/6/07, BNS share price has declined a little over 1%, compared to an over 13% decline for the Canadian peers and over 50% decline for comparable U.S. banks. On a total comparative return basis, BNS posted a nearly 13% favorable spread.
__________________________________________________________
Financial Post, Duncan Mavin, 13 June 2008

It is a familiar picture: a bunch of big Canadian banks jostle for top spot in the local banking sector, a market effectively carved up by a handful of big players.

But the market is Jamaica, not Canada, and the new number one bank in the island is Canadian-owned, but it is certainly not a household name here.

According to data from Jamaica's central bank, the country's new market leader is National Commercial Bank, a subsidiary of AIC Limited, the Canadian mutual fund company owned by billionaire investor Michael Lee Chin.

Mr. Lee Chin's bank -- AIC bought 75% of it in 2002 -- overtook Bank of Nova Scotia to become the biggest bank in Jamaica by net assets during the first quarter of 2008, the central bank's data shows.

The two banks are more or less neck-and-neck in terms of net assets as of March 31 this year. The Jamaican unit of Scotiabank, which has extensive operations throughout the Caribbean, has net assets of about $19-billion Jamaican ($275-million) compared with about $20.7-billion Jamaican ($296-million) at NCB.

The next two largest banks are First Caribbean International Bank, which is a subsidiary of Canadian Imperial Bank of Commerce, and Royal Bank of Trinidad and Tobago, which was bought by Royal Bank of Canada in March for US$2.2-billion.

Last month, NCB's group managing director Patrick Hylton said the bank had made strides by focusing on customer service and innovation in marketing and back office functions. The bank reported that profit for the quarter ended March 31, 2008, grew 64% to $2.6-billion Jamaican ($37-million).

Scotiabank's Jamaican operations also saw profits jump sharply in the most recent quarter, up 40% from last year to $2.5-billion Jamaican ($36-million). Bill Clarke, head of the local Scotiabank unit, said the bank enjoyed solid growth across all business lines and strong demand for loans from retail customers.

Scotiabank has long had a successful business in the Caribbean. Canada's self-styled most international bank has 200 branches in the region. Scotiabank has had a presence in Jamaica since 1889, and now operates 38 branches across the country.

But the bank's executives are likely bracing for more competition since Canadian rivals recently bulked up in the region. In addition to Mr. Lee Chin's acquisition of 45-branch NCB five years ago, RBC's purchase of RBTT means it now has 130 branches across the Caribbean up from 46 before the deal which was announced last year.

In late 2006, CIBC also upped its investment in the Caribbean, taking up the $1-billion option to buy out Barclays PLC, the British bank that had been its partner in First Caribbean International Bank since 2002. CIBC now owns more than 90% of Barbados-based FCIB which has more than 100 branches.
;

Monday, June 09, 2008

Dundee Securities has 'Sell' Recommendations on BMO, CIBC, & RBC

  
Canwest News Service, Keith Woolhouse, 9 June 2008

Two months after warning that more pain lay ahead for Canadian banks in the wake of their suspect loans and exposure to collaterized debts that stemmed from the downturn in subprime mortgages, Dundee Securities analyst John Mr. Aiken is advising investors to dump three of the Big Six.

Mr. Aiken has slapped "sell" recommendations on Royal Bank, Bank of Montreal and CIBC, their common shares no longer considered suitable as a long-term investment.

Mr. Aiken's recommendation comes one week after the banks, regularly eyed as a safe haven in troubled times, reported their second-quarter earnings, most of them with disappointing results.

Only TD Bank Financial Group and National Bank received "buy" recommendations. Scotiabank is rated "neutral."

All the banks have delivered over-the-top returns since bottoming out in mid-January. Bank of Montreal, the best, has soared 26.5% while Royal, the worst, has jumped 17.1%. Mr. Aiken believes shares of both will stagnate, if not worsen, over the coming 12 months.

TD and National are the only ones he expects to show continued improvement, both capable of returning 10%.

For the others, he sees bleak times as economic uncertainty persists. As we head into the summer months with consumer confidence plunging to a seven-year low, rumblings of the Canadian economy tilting toward recession, rising consumer debt, a tottering manufacturing sector, and the Tourism Industry Association of Canada warning that the tourism is "on the precipice of an unprecedented decline, which could have a massive impact on the 1.6 million Canadians whose jobs depend on the sector," it's not only bank stocks that could take the gloss off capital markets in coming months.

But for now, the focus is on the banks. Here is Mr. Aiken's assessment:

TD Bank

While disappointed with TD's earnings miss in the last quarter, Mr. Aiken was encouraged by the fact that the miss came from weaker capital markets, most notably the trading department, which attracts lower valuation multiples. Mr. Aiken rates TD his top pick going forward and has raised his 12-month target to $77 from $75. At $77, TD would be within 10 cents of its 12-month high, the best recovery in the banking sector and that warrants a "premium valuation multiple," says Mr. Aiken.

Trading at about $70, TD shares yield 3.4%. Price-to-earnings (P/E) ratio is 12.6.

National Bank

Credit where credit is due.

The knock against National is its higher exposure to volatile capital markets, its concentration in Ontario and Quebec, and its position in the non-bank asset-backed commercial paper market, although it expects to recover much of the losses there. Through all this, National thrives and trades at a significant discount to its peers.

Mr. Aiken has a "buy" recommendation, upped from "neutral," and jumped the 12-month target price to $60 from $52. At today's price of $54, National yields 4.6%. P/E is 18.2.

Scotiabank

Mr. Aiken deems BNS's international segment one of its greatest assets, which puts it in an excellent position for longer-term growth, but he also considers it an "area of potential near-term concern."

Domestic operations, particularly the improving contribution from Scotia Capital, are encouraging. The risk lies in areas where BNS has exposure to the U.S. economy. Mr. Aiken sees little significant upside and while he has raised the 12-month share target to $49 from $46, that is not only well below the 52-week high of $53.52, but also less than today's price of around $51, at which price the shares yield 3.8%. P/E is 13.5.

Royal Bank

Royal's second-quarter numbers exceeded analyst expectations and drove up shares 2%. That may be a case of great expectations for the numbers were due to exceptionally strong trading revenues outside of write-downs "and the possibility does exist for incremental charges and we note that the bank's exposure to U.S. builder finance will likely result in further increases in (loan loss) provisions." Mr. Aiken contends that Royal retains a higher risk profile than the market is pricing in. "This reflects exposure to the U.S. economy, significant contribution of trading to overall revenues and the potential for additional write-downs." With limited upside in the near-term, Mr. Aiken is maintaining his "sell" recommendation and a $50 target, which is around where shares now trade for a 3.9% yield. P/E is 13.64.

Bank of Montreal

The market may have a sense of relief regarding BMO as it appears that balance-sheet issues may be waning. Mr. Aiken is not so sure. "Although second-quarter earning were a stark improvement over the first-quarter, the lower relative earnings quality makes it difficult to materially change our outlook. However, as focus shifts from the balance sheet to future earnings, we believe that the second quarter reflects some significant impediments, despite the strength of its domestic retail operations. We continue to believe that BMO's outlook remains quite challenging in the near-term." Mr. Aiken offers a slight encouragement, raising the 12-month target to $47 from $45, but that offers no upside from today's share price around $48 and 5.8-per-cent yield. His verdict: "Sell." P/E is 12.27.

CIBC

The gloom deepens. "CIBC's writedowns may perversely be considered positive by some players in the market as a signal that we are close to the end - how much more could possibly be coming?" Mr. Aiken ponders. "CIBC's exposures could reasonably generate additional charges of up to $3.6 billion," and force it back to the market to raise additional common equity. The bank's decision not to pre-announce an unexpected $2.5-billion writedown in the quarter shocked him.

"We have to wonder if management is getting worn down by all of the losses as well as just investors."

No surprise, then, that Mr. Aiken figures CIBC shares will be worth $67 at this time next year, around a buck less than they're trading today. Massive writedowns have resulted in negative earnings-per-share of $2.43. For existing shareholders, the dividend yield of 5.1% offers some comfort. The P/E is invalid.
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Tuesday, June 03, 2008

RBC CM Upgrades Scotiabank and Downgrades CIBC & TD Bank

  
RBC Capital Markets, 3 June 2008

Remain cautious on Canadian bank sector; changing ratings on three of the five banks

We maintain our cautious view on Canadian bank stocks, reflecting our expectations for continued pressure on profitability, the potential for further negative earnings revisions and valuations that are not overly cheap on a historical basis considering the challenges we think the banks will face. Projected returns to our 12-month target prices are in the (4)% to 1% range.

We believe that the stocks of Canadian lifecos should outperform those of the Canadian banks, as we believe that the macro environment, while negative, should not impact lifeco earnings as much and is better reflected in valuations. Projected returns to our target prices are in the 9%-18% range for lifecos.

We believe that the drivers of stock prices over the next 6 months may not be the same as those in 2009. Over the six months we believe that the following three items will be most important for banks:

• Exposure to U.S. lending. Credit quality is deteriorating very rapidly in the U.S. and the Canadian banks with U.S. presences cannot escape from this trend. Based on known exposures and the increase in impaired loan formations seen in recently reported results, we believe that Bank of Montreal is most likely to suffer from deteriorating credit quality in the U.S., followed by TD Bank. National Bank, Scotiabank and CIBC’s exposures to deteriorating credit quality appear less concerning in the near term.

• Strength and performance in retail franchises. Q2/08 results showed continued underperformance at CIBC and National Bank, and, to a lesser extent, Bank of Montreal. Scotiabank had the strongest combination of revenue and net income growth, with TD Bank following. TD’s operating leverage will be less than usual in 2008, in our view, given rapid expense growth in late 2007/early 2008, which is more likely to pay dividends in 2009.

• Exposures to financial guarantors and CDOs of RMBS. We do not think that the bad news on CDOs of RMBS and financial guarantors is necessarily over, and are expecting further writedowns at CIBC ($1 billion). We do not believe that capital markets writeoffs will be as large as in prior quarters for the most affected banks, given improvements seen in many areas of credit markets. Off-balance sheet exposures remain a risk, however, as deteriorating economic conditions will likely lead to declining values in assets held in those conduits, which may ultimately lead to losses for the banks.

For 2009, we believe that the following factors will be important drivers of stock prices:

• Exposure to deteriorating credit quality that spread beyond exposures to the U.S. and impact business lending as well. We expect higher commercial and small business loan losses in Canadian manufacturing, forestry and agriculture sectors for the Canadian banks. Exports account for almost a third of Canada's GDP and about three quarters of exports head to the U.S. so Canadian businesses, particularly manufacturers in central Canada, are likely to feel the impact of lower demand from U.S. consumers and the strong Canadian dollar. Sharply rising energy prices are also negative for many businesses. We believe that National Bank and Scotiabank – two banks that look clean from a credit perspective near term, are likely to not look as clean relative to peers in 2009 given their strength in business lending.

• Strength and performance in domestic retail divisions will, as usual, be a key determinant of relative valuation multiples.

o It is difficult to assume that TD Bank will outperform its peers forever but we believe that betting on TD has a good chance of succeeding as (1) it has a very large customer base to which it can cross-sell products and services, (2) its revenue growth should benefit from sales initiatives and investments made in the past few years, and (3) growth in expenses could be moderated without a significant hit to market share for some time, in our view.

o Scotiabank is coming off a period of rapid asset growth and market share gains, and could probably afford to “milk” those gains at the benefit of the bottom line for some time, if it chose to.

o Of the other three banks, Bank of Montreal and National Bank are both putting a lot of time and effort into centralizing more functions, adding front life staff and improving customer service overall, but they are clearly playing catch up to the leading banks. CIBC’s focus on expenses probably limits its capacity to grow revenues as rapidly as the leading banks in 2009. We also cannot help but think about top management focus in the last 6-12 months, which was probably dealing with the serious issues they encountered in their capital markets businesses, rather than on domestic retail banking.

• Exposure to a rebound in capital markets businesses. This item is hard to quantify but it disadvantages CIBC and Bank of Montreal, in our view. Both firms have been hit by writeoffs that were very large in relation to their income base and we believe that the de-risking efforts that are underway will have a negative impact on risk appetite and net income growth potential on a rebound. The other banks have not been as affected by writedowns and we do not expect a meaningful shift in risk appetite.

• Capital strength will likely be valued more than in a normal environment. Well-capitalized banks (1) are better positioned to withstand surprises and rising credit losses; (2) can take advantage of organic and acquisition opportunities that present themselves as a result of market dislocations; and (3) will be under less pressure to strengthen their capital ratios. We believe that Scotiabank is best capitalized and TD least so when considering the combination of Tier 1 capital, tangible equity ratios, balance sheet ratios and risks to expected profitability (i.e. CIBC has the highest Tier 1 ratio but writedowns related to CDOs of RMBS and financial guarantors remain a risk).

• Larger retail deposit bases may help banks mitigate the negative impact of higher wholesale funding costs on margins. TD Bank stands out as having more of its loan portfolio funded with retail assets, while on the other side, Scotiabank’s domestic retail margins are most dependent on wholesale funding.

Upgrading rating on BNS; lowering ratings TD and CIBC

Our two favourite banks (TD Bank and Scotiabank) are now rated Sector Perform, as we rate them in the context of our financial services universe, which includes life insurance companies, P&C insurance companies and asset managers. In terms of large capitalization stocks (i.e. banks and lifecos), we prefer lifecos, as we discuss in an upcoming section. The relatively narrow distribution of ratings also reflects our view that the differentiation between the top and bottom bank stocks will be lower in the next year than it was in the past year.

We are upgrading our investment rating on Scotiabank from Underperform to Sector Perform, to reflect our expectations for benign credit deterioration near term, strong domestic retail momentum coming out of Q2/08 results and continuing strong asset growth in international banking, which are offsetting rising loan losses in Mexico, and the negative impact of currency. We continue to believe that deterioration in business lending and lower recoveries will lead to a material increase in loan losses in 2009 but to reduce our exposure to the stock today on that basis is early in our mind, especially since the retail division is performing well. Our 12-month target price of $49 (up from $46) is based on a P/BV multiple of 2.3x, versus the current 2.7x multiple, and it implies a P/E on 2009E EPS of 11.5x, whereas the stock currently trades at 12.1x 2008E EPS. We raised our 12-month target price by $3 per share to reflect better than expected retail momentum, and greater comfort over credit quality near term.

We are lowering our investment rating on TD Bank from Outperform to Sector Perform. We believe that TD Bank faces enough near term headwinds to reduce our rating including (1) recent expense initiatives in domestic retail banking are hurting operating leverage (although it is still positive), (2) loan losses in U.S. banking are likely to rise although we are not as nervous as we are with the other banks with U.S. banking platforms, and (3) two key elements of TD’s capital markets revenues are likely to remain muted near term – equity securities gains are likely to be low, and the bank’s basis trade is going the wrong way (with the rally credit derivatives outpacing the rally in cash assets, as seen in Exhibit 8). Outside of capital strength, we like TD in 2009, so our caution relative to peers is a matter of timing. We believe the bank has a stronger deposit base, it does not have large exposure to business lending (which we believe will cause banks credit headaches in 2009), its domestic retail platform should benefit from recently extended opening hours (via greater revenue growth or at least a slowdown in expense growth) and profitability should benefit from the integration of Commerce Bancorp. Our 12-month target price of $69 is based on a P/BV multiple of 1.7x, versus the current 1.9x multiple, and it implies a P/E on 2009E EPS of 10.9x, whereas the stock currently trades at 12.5x 2008E EPS (the decline in multiples appears high but 2008E earnings do not include earnings from Commerce Bancorp in H1/08 and little in synergistic benefits from that acquisition in H2/08 so true “earnings power P/E” is lower than 12.6x).

We are lowering our investment rating on CIBC from Sector Perform to Underperform. CIBC’s Q2/08 results highlighted weaker than average growth trends in retail banking, which we expect will continue, and the strategic review of the wholesale division is likely to lead to a decline in the earnings capacity of the division as we believe the focus will be on risk reduction. CIBC has the highest Tier 1 ratio of the six Canadian banks, but we expect writeoffs related to CDOs of RMBS as well as exposures to financial guarantors will continue to cause the ratio to fall next quarter. These concerns outweigh our relative comfort on deteriorating loan losses in CIBC’s loan book. Our 12-month target price of $64 (down from $67) is based on a P/BV multiple of 2.0x, versus the current 2.4x multiple, and it implies a P/E on 2009E EPS of 8.6x, whereas the stock currently trades at 9.5x 2008E EPS. We lowered our 12-month target price by $3 per share to reflect our continued concerns over financial guarantors and its potential impact on book value.

We maintain our Underperform rating on National Bank’s shares, but have removed the Above Average Risk qualifier (changed to Average Risk like its peers) given the progress made in the ABCP restructuring plans and lower credit risk spreads compared to the March peaks (seen in Exhibit 10), which has positive implications for the value of the ABCP. ABCP-risk is down in our view, but risk remains as the restructuring is not yet complete, and there has been no external validation of the value of the restructured assets since no notes have traded. In the near term, National Bank’s shares may benefit from limited exposure to structured finance holdings and little in the way of U.S. operations compared to peers, which is one of the reasons why we are relatively comfortable with National Bank’s exposure to credit deterioration near term. However, the retail division’s retail performance remains weak compared to peers and, looking out to 2009, we are more concerned about credit for National Bank given its large business loan book in central Canada. The bank’s greater than average reliance on wholesale earnings is also likely to be a continued drag on the bank’s multiple relative to peers. Our 12-month target price of $52 (up from $48) is based on a P/BV multiple of 1.6x, versus the current 1.9x multiple, and it implies a P/E on 2009E EPS of 9.0x, whereas the stock currently trades at 9.6x 2008E EPS. We raised our 12-month target price by $4 per share to reflect greater comfort over credit quality near term, as well as declining risk related to the ABCP restructuring, in our view.

We maintain our Underperform rating on Bank of Montreal’s shares. We believe that BMO's share price is likely to lag its peers' given (1) our outlook for greater deterioration in credit quality near term; (2) retail banking results that are likely to continue lag the leading banks on a combination of revenue and bottom line growth (although BMO delivered better results than National Bank and CIBC in Q2/08); (3) greater concerns over the sustainability of wholesale earnings than most peers; and (4) continued overhang from off-balance sheet exposures. Our 12-month target price of $44 is based on a P/BV multiple of 1.4x, versus the current 1.6x multiple, and it implies a P/E on 2009E EPS of 8.5x, whereas the stock currently trades at 9.9x 2008E EPS.

We remain cautious on the bank stocks

We maintain our cautious view on bank stocks, reflecting our expectations for continued pressure on profitability, the potential for further negative earnings revisions and valuations that are not overly cheap on a historical basis. Projected returns to our 12-month target prices are in the (4%) to 1% range.

We expect the pressure on earnings growth to come from rising credit losses, slower growth in wealth management businesses, slowing loan growth in retail lending, and deleveraging. The Canadian banks have high Tier 1 ratios but we believe that the banks will review capital markets areas that have not historically attracted a lot of regulatory capital but led to losses in recent quarters (i.e. certain trading businesses, structured finance businesses as well as off-balance sheet exposures). We believe that banks will allocate more capital to those areas, or they will reduce the size of those businesses.

Our expectations for a decline in profitability are not unique on the street but we remain concerned that our expectations for profitability (which are already lower than the street’s for 2009) could still be too high given the current headwinds, which include credit quality, wealth management revenue growth, capital markets writeoffs, wholesale revenue visibility, wholesale funding rates, and potentially slowing personal loan growth. The impact of a slowing U.S. economy and rising food and energy price inflation is likely to be felt on many economies outside of the U.S. as well. We had a positive view on bank margins given their ability to reprice loans at this stage of the cycle, as well as the reemergence of a steep yield curve, but recent pricing actions in mortgages indicate the market is still competitive (Exhibit 7), and banks have greater dependence on wholesale funding than in prior cycles, which reprices more quickly than retail deposits. The financial guarantee industry also remains on unsettled ground, in our view.

It is tempting to argue that the worst is over and P/B multiples should increase given the healthier tone in capital markets, but if credit quality indeed deteriorates, loan growth slows and banks are required to hold more capital, there could still be pressure on profitability and on P/B multiples. It was only six years ago that weak credit and shaky equity markets led to bank P/B multiples dropping to 1.65x book value, compared to an average of 2.1x today. Forward P/E multiples declined to a low of 9.9x in that period, compared to an average of 10.4x today. (Exhibit 3 and 4). The banks are not expensive on a forward P/E basis and dividend yield basis, but we believe that in times of limited visibility on earnings, a price to book approach to valuations is more appropriate.

We prefer the stocks of lifecos

We prefer the stocks of lifecos versus those of banks for the following reasons:

• Currency conversions should become more accommodating for lifecos than in recent quarters, if the Canadian dollar stays at current levels (Exhibit 5). Canadian lifecos generate more of their income outside of Canada than banks, and lifeco earnings growth has been more negatively impacted by the rising Canadian dollar. YoY increases in the dollar have been in a fairly tight range since mid-November (between $0.97 and $1.03), so the currency impact should decline from recent quarters.

• Credit deterioration is negative for both banks and lifecos, but more so for banks. Their business models are different and banks tend to have more risk in their loan portfolios than lifecos do in their bond portfolios. Lifeco provision for credit loss rates as a result have been lower compared to banks, and Canadian lifeco ROEs were more stable than bank ROEs in the last credit cycle.

• Rising inflation pressures could put an end to declining long-term rates. Low and declining long term rates are bad for life insurance companies, given the long-dated nature of their liabilities. 10-year bond yields are up from their lows in mid- March both in Canada (from 3.4% to 3.7% today) and the U.S. (from 3.3% to 4.1%). (Exhibit 5)

• We have more comfort in our earnings/ROE forecasts for lifecos than banks. Areas of concern for banks include credit, capital markets revenues, and the potential for declining balance sheet leverage.

• Valuations have come off for lifecos as well as for banks. Lifeco forward P/E multiples declined from 13.4x a year ago to 11.5x today, while the banks’ forward P/E was 12.7x a year ago and is 10.7x today (bank P/B was 2.8x down to 2.2x today).

Overview of Q2/08 results

Q2/08 results were weaker than we and the street had expected.

• The industry’s core cash EPS declined at a median of 4% versus Q2/07 (Exhibit 11). On a GAAP basis, the EPS decline was 18%. Only National Bank’s core EPS came in ahead of our estimates.

• GAAP EPS were lower than core EPS for four banks. CIBC’s GAAP loss per share was much larger than expected after it took another $2.6 billion in capital markets related writeoffs and unusual items. Several banks reported capital markets related gains that partially offset (or in the case of Bank of Montreal, more than offset) the writedowns. (Exhibit 12)

• Core wholesale earnings trended down (29% YoY and 27% QoQ) as the weak operating environment reduced M&A, underwriting and trading results in most capital markets divisions. We should note that some of the volatility that caused trading losses also undoubtedly led to the establishment of trading positions that generated gains that would not have occurred in a normal environment.

• Credit quality continued to deteriorate, with Bank of Montreal being the negative outlier among the banks. Specific provisions for credit losses have grown to their highest level since 2003 but are still below historical averages. New formations of impaired loans (a good indicator of future provisions, in our view), declined slightly from Q1/08, but were at levels not otherwise seen since Q4/02.

• Domestic retail revenue growth slowed to just 2% year-over-year and earnings growth was 8% despite a relatively stronger economy than in the U.S. CIBC, TD and National Bank stood out on the weaker side while Scotiabank fared the best. The difficult equity markets contributed to a slowdown in wealth management revenue, which declined 6% from Q2/07.

• Capital ratios declined QoQ but remain high by global standards (Scotiabank’s Tier 1 ratio rose because the bank benefited from the removal of a transitional adjustment related to the implementation of Basel II, but the ratio would have declined under Basel I). We expect banks will hold higher levels of capital than in the past given that capital markets are uncertain, credit risk is rising and demands on bank balance sheets are likely to increase.

Credit quality is deteriorating

We believe that banks are past the turning point after many years of below average loan losses, and Q2/08 results showed the trend is worsening, particularly at Bank of Montreal. The deterioration of credit quality that started in early 2006 accelerated during the first half of 2008 (Exhibit 39 provides credit quality metrics for each bank). We expect credit losses to continue to rise in 2008 particularly for those with U.S. exposure (Bank of Montreal and to a lesser extent, TD Bank) and those banks that saw large increases in impaired loan formations. In 2009, business lending in Canada and potentially higher consumer loss rates will likely add on to the banks’ credit problems, in our view.

• Specific provisions for credit losses have risen to their highest level since 2003 but are still below historical averages for the industry. The specific PCL ratio rose to 0.40% from 0.29% in Q2/07, and compares to a 17-year average of 0.58%.

• New formations of impaired loans (a good indicator of future provisions, in our view), declined slightly from Q1/08, but were at levels not otherwise seen since Q4/02, and they were up by 156% from Q2/07. (Exhibits 13 to 15)

• Q2/08 allowance ratios declined as gross impaired loans have risen more rapidly than reserves. The total coverage ratio of 113% was down from 129% in Q1/08 and 158% in Q4/07, representing the weakest coverage ratio since Q2/04. (Exhibit 16)

o Specific allowances as a percent of impaired loans are on a declining trend. They are lowest at Bank of Montreal and strongest at CIBC and Scotiabank.

o Reserves in relation to historical losses are strongest at Scotiabank and Bank of Montreal, and weakest at National Bank.

• Recent provisions for credit losses at Scotiabank and National Bank were lowest relative to historical averages. The two banks look clean from a credit perspective in the near term, but their provisions are more at risk of normalizing in 2009 in our view given the two banks’ strength in business lending.

• We are expecting specific provisions for credit losses to rise from $2.0 billion in 2007 to $3.0 billion in 2008 and $5.3 billion in 2009. This implies loss rates of 0.27% in 2007, 0.40% in 2008 and 0.52% in 2009, compared to a 16-year average of 0.52%, adjusted for current loan mix. (Exhibit 17)

U.S. credit losses likely to rise further at BMO (and less so at TD)

• Mortgage delinquencies are at record levels, home equity loan defaults are steadily rising and residential construction and land loan nonperforming assets are skyrocketing for lenders with excess exposure to weakest housing markets in the U.S. We believe losses will continue to rise especially in HELOCs, credit cards, automobile lending, construction lending, commercial real estate and leveraged lending.

o U.S. construction loan exposures are problematic for three of the Canadian banks given the challenged state of the U.S. residential mortgage market, but their size for the three banks that have exposure is manageable. TD Bank has 1.6% of its total loans in U.S. construction loans, and Bank of Montreal 1.2%.

o Exposures to U.S. commercial real estate are also likely to lead to losses. Commercial real estate loans have grown rapidly over the last five years while at the same time credit quality improved and loss ratios reached unsustainably low levels. TD has 6% of its loan portfolio tied up in U.S. commercial real estate following the closing of the Commerce Bancorp acquisition, a higher percentage than for Bank of Montreal (2%).

• Bank of Montreal’s U.S. loans represent 31% of total loans, highest among Canadian banks and the percentage would rise to 33% if including the exposures within Fairway, an off-balance sheet conduit which Bank of Montreal sponsors and has taken over troubled assets from.

• TD's U.S. exposures (26% of total loans) are worth paying attention to but we believe that issues are more likely to arise in 2009 than 2008 as TD fair valued Commerce Bancorp's loan book as at the acquisition closing date. The bank would have had a fair bit of visibility on potential near term impairments, in our view, and would have fair valued loans that had the potential to become impaired in the near term.

Business loans are the loan category witnessing loan losses most below long-term averages and, many indicators are pointing to a turn.

• Rapidly widening credit spreads are usually an indicator that loan losses are about to rise, and we do not believe that the current spread widening is an exception to the rule. (Exhibit 18) The magnitude of the widening does not, however, in our view, solely reflect higher expected defaults and losses. We believe that other factors are also contributing, including risk aversion and deleveraging in the U.S. and Europe.

• Business loan losses have generally followed increases in rating agency downgrades versus upgrades, such as the one we are currently seeing. (Exhibit 19). According to a recent report by Standard and Poor’s, global corporate credit rating downgrades in Q1/08 reached its highest level since 2002 and will likely accelerate because the U.S. has entered a recession.

• Initial signs of this credit contraction were evident in the U.S. senior loans’ officer surveys, as tightening of lending standards has historically been associated with rising credit losses (Exhibit 20). The percentage of institutions indicating that they had tightened lending standards for commercial and industrial loans has been increasing since early 2006, a marked increase from the loose lending standards reported in the period from 2003 to 2006. Even Canadian businesses are feeling tighter conditions. (Exhibit 21)

• Declining corporate output and lower corporate earnings have also been good indicators of rising business loan losses, and those have both started to point downwards. (Exhibits 22)

Outside of the U.S., we expect higher commercial and small business loan losses in Canadian manufacturing, forestry and agriculture sectors for the Canadian banks. Exports account for almost a third of Canada’s GDP and about three quarters of exports head to the U.S. so Canadian businesses, particularly manufacturers in central Canada, are likely to feel the impact of lower demand from the U.S. consumer and the high Canadian dollar. Sharply rising energy prices are also a negative for many businesses.

Business loan losses have been essentially non-existent in recent years for the Canadian banks, averaging (0.07)% in 2005, 0.03% in 2006 and 0.09% in 2007. Loan losses have been low given a solid North American economy, recoveries from loans classified as impaired in the early part of the decade and the relatively easy availability of refinancing options for companies that were getting in financial difficulty. Those factors are all likely to shift in the opposite direction.

• The banks most directly exposed to business lending are Scotiabank, National Bank and Bank of Montreal. CIBC and TD are less exposed.

• If business loan losses rose from 2007 levels to their average of the last 16 years, it would have a material negative impact on the industry’s profitability. Loan losses for the industry would rise by $2.5 billion, or 2.5% of common equity (Exhibit 23).

• Banks could have business credit losses that are lower than the peaks of the early 1990s and early 2000s because of (1) better leverage and liquidity positions today, (2) lower industry and single name limits compared to those prior credit cycles, and (3) more tools to manage risk through credit default swaps, loans sales and securitizations.

Canadian consumer loan losses have not been a worry but a potential increase should not be totally discounted. We believe that the Canadian consumer is healthier than the U.S. consumer, partly because of a healthier housing market. There signs, however, that indicate that losses could inch up, including:

• Canadian employment growth, which peaked in Q4/07 at 2.4%, has declined to 2.1% (Exhibit 24). The labour market beat forecasts once again, creating another 19,200 jobs in April beating market forecasts for a 10,000 job increase, but the unemployment rate edged up to 6.1%.

• Retail sales growth was muted, up a modest 0.1% in March. Excluding autos and parts, sales registered no growth. Although March’s retail sales report showed an increase in real retail sales activity, manufacturing shipments tumbled pointing to subdued GDP growth in March.

• Nationwide housing affordability deteriorated in every quarter throughout 2007 to end up at the worst level since the housing bubble peaked in 1990, according to RBC Economics. (Exhibit 25).

• We are not very worried at this time, but nonetheless retail loan growth and credit quality is unlikely to be as strong in upcoming years as it has been in recent years.

Regulatory capital ratios declined but remain at high levels

Canadian banks’ regulatory capital ratios declined despite raising capital in Q2/08, but capital positions remain strong by global bank standards. Tier 1 ratios are between 9.1% to 10.5%, well above the regulatory minimum of 7.0% (Exhibit 26), but we believe that the banks will review capital markets areas that have not historically attracted a lot of regulatory capital but led to losses in recent quarters, and may reduce the size of those businesses or allocate more capital toward them.

We expect capital ratios to remain well in excess of minimum required regulatory levels (Tier 1 ratio of 7.0%) as we believe it is prudent for banks to hold excess capital in an environment where capital markets are uncertain, credit risk is rising (which should lead to higher RWAs under Basel II) and demands on bank balance sheets are likely to increase as corporate clients increasingly turn to banks for their borrowing needs.

• We believe that rating agencies, regulators and bank boards of directors will all pressure banks to hold higher capital than in the past. For example, The Financial Stability Forum recently proposed several actions on capital requirements to the G7 Ministers and Central Bank Governors, which we believe will be implemented over time:

o To raise Basel II capital requirements for certain complex structured credit products;
o Introduce additional capital charges for default and event risk in trading books;
o Strengthen the capital treatment of liquidity facilities to off-balance sheet conduits.

• We think that regulators and banks themselves will pay more attention to unadjusted balance sheet leverage ratios. Many of the issues that have led to writeoffs came from areas that attracted little in capital requirements on a risk adjusted basis (i.e. certain trading businesses, structured finance businesses as well as off-balance sheet exposures). As a result, banks with strong Tier 1 ratios but high balance sheet assets relative to capital may not be in a position to fully take advantage of what appears to be a strong capital position.

o Bank assets-to-capital multiples declined as shown in Exhibit 27, which is a function of banks having raised approximately $1.8 billion of Tier 1 capital (and more Tier 2 capital) during the quarter with flat asset growth. TD Bank’s multiple increased as its acquisition of Commerce Bancorp boosted assets, and CIBC’s multiple rose as it recorded large writedowns and did not raise any regulatory capital this quarter.

Capital strength will likely be valued more than in a normal environment. Well-capitalized banks (1) are better positioned to withstand surprises and rising credit losses; (2) can take advantage of organic and acquisition opportunities that present themselves as a result of market dislocations; and (3) will be under less pressure to strengthen their capital ratios. We believe that Scotiabank is best capitalized and TD least so when considering the combination of Tier 1 capital, tangible equity ratios, balance sheet ratios and risks to expected profitability (i.e. CIBC has the highest Tier 1 ratio but writedowns related to CDOs of RMBS and financial guarantors remain a risk). Exhibit 28.

The implementation of Basel II in Q1/08 was timely for Canadian banks as Tier 1 ratios under Basel I would be much lower.

• Bank of Montreal's Tier 1 ratio of 9.4% was down slightly (from 9.5% in Q1/08) as risk weighted assets grew 4%, with the highlight being an increase in risk weighted assets related to securitizations, which came as a result of the bank's initiatives to restructure Apex/Sitka. The bank's assets to regulatory capital ratio declined from 18.4x in Q1/08 to 16.2x, highlighting that the bank raised capital to delever the balance sheet. Assets were almost unchanged sequentially while total regulatory capital grew 7%.

• Scotiabank's capital position is strongest among its peers, in our view. The Tier 1 ratio of 9.6% was up from 9.0% in Q1/08 as the bank benefited from the removal of a transitional adjustment related to the implementation of Basel II. The Tier 1 ratio would have otherwise declined by 0.2% in spite of a decline in the assets to regulatory capital ratio. We estimate the bank holds $2.2 billion of excess capital and will generate about $560 million in the next twelve months.

• CIBC’s Tier 1 ratio of 10.5% (down from 11.4%) is highest of the big six Canadian banks. Tangible equity to risk weighted
assets is also higher for CIBC than other banks. We expect a further decline in the Tier 1 ratio in Q3/08, but for CIBC to get into capital difficulties, we believe that financial guarantors have to fail, CDO of RMBS values have to collapse further, and CLO values need to continue deteriorating. In such a scenario, it is important to consider that all bank stocks would be very weak because (1) the failure of financial guarantors would increase concern over the health of the financial system; (2) CLOs trading at a large discount to par would only be economically justifiable if a very nasty credit cycle was about to hit corporations, which would likely have negative implications on the corporate loans of all banks; and (3) concerns over counter-party risk for derivatives would broaden beyond financial guarantor exposures.

• National Bank’s Tier 1 ratio of 9.2% was down from 9.3% in the prior quarter as a 7% increase in risk weighted assets on RWA growth (for both credit and market risk) more than offset a 5.5% increase in Tier 1 capital. The bank's Tier 1 ratio is at the low end of its Canadian peers, partly because the bank will not be ready to adopt Basel II's Advanced IRB approach until fiscal 2010. Its Tier 1 ratio should rise by approximately 50 basis points when that occurs.

• TD Bank’s Tier 1 capital ratio of 9.1% is down from 10.9% in Q1/08 following the close of the Commerce Bancorp transaction. The Tier 1 ratio is the lowest of its peer group and the excess capital the bank generates between now and Q4/08 will be offset by a negative impact of 1.3% on the bank's Tier 1 ratio given changes to the way the bank accounts for its investment in TD Ameritrade. If the year goes as management plans, then we believe TD can improve the ratio quickly after Q4/08 because TD generates about 20-30 basis points of Tier 1 capital per quarter. Our forecast Tier 1 ratio of 8.1% at the end of Q4/08 gives TD very little room for slippage against profitability estimates, particularly when considering ratios based on tangible equity.

Growth in retail businesses slowed in Q2/08; bottom-line growth to slow from recent years

Domestic retail revenue growth was only 2% YoY as pressured margins and difficult equity markets offset solid loan growth. Net income was up 8% from Q2/07 helped by strong growth at Scotiabank (15%), which helped to offset a decline at CIBC (–2%) and no growth at National Bank.

• Scotiabank had the strongest combination of revenue and net income growth, with TD Bank following. We also saw continued underperformance at CIBC and National Bank, and, to a lesser extent, Bank of Montreal. (Exhibits 30 and 31).

o TD’s operating leverage will likely be less than usual in 2008, in our view, given rapid expense growth in late 2007/early 2008, which is more likely to pay dividends in 2009.

o It is difficult to assume that TD will outperform its peers forever but we believe that betting on it has a good chance of succeeding as (1) it has a very large customer base to which it can cross-sell, (2) revenue growth should benefit from sales initiatives and investments made in the past few years, and (3) growth in expenses could be moderated without a significant hit to market share for some time, in our view.

o Scotiabank is coming off a period of rapid asset growth and market share gains, and could probably afford to “milk” those gains at the benefit of the bottom line for some time, if it chose to.

o Of the other three banks, Bank of Montreal and National Bank are both putting a lot of time and effort into centralizing more functions, adding front life staff and improving customer service overall, but they are clearly playing catch up to the leading banks. CIBC’s focus on expenses probably limits its capacity to grow revenues as rapidly as the leading banks in 2009. We also cannot help but think about top management focus in the last 6-12 months was on dealing with the serious issues they encountered in their capital markets businesses, rather than on domestic retail banking.

• Retail loan growth was strong (13% YoY and 5% QoQ) but we believe it will decline as we have started to see deterioration in some factors that drive rapid loan growth – employment growth has slowed, the housing market shows signs of cooling, and the Bank of Canada has signaled an end to lower interest rates.

• Retail net interest income margins remained pressured, down 8 basis points from Q2/07 and up just 3 basis points from last quarter (Exhibit 29). The slight improvement from last quarter was less than we expected given the increase in the Prime/BA spread.

o We had a positive view on bank margins given their ability to reprice loans at this stage of the cycle, as well as the reemergence of a steep yield curve, but recent pricing actions in mortgages indicate the market is still competitive (Exhibit 7), and banks have greater dependence on wholesale funding than in prior cycles, which reprices more quickly than retail deposits. We are not modeling margin improvements for the remainder of the year.

o Larger retail deposit bases may help banks mitigate the negative impact of higher wholesale funding costs on margins. TD Bank stands out as having more of its loan portfolio funded with retail assets, while on the other side, Scotiabank’s domestic retail margins are most dependent on wholesale funding.

• Wealth management revenues were down 6% YoY (and down 1% QoQ, shown in Exhibit 32) due to difficult equity markets, weakened retail brokerage activity including new issue flow and the negative impact of the Canadian dollar for Bank of Montreal. Short term prospects for revenue growth look favourable compared to Q2/08 with the S&P/TSX trading near record levels even after starting the year off on the wrong foot. Asset management and retail brokerage (the main drivers) are heavily influenced by equity market direction.

Capital Markets challenges will continue, but writedowns are likely to get smaller

Bank of Montreal’s exposure to Fairway Finance takes the spotlight from SIVs and ABCP in the near term as our focus shifts on real credit deterioration rather than secondary market credit spreads.

• Fairway Finance - the bank's $9.9 billion U.S. asset backed commercial paper conduit - again led to Bank of Montreal repurchasing assets on which it incurred losses. BMO has funded $851 million in assets, $590 million of which are classified as impaired. Bank of Montreal maintains that the credit quality of what is left is fine but, given the rapid speed at which credit quality is deteriorating in the U.S., Fairway Finance remains a source of credit risk for the bank in our view. $7.2 billion of the $9.9 billion was outstanding as at March 31, 2008.

• BMO-sponsored SIV assets continues to decline as asset sales continue. There is now US$9.5 billion invested in Links and €840 million in Parkland. Negatively, the net asset value of the funds is also declining; as at April 30, it was US$382 million for Links and €108 million for Parkland. In other words, a decline of more than 4% in the market value of Links' assets (13% for Parkland) is all that is required for senior debt holders to incur losses. BMO has undertaken to provide support for the senior funding of Links and Parkland as it matures.

• The bank's exposure to Apex/Sitka led to a recovery of past provisions of $85 million. The bank completed the restructuring of the trusts following the quarter end, and we expect further provision releases in Q3/08. In essence, BMO avoided crystallizing losses by restructuring the trusts and will be proven right if credit spreads remain at current levels over the next five years and/or North America avoids a deep recession. It will, however, suffer greater losses down the road if BBB-rated bond defaults surge to record levels. The bank's exposure to the senior-funding facility (some of which we believe would be drawn if credit spreads widened back to the March peaks) rose from $850 million to $1.0 billion. We do not expect drawdowns on the facility if investment grade spreads remain at current levels. Scotiabank has not been very affected by exposures to hot topic issues so far.

• The $5.9 billion U.S. automobile lending portfolio originated and managed by GMAC but financed by Scotiabank remains an unknown to us. The bank structured the agreement with over-collateralization to protect itself on the downside from a credit perspective (and gave up yield as a result) and management appears very comfortable with its exposure. We do not know, however, at what portfolio loss levels (whether a function of rising delinquencies and/or declining used car values) would Scotiabank begin to incur losses. The bank and GMAC have amended their agreement to include some Canadian automobile loans as part of the $6 billion portfolio.

CIBC’s troubles related to financial guarantors and CDOs of RMBS are not over, in our view.

• We do not think that the bad news on CDOs of RMBS and financial guarantors is necessarily all out, and are expecting further writedowns at CIBC ($1 billion in Q3/08E). CIBC's writeoffs and other unusual items of $2.6 billion in Q2/08 were much larger than the $1.5 billion we had expected. The bank has put its structured finance operations in "run-off" and will look to reduce its positions over upcoming quarters and years. The bank still has $2.9 billion in fair value of hedges with financial guarantors, and an additional notional $1.7 billion in CDOs of RMBS hedged with financial guarantors. Outside of those two items, which we perceive of being at a high risk of further writedowns, the bank has an additional $22.9 billion in structured finance exposures that relate mainly to corporate debt/CLOs that are hedged with financial guarantors, and $2.2 billion in of various other unhedged holdings of structured credit.

National Bank still faces risk with ABCP but that risk is down today, in our view.

• We view the bank’s exposure to ABCP as less than problematic than before given the progress made in the ABCP restructuring plans and lower credit risk spreads compared to the March peaks (Exhibit 10), which has positive implications for the value of the ABCP. Risk remains as the restructuring is not yet complete and there has been no external validation of the value of the restructured assets since no notes have traded.

• There was no change to the bank's allowance for ABCP (we had estimated an allowance of $150 million, which would have taken the allowance from 25% of par value to just over 30%). We have moved that estimated allowance to Q3/08 in our model, with key drivers of value between now and then being (1) a successful restructuring of the ABCP under the Montreal accord, and (2) the direction of investment grade spreads. We should point out that Q3/08 results should benefit from an $88 million ($59 million after tax) securities gain related to the merger of the Montreal Exchange and TSX Group.

Capital markets businesses weak in Q2/08 – we expect a rebound in H2/08

Bank wholesale earnings were negatively impacted by large writedowns that totaled $3.7 billion as shown in Exhibit 12. Furthermore, the capital markets turmoil made it a tough environment for banks to grow core earnings.

• Core net income declined across the board, down 29% YoY and 27% QoQ. Core wholesale revenues also declined on a core basis as well as on a GAAP basis (except Bank of Montreal which saw a 5% increase from net gains). (Exhibit 37)

• Writedowns were partly offset by gains. CIBC recorded the largest writedown ($2.6 billion). Four banks also recorded gains in the quarter led by Bank of Montreal’s net gain of $213 million.

• Trading revenues were $(1.9) billion, versus an industry run rate of $1.2 to $1.6 billion per quarter. Excluding writedowns, trading revenues were weak at CIBC and TD. Certain trading businesses such as foreign exchange and commodities benefited from higher volatility and activity, but liquidity declined in other areas related to fixed income and credit trading.

• Provisions for credit losses of $88 million for the six banks are low by historical standards but still grew from the $25 million recovery in Q2/07. Bank of Montreal saw the largest loan loss increases. (Exhibit 38)

We expect a rebound from the weak performance in the second half of the year at most banks, but the profitability of the wholesale divisions compared to the “pre-disruption quarters” could be weakest for CIBC and Bank of Montreal, in our view.

• Both firms have been hit by writeoffs that were very large in relation to their income base and we believe that the de-risking efforts that are underway will have a negative impact on risk appetite and net income potential on a rebound. The other banks have not been as affected by writedowns and we do not expect a meaningful shift in risk appetite.

We still expect capital markets writedowns to continue, particularly for banks exposed to financial guarantors and CDOs of RMBS, but they will likely be smaller.

• We do not think that the bad news on CDOs of RMBS and financial guarantors is necessarily over, and are expecting further writedowns at CIBC ($1 billion). However, we do not believe that capital markets writeoffs will be as large as in prior quarters for the most affected banks, given improvements seen in many areas of credit markets. Off-balance sheet exposures remain a risk, however, as deteriorating economic conditions will likely lead to declining values in assets held in those conduits, which may ultimately lead to losses for the banks (particularly at Bank of Montreal).

• Banks that have reduced risk or entered into trading strategies involving cash assets and credit derivatives may face unexpected losses given the divergence between spreads on cash assets and derivatives. The spreads on credit derivative indices (what banks typically use to hedge their cash positions) have tightened more rapidly than have the spreads on cash assets in recent months, which may cause the banks to record losses related to what were hedged positions.

Valuation and Price Target Impediments

• BMO (Underperform, Average Risk): Our 12-month price target of $44 is based on a price to book methodology. Our P/B target of 1.4x book value in 12 months is at the low end of the banking sector given a lower ROE and higher risks related to off-balance sheet exposures. Our target implies an approximate P/E multiple of 8.5x 2009E earnings. The 5-year average forward multiple is 12.2x. Risks to our price target include the health of the overall economy and sustained deterioration in the capital markets environment, the US housing market, its exposure to ABCP conduits and Structured Investment Vehicles, and its commodities trading portfolio.

Additional risks include greater-than-anticipated impact from off-balance sheet commitments, the potential for non-accretive acquisitions and/or related execution risk, litigation risk, declining domestic market share and a rising Canadian dollar. Risks to our cautious view relative to peers include better than expected operating leverage, a turnaround in retail earnings and changing sentiment toward bank mergers.

• BNS (Sector Perform, Average Risk): Our 12-month price target of $49 is based on a price to book methodology. Our P/B target of 2.3x in 12 months is higher than our target average for the banks given a higher ROE as its lower exposure to headline risks and solid performance in the rapidly growing international division is offset by greater exposure to business lending and the strong Canadian dollar, while the domestic franchise (although improving) lags the leading banks', in our view. Our target implies an approximate P/E multiple of 10.9x 2009E earnings. The 5-year average forward multiple is 12.6x.

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment and greater than anticipated impact from off-balance sheet commitments. Additional risks include the potential for non-accretive acquisitions and/or related execution risk, deterioration in the Latin American political and economic climate, litigation risk, a rising Canadian dollar and rising business loan losses.

• CM (Underperform, Average Risk): Our 12-month price target of $64 is based on a price to book methodology. Our price to book target multiple of 2.0x reflects a higher risk premium offset by the bank's high ROE relative to peers. Our target multiple relative to ROE is the among the lowest of its peers reflecting more exposure to sub-prime CDOs and financial guarantors, below average retail banking trends, and lower confidence about unknown exposures. Our target implies an approximate P/E multiple of 8.6x 2009E earnings. The 5-year average forward multiple is 11.8x.

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment, the US housing market and the monoline industry, litigation risk, and greater than anticipated impact from off-balance sheet commitments. Additional risks include loss of domestic market share, a decline in underwriting activity and weakening retail credit quality.

• NA (Underperform, Average Risk): Our 12-month price target of $52 is based on a price to book methodology. Our P/B target of 1.60x in 12 months is among the lowest of our target for banks given a higher risk premium, based on more exposure to ABCP and wholesale earnings, and deteriorating credit quality. Our target implies an approximate P/E multiple of 9.0x 2009E earnings. The 5-year average forward multiple is 11.2x.

Risks to our price target include additional write-downs of Asset-Backed Commercial Paper assets held on its balance sheet, the health of the overall economy, sustained deterioration in the capital markets environment, the health of the Quebec economy, an unexpected acquisition and a change in the competitive or political environment in Quebec. Additional risks include rising business loan losses, greater than anticipated impact from off-balance sheet commitments, and litigation risk.

• TD (Sector Perform, Average Risk): Our 12-month price target of $69 is based on a price to book methodology. Our P/B target of 1.7x in 12 months is slightly lower than our target for banks given a lower ROE offset by its relatively lower exposure to headline risks and leading domestic retail franchise. It implies an approximate P/E multiple of 10.9x 2009E earnings. The 5-year average forward multiple is 12.2x.

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment and greater than anticipated impact from off-balance sheet commitments. Additional risks include an unexpected acquisition, integration risk with Commerce Bank, TD Ameritrade and TD Banknorth, pricing pressure in the discount brokerage industry, a rising Canadian dollar, litigation risk and a worse than expected impact from Enron-related litigation (although it appears that risk has declined, given a court ruling in another Enron trial).
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