11 September 2007

Scotia Capital’s Financials Summit

The Globe and Mail, Tara Perkins, 11 September 2007

The chief executive officers of Canada's big banks weighed in on the rocky state of financial markets Tuesday, with the heads of two of the top banks suggesting the turmoil is far from over.

The financial system is going through a necessary cleansing because people did some “stupid things,” and it could be spring before the markets complete the adjustment, said Toronto-Dominion Bank chief executive officer Ed Clark.

“You've just got to fasten your seatbelts, we're going for a ride here for the next three or four months,” he told banking analysts and investors at a conference in Toronto Tuesday, where all of the big bank CEOs spoke.

There are more shoes to drop because the market has not been transparent, Mr. Clark said.

“The reality is, I think it's going to be quite ugly in the next few months,” and the market will reel back, he said.

But that's a good thing, “because if people do stupid things and don't pay a price for it, you don't run a good market system, and you've got to cleanse this out.”

Mr. Clark's hoping that most of the repricing that must take place in securities that are related to U.S. mortgages will be done with by March.

“I think people haven't gone to confession yet,” Mr. Clark said. “Your gut is telling you there's a lot of stuff to come out in the marketplace.”

Gordon Nixon, chief executive officer of Royal Bank of Canada, also said he expects it will take some time before market conditions return to normal.

And he warned that, when it comes to the Canadian asset-backed commercial paper market, “it may get worse before it gets better.”

Bank of Nova Scotia chief executive officer Rick Waugh injected a positive note into the conference by saying he does not believe there will be a recession either globally or in the United States, and “certainly not in Canada.”

“Liquidity has to be repriced and has to be reallocated, and this will require some adjustment and in some cases some significant adjustment. But I believe these can be made successfully by the global markets and by most financial institutions,” Mr. Waugh said.

Canadian Imperial Bank of Commerce chief executive officer Gerald McCaughey noted that the problems have been widespread and said the markets are now at a turning point because policy decisions are being made, which is when they tend to work themselves out, he said.

The main financial headache in the Canadian system has been the problems in the $35-billion market for asset-backed commercial paper (ABCP) that is not sponsored by the big banks.

That market is now essentially frozen as a number of its major participants attempt to hammer out a plan to restructure it.

The larger market for bank-sponsored ABCP – which is roughly three times the size of the non-bank market – is still functioning, but not as smoothly as it did prior to the chaos that erupted in August.

Bank of Montreal chief executive officer Bill Downe said he's seen an improvement in the tone of the ABCP market in the last week.

In a separate conference call Tuesday, Peter Routledge, a senior credit officer at Moody's Investors Service Inc., said spreads for Canadian ABCP appear to have widened to 50 to 60 basis points above the banker's acceptance rate. Before all of this market turmoil began, the normal spreads were below 10 basis points.

ABCP is commercial paper that's backed by big packages of loans, ranging from credit card debts to mortgages.

Those loans are pooled together and bought by trusts that fund them by issuing short-term commercial paper.

Because the vast majority of the loan pools, or assets, underlying the bank-sponsored ABCP remain relatively healthy, there's limited risk that their value will take any sizable hit, Moody's said.

Tuesday, the group of financial institutions that are working to come up with a restructuring plan for the non-bank ABCP market said a data room containing information about many of the trusts will be open to ABCP investors beginning today.

Parties who signed the proposal, which was released in mid-August, agreed that investors would not try to take their money out of ABCP trusts and that the trusts would not ask their banks for emergency loans for a 60-day period. After that, the plan calls for the commercial paper to be turned into longer-term debt instruments called floating-rate notes.
Investment Executive , 11 September 2007

BMO Financial Group is focusing more sharply on customer service and growth in its core businesses, said president and CEO Bill Downe at Scotia Capital’s Financials Summit 2007 conference on Tuesday.

BMO’s Canadian personal and commercial banking business posted record earnings of $350 million in the third quarter, up 14% over a year ago, excluding the IPO gain related to MasterCard International and tax recoveries. Cash productivity was 53.3% — also a record. Year-over-year, revenue in commercial banking grew almost 7%, loans grew 7.7%, and deposits grew 9.6% as share increased strongly for the second quarter in a row, rising 56 basis points year-over-year.

Downe noted that BMO’s emphasis on branch-originated sales is paying-off in its cards business, where core revenues grew 13% year-over-year. Year to date, BMO has seen new cardholders rise by 40% and the number of applications coming from the branches has increased by 118%. Downe said BMO is looking for the best way to distribute other products through its branches. “In our mortgage business, we exited the broker channel, which has low spread and fewer cross-sell opportunities. We are hiring more mortgage specialists. We expect to increase volumes and regain lost share - but with a much higher margin.”

Commenting on the major management renewal of BMO’s Canadian retail banking arm, Downe said: “The new executive team has considerable line experience, and throughout the organization, managers are closer to the customers, and decision-making is closer to the front line. More than a third of the 28 district heads are new appointments.”

As for the performance of the Private Client Group, Downe stated, “The Private Client Group is delivering outstanding results. PCG’s efficiency is top decile, with a cash productivity ratio of 68.4%.”

BMO Capital Markets reported net income of $196 million in the third quarter. “Excluding the impact of the commodities losses, these are exceptional results,” Downe said. Adjusted for those losses, earnings grew 45% from a year ago to $293 million.

BMO’s U.S. personal and commercial arm, Chicago-based Harris Bank, has averaging acquisition integration expenses of between $4 million and $6 million for the past three quarters; but without those expenses, Q1, Q2, and Q3 of this year generated consecutive growth in earnings — up 19% from Q4, 2006.

“We have a very strong franchise here with an enviable network of high quality locations, strong customer satisfaction and loyalty scores, and a breadth of service beyond the reach of smaller competitors. We see real opportunity in business banking. We can gain real leverage as we add more branches to our network,” Downe noted.

In referring to comments by U.S. Federal Reserve Chairman Ben Bernanke, who stated in a recent speech that delinquency rates for sub-prime mortgages with adjustable rates rose to about 13.5% in June, Downe stressed, “Harris does not originate sub-prime and has very little direct retail exposure with sub-prime characteristics. Harris’s overall delinquency rate was 0.4% in June.”
Canadian Press, 11 September 2007

The current turmoil in credit markets is “a very good thing,” Toronto-Dominion Bank's Ed Clark declared Tuesday — a position endorsed less floridly by other big-bank chief executive officers who also see opportunity in volatility.

“Time will cure this problem,” Mr. Clark told a financial services industry conference.

“In fact, there were excesses going on. The market was taking risks that I think were not adequately being rewarded.”

He said Canadian banks are “in very good shape” as the U.S. subprime mortgage market crisis plays out.

However, in the wider world “it's going to be quite ugly in the next few months,” Mr. Clark said.

He noted that the housing slump concentrated in seven U.S. states has already hit banks as far afield as Australia and Germany, and “I think people haven't gone to confession yet.”

Meanwhile, investors “are dumping quality assets because they have to” in order to cover losses on low-quality debt.

Still, “This is good, because if people do stupid things and don't pay a price for it, you don't run a good market system — and you've got to cleanse this out.”

Asked how long the cleanout will take, Mr. Clark replied: “I'm sort of hoping that by next March, we're through this.”

In the meantime, banks can expect “some headwinds,” Bank of Montreal CEO Bill Downe told the conference.

However, “market volatility and wider credit spreads may ultimately benefit both our trading business and the corporate loan book,” he added.

“This market presents opportunities for large, well capitalized, well diversified financial institutions,” said Royal Bank of Canada CEO Gordon Nixon.

“Risk is being more appropriately priced, which will positively impact our return on assets in the long term.”

Rick Waugh, CEO of conference organizer Bank of Nova Scotia, advanced a similar sentiment: “We are now starting to get paid appropriately for our credit risk, for our credit risk analysis and for our liquidity.”

TD's Mr. Clark said “I've not seen a situation in the financial services industry quite like this,” as market players struggle to price risk because nobody knows how big the losses will be from the collapse of the U.S. subprime mortgage market, and where the pain will occur.

“Many institutions have exposures here that they haven't really come to grips with,” he said, but the sooner they make their accounts conservative, the sooner the world will be reassured “that the financial institutions are actually quite strong.”

He stressed the solidity of the Canadian commercial paper market, despite last month's seize-up in non-bank asset-backed commercial paper — short-term notes that package mortgages, credit cards and other debts.

Mr. Clark said banks originate $80-billion of the $120-billion Canadian asset-backed commercial paper market, and “the six banks will not let that market go down.”

Although fearful investors now are clinging to government notes and accepting lower returns than they could get from commercial paper, “eventually greed will triumph.”

BMO's Mr. Downe said “the liquidity of the banks has been quite good,” with the vast majority of commercial paper rolling over uneventfully, adding: “We've seen an improvement in the tone of the market in the last week.”

Asked how the banks might profit from the so-called Montreal accord — under which tens of billions of dollars worth of troubled non-bank asset-backed securities are to be converted into floating-rate longer-term notes that normal commercial paper investors won't want — Mr. Nixon said RBC is not involved in this market and “I just don't know the answer to that question.”

The U.S. asset-backed commercial paper market is improving, while in Canada “paper is rolling, but it's tougher,” he said.

“Over time, markets will become rational” and buyers will return to high-quality commercial paper, the RBC chief added. “Now, whether that takes two or three months to work itself out remains to be seen.”

Going forward, “Market and industry conditions are not as favourable as they were,” said Gerry McCaughey, CEO of Canadian Imperial Bank of Commerce, citing “a shifting of gears going on from a period of very mild pricing of risk, and we're now moving to a more traditional level of the pricing of risk.”

However, “I would expect that the issues will subside,” he said.

As for acquisitions, TD's Mr. Clark said the asking prices for financial services companies “haven't really moved down significantly; we've passed on a number of opportunities recently,” and TD is focused on organic growth.

On the other hand, Mr. Downe said BMO is on the watch for acquisitions in the U.S. Midwest, where its Chicago-based Harris Bankcorp subsidiary is already a significant force.

RBC Centura, based in the southeastern U.S., last week undertook a $1.6-billion (U.S.) takeover of Alabama National BanCorporation, which owns 11 small banks in the region.

However, Mr. Nixon said “there are not a significant number of obvious opportunities” that match Centura's philosophy and geographical focus.

Mr. McCaughey said CIBC's dividend is “still at the lower end of our range” and its share buyback is likely to continue, as “in terms of major acquisitions I don't at the moment see any on the horizon.”

Mr. Waugh stressed Scotiabank's strong capital and liquidity position, saying it remains set to grow after $2.5-billion (Canadian) worth of acquisitions in Latin America and the Caribbean in the last two years, while also picking up Canadian businesses in mortgage brokerage and auto finance, along with the Canadian operations of the National Bank of Greece.

Scotiabank intends to add to its “multiple distribution channels” through wealth management acquisitions in Canada, Mr. Waugh added.

Mr. Downe stressed that Harris Bankcorp “draws its customer base from some of the most desirable segments in the Midwest” and is insulated from the housing-market woes racking U.S. coastal states.

TD, meanwhile, is “transforming the business model” of its Maine-headquartered TD Banknorth subsidiary to reflect the bank's Canadian stress on branch convenience and small-investor wealth management.

At home, “our domestic retail growth prospects are faster than the wholesale prospects,” Mr. Clark said, and all the bank bosses emphasized a commitment to retail customer service, with each striving to, as RBC's Mr. Nixon put it, “differentiate ourself in this area.”