RBC CM: Still Too Early to Buy Banks

RBC Capital Markets, 10 December 2008

We continue to believe that it is too early to buy Canadian banks based on: (1) an economic environment that continues to deteriorate rapidly, (2) increased risk over the sustainability of some banks' current dividends and increased risk of equity issues (both of which are a function of the deteriorating economy and continuing capital markets writedowns), a scenario we would have viewed as highly unlikely only a few months ago, (3) our belief that the street needs to lower its profitability estimates (our EPS estimates are currently 7% below the street's) to reflect the rapidly slowing economy and credit/funding markets that remain challenged.

• Valuations have come down for bank stocks but for them to rally on a sustainable basis, we believe that signs of improvement in the banks' fundamental outlook are needed.

• We have gradually increased our loan loss estimates in recent quarters and have consistently reduced our P/BV multiples to reflect a worsening economy. The economy continues to worsen as highlighted by Friday's employment reports in both Canada and the United States. As a result, we have lowered our 12-month target prices again.

The likelihood of capital raises or dividend cuts for Canadian banks has risen in the last months, in our view.

• Q4/08 writedowns have proven larger than we anticipated, which, combined with growth in risk weighted assets that was faster than we were looking for, has led to lower than expected capital ratios.

• TD, Royal Bank and Scotiabank had lower Tier 1 ratios as at Q4/08 although there was no clear outlier as there was before TD raised equity. National Bank and TD had lower tangible equity ratios as at Q4/08.

• Over the next three months, we expect Scotiabank to face the most pressure to raise capital. It has room to issue meaningful amounts of innovative Tier 1 capital (Scotiabank has a tangible common equity ratio at the high end of the peer group) but we do not believe that the market is as liquid as it would be for common equity.

• We believe TD might be pressured to raise capital again if Scotiabank raises equity as it would again find itself as the clear outlier from a capital standpoint.

We expect 2009 earnings per share to again come short of consensus estimates.

• Our current EPS estimates are a median 7% below consensus.

• Directionally, we feel that there is downside risk to our EPS estimates as (1) economic risks have risen, and (2) the risk of equity issues has risen.

• Our 2009 GAAP EPS estimates represent a median 3% increase in profitability compared to a 11% decline in 2008.

• Our core cash EPS represent a median 12% decline in profitability versus a 6% decline in 2008.

• BMO's target price is cut to $35 from $38
• CIBC's target price is cut to $52 from $53
• National Bank's target price is cut to $43 from $46
• Scotiabank's target price is cut to $33 from $36
• TD Bank's target price is cut to $43 from $48

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Dow Jones Newswires, 10 Deceber 2008

The likelihood of a Canadian bank cutting its dividend is very slim, BMO Capital Markets says. Dividends survived the 1981-82 and 1990-91 recessions, the collapse of Third World loans and the collapse of commercial real estate. The Big Five - Bank of Montreal (BMO), Toronto-Dominion Bank (TD), Royal Bank of Canada (RY), Bank of Nova Scotia (BNS) and Canadian Imperial Bank of Commerce (CM) - haven't cut dividends since the Great Depression, BMO says. But analysts suggests the banks should reintroduce dividend reinvestment programs (DRIPs), which could generate C$3-4B in common equity, boosting capital levels.

Bank of Nova Scotia (BNS) likely to be next Canadian bank to issue equity, as the banks scramble to get Tier 1 Capital ratios above 10%. Following RBC's (RY) C$2.3B offer, BNS now has lowest ratio of peers. Credit Suisse suggests it needs C$2.3B in common equity to get to 10%, while Toronto- Dominion (TD) needs another C$1.98B even after last week's issue; Bank of Montreal (BMO) needs C$425M and National Bank of Canada (NA.T) needs C$3.27M. CIBC (CM), which raised C$2.9B in January after taking huge charges, remains in top spot with Tier 1 ratio of 10.5%

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Financial Post, Eoin Callan And Gary Marr, 10 December 2008

Bay Street's profit margins are starting to come under pressure as official interest rates creep closer to zero, prompting retail banks to change the rules of the game so customers pay more.

While the Bank of Canada yesterday cut interest rates to the lowest level since the 1950s, the country's five big banks indicated they would no longer march in lock step with the central bank.

Instead, Bay Street is keeping the cost of borrowing for consumers more elevated in a bid to protect corporate earnings, passing on only part of the rate cut to customers.

While the decision of Bay Street to pocket part of the Bank of Canada rate cut is seen as good for shareholders and bad for customers, there is less certainty about how it will impact wider demand, partly because there are few historical precedents.

"We just don't have much experience with this," said an official at the Federal Reserve who has studied how financial institutions behave when central banks cut rates close to zero.

The central banker said data were limited, but suggest retail banks remain willing to lend even when official rates fall near zero, as they tend to find ways to protect profit margins on loans.

In normal times, financial institutions do better when the central bank lowers the cost of funds, happily passing on cheaper loan rates to consumers to encourage them to borrow more. But when the official rate starts getting closer to zero, the dynamics start to change, as the prime rate that banks charge customers is pushed nearer to their own cost of funds.

This was key to yesterday's decision by RBC, TD, Scotiabank, BMO and CIBC to cut their prime rate by 50 basis points instead of the full Bank of Canada cut of 75 basis points, according to people in the industry.

Joan Dal Bianco, vice-president of real estate-secured lending with TD Bank, said it would have left the bank without a profit if the full rate cut had been passed on to customers with variable products tied to prime.

"We are still trying to earn something on this stuff. This has been quite the roller-coaster ride and it has not been too hot on the mortgage front. We just can't take on the whole 75-point cut," Ms. Dal Bianco said.

Nancy Hughes-Anthony, head of the Canadian Bankers Association, acknowledged the decision to break step with the Bank of Canada created a public-relations challenge for Bay Street.

But she said: "The banks are still borrowing in a very volatile marketplace. The Bank of Canada rate is only one component of their cost of funding, and while the cost of borrowing in inter-national markets has come down a bit, it is still higher than before the crisis."

John Aiken, an analyst at Dundee Securities, said banks were "starting to see margin compression" as the central bank cut rates to 1.5% from 2.25%, while banks reduced their prime lending rate to 3.5% from 4%.

"The new loans that are being put in the books are arguably at a less profitable rate," he said.

Vince Gaetano, a vice-president with Monster Mortgage, said he expects pressure will start to mount on the banks in the coming weeks to reduce prime further.

"That's what happened the last time they tried to resist rate cuts," he said.

This willingness to pass on rate cuts is critical to determining the ability of the Bank of Canada to stimulate the economy in the midst of a downturn.

The central bank's own research shows "it is the real rate of interest that is most relevant" to the purchasing decisions of households, and that it can "influence demand only to the extent that adjustments to the [official] interest rate feed through to the real interest rate."

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Financial Post, Jonathan Ratner, 9 December 2008

When it comes to Tier 1 capital ratios at Canada’s biggest banks, it looks like 10% is the new 9%.

On Monday, Royal Bank announced that it is issuing $2-billion in common equity at $35.25 per share, which represents a 6% discount to its closing price, as well as an over-allotment for maximum proceeds of $2.3-billion. The issue is expected to be approximately 4% dilute to common shareholders.

It will also bring the bank’s Tier 1 capital ratio to 10.1%, up from 9.0% at the end of the fourth quarter as a result of its recently-issued $525-million in preferred shares and this $2.3-billion.

Credit Suisse analyst Jim Bantis expects other banks will follow RBC’s lead, noting a few weeks ago that the Tier 1 capital levels of Canadian banks were among the highest of their global peers at 9.7%. Since then, banks in the United States and Europe have received capital injections via government initiatives and dilutive stock offerings, bringing their Tier 1 ratios into the low double-digits.

“We look for continued balance sheet deleveraging, zero dividend growth and further capital offerings in 2009,” Mr. Bantis told clients.

He noted that RBC management acknowledged that the offering was driven by investor concerns regarding the need for a stronger capital base given the challenges associated with market conditions.

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TD Securities, 8 December 2008

The underlying results of Q4/08 were not that bad relative to our expectations for one of the worst quarters in a very long time. However, visibility into 2009 is extremely poor and management teams were universal in their cautious tone on the near-term outlook. As a result we further reduced our 2009 estimates and cut our Target Prices which reflect a wider discount to our estimates of equity fair value.

Fundamentals continue to suggest attractive upside across the group 12-16 months out, but we expect fears/concerns to continue to dominate short-term movements amid broader equity market weakness and volatility. Against that back drop we remain focused on names that we believe have the strongest medium term operating platforms that we want to own for the long term (Scotia) or heavily discounted valuations with fairly clean stories (CIBC).

Q4/08 met expectations by delivering one of the worst quarters the group has reported in a very long time, filled with a number of negative surprises.

As we suspected, the group appears to have used Q4/08 reporting as an opportunity to clean-up their exposures with a range of charges. Further downside risks will remain highly market dependent, and we do expect more, but with the help of new accounting flexibility we believe the acute risk presented by significant and immediate write-downs (i.e. those that would impair the capital structure) is greatly reduced. Ultimately we believe the industry will be in a position to enjoy substantial write-backs.

In terms of operating outlook, the credit cycle remains the dominant theme for the industry and will present a significant headwind for earnings in 2009. We further reduced our estimates across the board coming out of the quarter reflecting even greater conservatism on our outlook for credit costs in 2009. Our outlook is now reflecting a move to levels of credit expense comfortably above historical averages (taking into account today’s higher quality portfolio mix) on the order of 60bp. Where there is meaningful exposure, U.S credit books remain the key concern relative to trends within Canada where exposures appear well managed.

On the basis of our revised earnings expectations, 2008 and 2009 will represent among the two worst years of earnings development the industry has reported since the 1960s (as far back as our data set extends).

It is a long ways out, but we are introducing 2010 numbers driven by our bigger picture views of how the environment will unfold. Simply put, under the expectation that the macro environment will be in recovery and credit cost growth will moderate, the industry should be able to return to modest bottom-line growth.

What we viewed as exceptional capital levels just months ago, now appear very ordinary as a number of financial institutions globally have attracted sizeable capital infusions, including a sizeable portion from their respective governments.

In terms of the regulatory environment, in our discussions we have noted increased comments among senior management regarding the prospect of direct capital investment by the Canadian government (heightened by recent government proposals to allow such flexibility). At this stage, our view is that the discussions reflect an effort to anticipate worst case scenarios and provide solutions proactively. For the most part the banks seem disinclined to accept such investments, but they are also mindful of the competitive reality that has seen many of their global competitors accept similar support.

Valuations have come under material pressure over the past month amid continued concern and weakness in global equity markets. In our view the group is currently trading at material discounts to equity fair values implied by assumptions around long term fundamentals (assuming the world eventually recovers from among the worst economic conditions seen in decades). That said, amid very poor visibility generally and the heightened risk of unforeseen problems within financials we continue to expect volatility near-term.

Against that backdrop, we are focused on names that we believe have the strongest fundamental platforms that are well situated to perform when we eventually make it to the upside of the current downturn. In our view, Scotia is a platform well suited for medium-term growth via their international presence, although they are therefore more exposed to the current downturn.

For a shorter term focus, we highlight CIBC where we believe the model has been materially discounted even based on fairly modest operating results for 2009, there is an attractive dividend yield and the overhang of concerns around the bank’s capital position (relative to risks/exposures) is beginning to fade. We expect additional charges in the coming quarters if credit markets remain under-pressure (on the order of few hundred million) which should be easily tolerated by the bank’s industry leading 10.5% Tier 1 ratio in the context of ongoing earnings generation. With this report we are upgrading CIBC to the Action List.

With this report we have also made additional changes to our Target Price for both BMO and National Bank; reducing both targets to reflect additional conservatism around our valuations (assuming the stocks trade at a wider discount to fair value).

• BMO's target price is cut to $40 from $50
• CIBC's target price is cut to $67 from $76
• National Bank's target price is cut to $50 from $62
• RBC's target price is cut to $40 from $55
• Scotiabank's target price is cut to $45 from $54

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RBC Q4 2008 Earnings

• BMO Capital Markets cuts target price to $43.50 from $53.50
• Dundee Securities cuts target price to $38 from $43
• Genuity Capital Markets cuts target price to $44 from $52
• RBC Capital Markets target price is $47
• TD Securities cuts target price to $40 from $55

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Scotia Capital, 8 December 2008

Q4/08 Operating Earnings Solid

• Royal Bank (RY) cash operating earnings were flat at $1.01 per share slightly better than pre-released numbers. Operating ROE was 20.0% versus 22.9% a year earlier. Reported earnings were $0.84 per share after writedowns with ROE a solid 16.3%.

• Positives this quarter were operating results in Canadian Banking and RBC Capital Markets with negatives being gross impaired loans and credit losses especially in U.S. home builder portfolio.

• Reported earnings of $0.84 per share included net writedowns of $242 million after-tax or $0.18 per share, gains on CDS hedging corporate loan book of $105 million after-tax or $0.08 per share, and a general provision of $145 million ($98 million after-tax or $0.07 per share). Reported ROE for fiscal 2008 was solid at 18.2%.

• Earnings were driven by strong Canadian Banking earnings which increased 11% YOY followed by 16% growth at RBC Capital Markets (excluding writedowns) with Insurance increasing 36% to $139 million. Wealth Management earnings declined 10%. The operating performance in the U.S. was disappointing as earnings declined to a loss of $13 million (excluding writedowns) from net income of $36 million a year earlier due to higher loan loss provisions.

Positive Operating Leverage Continues

• Overall bank operating leverage was a positive 1.0%, with revenues (excluding writedowns) increasing 12.6% and non-interest expenses adjusted for insurance and VIEs increasing 11.6%.

Canadian Banking Earnings Increase 11%

• Canadian Banking earnings were up 11% to $679 million from $611 million a year earlier due to strong volume growth and cost control.

• Revenues in the Canadian Banking segment increased 3.7%, with non-interest expenses flat from a year earlier, resulting in positive operating leverage of 3.7%.

• Loan loss provisions (LLPs) increased 6% to $225 million from $212 million a year earlier, reflecting portfolio growth.

• Fiscal 2008 Canadian Banking earnings increased 13% to $2,669 million from $2,364 million a year earlier.

Canadian Retail NIM Declines 6 bp

• Retail net interest margin (NIM) declined 6 basis points (bp) sequentially and 21 bp from a year earlier to 2.89%.

Insurance

• Insurance earnings were strong this quarter at $139 million (excluding writedowns) versus $137 million in the previous quarter and $102 million a year earlier.

• Insurance earnings in fiscal 2008 were $469 million versus $442 million in fiscal 2007.

Wealth Management Earnings Decline 10%

• Wealth Management cash earnings declined 10% to $166 million from $185 million a year earlier.

• Revenue increased 4%, with operating expenses increasing 9% for negative operating leverage of 5%.

• U.S. Wealth Management revenue improved 1%, with Canadian Wealth Management flat and Global Asset Management revenue increasing 25%.

• Mutual fund revenue increased 4% from a year earlier to $387 million. Mutual Fund assets (IFIC) declined 9% from a year earlier to $93.2 billion including PH&N.

• Wealth Management earnings for fiscal 2008 declined modestly to $739 million from $784 million in fiscal 2007.

U.S. & International Banking Records a Loss

• U.S. & International recorded a loss of $13 million versus net income of $36 million a year earlier due to a 175% increase in loan loss provisions. LLPs continued to rise, increasing to $198 million from $72 million a year earlier and up from $137 million in the previous quarter, relating primarily to U.S. residential builder finance. LLPs are at an extremely high levels of 2.32% of loans.

• Net interest margin improved 38 bp from a year earlier and 6 bp sequentially to 3.78%.

• Fiscal 2008 U.S. & International Banking earnings declined by half to $128 million from $299 million in fiscal 2007 mainly due to higher loan loss provisions.

RBC Capital Markets Earnings Increased 16%

• RBC Capital Markets earnings increased 16% (excluding writedowns) to $403 million from $346 million a year earlier due to strong capital markets revenue.

• RBC Capital Markets earnings in fiscal 2008 increased 11% to $1,620 million from $1,453 million in fiscal 2007.

Underlying Trading Revenue Solid

• Trading revenue was solid at $588 million (excluding writedowns) versus $717 million in the previous quarter and $517 million a year earlier.

• Fiscal 2008 trading revenue increased 28% to $2,982 million from $2,321 million in fiscal 2007.

Capital Markets Revenue

• Capital markets revenue was strong at $643 million from $588 million in the previous quarter and $625 million a year earlier.

• Securities brokerage commissions increased 20% to $390 million from $324 million a year earlier, with underwriting and other advisory fees at $253 million, declining by 16%.

• Capital Markets revenue declined 12% in fiscal 2008 was $2,252 million versus $2,570 million in fiscal 2007.

Security Gains Negligible - Large Unrealized Deficit

• Security gains were a loss of $15 million or $0.01 per share versus nil per share in the previous quarter and a loss of $0.01 per share a year earlier.

• Unrealized security surplus was a deficit of $1,729 million versus a deficit of $546 million in the previous quarter and a surplus of $105 million a year earlier.

• RY reclassified its $6.9 billion in securities including U.S. auction rate securities and U.S. agency and non-agency mortgage backed securities from Held for Trading (HFT) to Available-for-Sale (AFS) effective August 1, 2008.

Loan Loss Provisions Increase

• Specific loan loss provisions (LLPs) increased to $474 million or 0.63% of loans from $334 million or 0.47% of loans in the previous quarter and $263 million or 0.42% of loans a year earlier. LLPs in Canadian Banking increased 6% to $225 million from $212 million a year earlier. LLPs in International Banking continue to rise, increasing to $198 million from $72 million a year earlier and up from $137 million in the previous quarter relating to U.S. residential builder finance.

• RY added $145 million ($98 million after-tax or $0.07 per share) to general reserves. Therefore total loan loss provisions were $619 million or 0.82% of loans.

• Loan loss provisions in fiscal 2008 were $1,450 million or 0.48% of loans versus $791 million of 0.32% of loans in fiscal 2007.

• We are increasing our 2009 and 2010 LLP estimates to $1,800 million or 0.58% of loans and $2,000 million or 0.62% of loans from $1,500 million or 0.51% of loans and $1,800 million or 0.59% of loans, respectively.

Loan Formations Increase

• Gross impaired loan formations increased to $1,091 million versus $753 million in the previous quarter and $573 million a year earlier. Net impaired loan formations increased to $1,192 million, up from $605 million in the previous quarter and $424 million a year earlier, reflecting mainly higher impaired loans in the U.S. residential builder finance portfolio.

Tier 1 Ratio Declines to 9.0%

• Tier 1 capital (Basel II) declined to 9.0% from 9.5% in the previous quarter due to 10% sequential increase in risk-weighted assets with 2/3 due to depreciation in the C$.

• Risk-weighted assets increased 13% at $278.6 billion from a year earlier. Market-at-risk assets increased 5% to $17.2 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 10.1%, versus 10.4% in the previous quarter and 9.0% a year earlier.

Additional Disclosure on High-Risk Assets

• The bank provided additional disclosure on its exposure to U.S. sub-prime, auction rate securities, municipal GICs, CMBS, U.S. insurance and pension solutions, and U.S. MBS and other securities. The notional and fair value exposures to these areas as well as writedowns are detailed in Exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.

Recommendation

• We are reducing our 2009 and 2010 earnings estimates to $4.20 per share and $4.80 per share from $4.70 per share and $5.20 per share, respectively.

• Our 12-month share price target is unchanged at $60 per share representing 14.3x our 2009 earnings estimate and 12.5x our 2010 earnings estimate.

• We maintain our 1-Sector Outperform rating on the shares of Royal Bank based on strength of franchise and operating platforms, particularly Retail Banking and Wealth Management, growth prospects from RBC Capital Markets, and higher than bank group ROE.

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Financial Post, Eoin Callan, 5 December 2008

Royal Bank of Canada's bank branches in the United States has turned into a money-losing enterprise, in a sign of how worsening economic conditions are starting to compound the damage being inflicted on banks by volatile financial markets.

Having pushed deep into southeastern states such as Florida and Alabama when local housing markets were soaring, Canada's largest bank now finds itself losing money amid plunging home prices and heavy job losses.

The reversal is only one of many headaches for chief executive Gord Nixon, who is also grappling with ongoing exposures to complex credit instruments and mortgage-backed securities that have already cost the bank $2.8-billion this year.

Yet the setback at the retail chain is significant because it suggests new sources of losses are arising for banks as market turmoil fuels an economic nosedive.

RBC predicts that financial "volatility will continue to dampen both consumer and business spending and will likely cause the U.S. recession to deepen."

The bank also suspects the Canadian economy has already slipped into a recession, while official figures Friday showed job losses were the worst in a quarter century last month.

This means Bay Street is likely to find more Canadians will struggle to pay back loans after years of record borrowing, which in turn means banks may be forced to set aside increasing amounts to cover credit losses.

This combination of investment losses and exposures to worsening credit conditions means bankers are increasingly resigned to tough times next year.

In its end-of-year update Friday, RBC declined to provided guidance on how its business would perform next year, choosing instead to guide investors toward a time horizon of three to five years from now.

With persistent uncertainty about how long it will take for world stock indices to settle and the wider economy to recover, RBC's chief executive said Friday his bank would rein in risky bets and shrink the balance sheet it uses to trade in international markets.

While this will do little to address RBC's already-substantial exposure to highly-impaired credit markets -- a major source of concern for investors -- it may help the bank preserve capital so it can better deal with losses lurking in its books.

This is a top priority for executives, who Friday confirmed RBC's reserves had fallen to the lowest level of any bank in the country after four quarters of falling profit and trading losses.

This means RBC has a thinner capital cushion than its peers to absorb future losses, which analysts said Friday were highly probable.

Mr. Nixon said the bank would manage its books "prudently" and pointed out the bank "earned over $4.5-billion for our shareholders in 2008," as analysts underlined the bank's ability to re-balance its reserves over time from incoming cash.

The bank also eased pressure on its capital base by taking advantage of looser accounting rules to shift almost $7-billion of assets out of its trading book.

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TD Bank Q4 2008 Earnings

• BMO Capital Markets cuts target price to $53 from $70
• Desjardins Securities cuts target price to $72 from $81.50
• Genuity Capital Markets cuts target price to $54 from $65
• National Bank Financial cuts target price to $47 from $59
• RBC Capital Markets cuts target price to $48 from $49

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RBC Capital Markets, 5 December 2008

We are reinstating our Underperform rating on TD's shares. We do, however, like TD's shares more than we did before we became restricted for two reasons:

• The bank strengthened its industry-lowest Tier 1 ratio by raising equity.

• The challenges related to the closing of the BCE privatization are a potential positive for TD. If the transaction does not close, TD would likely reverse provisions taken in past quarters.

We maintain our Underperform rating as capital ratios are still at the low end of the peer group, U.S. lending exposures are second highest among Canadian banks and overhangs related to Alt-A securities and the bank's basis trade remain. TD's Q4/08 cash EPS of $1.37 had been pre-announced, as had core cash EPS of $1.22.

• The two largest items of note were a credit trading loss of $350 million after tax, which was largely offset by the reversal of a substantial part of the bank's reserve for Enron litigation charges ($323 million after tax). EPS would have been approximately $0.70 lower had the bank not reclassified some securities into its available for sale portfolio.

• GAAP EPS declined 19% YoY ($1.50 in Q4/07) while core cash EPS were down 13% ($1.40 in Q4/07).

• Loan losses of $288 million were in line with our estimate. Impaired loans, loan formations, and provisions are all trending up (not surprisingly, in our view, and not unique to TD).

• The pro-forma Tier 1 ratio following the $1.4 billion common equity issue and the change related to the bank's ownership interest in TD Ameritrade is 9.1%.

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CIBC Q4 2008 Earnings

• BMO Capital Markets cuts target price to $58 from $68
• Blackmont Capital cuts target price to $50 from $62
• National Bank Financial cuts target price to $50 from $56
• RBC Capital Markets raises target price to $53 from $51
• Scotia Capital cuts target price to $70 from $80
• TD Securities cuts target price to $67 from $77

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RBC Capital Markets, 5 December 2008

GAAP EPS were $1.06, well ahead of our estimate of $(1.13).

• There were numerous moving parts to EPS and we do not spend as much time as usual in using "core" EPS as a driver of valuation, but it looks like core EPS were $1.55 versus our estimate of $1.44.

• Better than expected wholesale results offset weaker than expected retail results.

The better than expected GAAP earnings led to a Tier 1 ratio of 10.5% - well ahead of the 9.6% we were expecting and highest of the Canadian banks that have reported.

Loan losses of $219 million were ahead of our $203 million estimate. The increase from Q4/07 was driven by higher losses in cards (volume growth, higher loss rates and the expiry of a securitization), as well as lower recoveries and higher losses in the corporate lending portfolio.

Accounting rule changes helped CIBC, as expected.

• $6.4 billion in CLO and trust preferred securities were reclassified from trading to held-to-maturity, which avoided losses of $629 million.

• Management also took advantage of new fair value rules to value CLO holdings based partly on models rather than solely on broker quotes, which increased the fair value of those instruments by $310 million, even though the market value of the assets would have declined during the quarter.

• These changes in value are justifiable based on accounting standards but they mask a decline in the market value of assets during the quarter.

We continue to rate the stock as Sector Perform, which is the highest rating we have for a Canadian bank. For the next three to six months, CIBC's stock should benefit from (1) low exposure to U.S. credit, (2) lower exposure to corporate credit risk, and (3) a higher Tier 1 ratio than peers. Offsetting these positives is continued lackluster relative retail revenue growth (down 2% YoY) and, looking further out, we believe that a significant increase in unemployment (which is not happening right now in Canada) would be most negative for CIBC relative to Canadian banks.

• We have raised our 12-month price target by $2 to $53 per share to reflect the higher than anticipated book value.

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Scotia Capital, 5 December 2008

• CM reported a decline in cash operating earnings of 32% to $1.57 per share, in line. The decline in earnings was led by CIBC World Markets with a 59% drop and CIBC Retail Markets declining 10%. Retail Markets revenue and earnings momentum remain weak.

What It Means

• Reported earnings were $1.09 per share better than expected. Net charges were $0.48 per share less than expected due to large gain of $895 million on reduction of unfunded commitment on VFN (LEH).

• Book value per share declined 12% in fiscal 2008 to $29.40 per share.

• Fiscal 2008 operating earnings declined 23% to $6.85 per share from $8.88 per share in fiscal 2007. Operating ROE was 21.3% versus 27.5% a year earlier.

• CIBC reported earnings were a loss of $5.80 per share in fiscal 2008 after writedowns of $4.7 billion or $12.65 per share related mainly to structured credit.

• Reducing earnings and target price due to weaker earnings outlook and lower equity multiples. CM is rated 2-Sector Perform.

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Financial Post, Jonathan Ratner, 4 December 2008

CIBC was downgraded to a “sell” by Dundee Securities analyst John Aiken after the bank reported its quarterly results Thursday morning. While he does not believe CIBC will need to raise more common equity in the near term, the bank “may not be deploying capital in areas that will generate growth once some stability returns to its operating environment.”

Mr. Aiken also told clients that external uncertainty and the impact on CIBC’s on and off balance sheet items suggest the coming quarters are not a good time to hold the stock.

“Despite a weakened valuation and a very strong regulatory capital ratio, we are hard pressed to recommend CIBC’s stock as the fourth quarter demonstrated way too many moving parts to have any confidence in limiting future write-downs,” he said.

Mr. Aiken is looking for more clarity on the bank’s outlook for additional write-downs. While this could come from CIBC’s afternoon conference call, it will probably take better visibility on the structured credit markets, the analyst said. “No one is forecasting this to occur any time soon.”

CIBC’s positive tax adjustments helped offset damage from another quarter of write-downs. Meanwhile, its net loss of almost $400-million from structured credit activities was offset by a change in valuation methodology to internal modelling from relying on external, arguably liquidation, quotes, Mr. Aiken said. This provided a $300-million benefit, while a change in classification of certain securities allowed the bank to avoid recognizing fair value adjustments of more than $600-million.

“All told, the gross charges relating to the run-off business appeared to be more in the neighbourhood of $1.3-billion,” the analyst said, adding that “significant, material economic losses and write-downs are still a potential for CIBC, regardless of accounting treatment.”

His previous rating was "neutral," while his price target stands at $54.

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National Bank Q4 2008 Earnings

TD Securities, 5 December 2008

Event

National Bank reported its full Q4/08 operating results yesterday consistent with the Core Cash FD-EPS of C$1.36 they pre-announced on November 26, 2008.

Impact
Slightly Positive. Relative to expectations based on the pre-announced results, the operating details provided some relief around the underlying operating momentum. Credit trends are slipping, but appear manageable and the bank has a middle of the pack capital position at 9.44% Tier 1. The stock appears to be attractively valued on an operating basis, although the yet to be completed restructuring of the ABCP market remains a risk/overhang. On the view that the restructuring is ultimately successful, we see good upside on the name even on slightly lower earnings and reduced Target Price.

Details

Getting to an earnings run rate. In its pre-announcement, the bank reported an adjusted number of C$1.36 inclusive of approximately C$0.25 in gains related to AMF. Ex the gain, the number was below expectations (C$1.11) and suggested a below consensus run rate for 2009. However, the full release offered additional details that indicate the bank also incurred trading related losses on the order of C$61 million after-tax that could be considered one time in nature and an offset to the gain. All in, the trend looks closer to C$1.40+/-; more consistent with the otherwise decent operating trends.

Reasonable underlying operating trends. The quarter suggests continued modest progress here, consistent with our expectations with decent volume growth in P&C and good cost control delivering low single digit growth while Wealth was surprisingly strong at +17.5%. We continue to hold modest expectations for 2009, but management does seem to be moving forward against its initiatives.

ABCP remains THE risk. The proposed restructuring of the 3rd Party ABCP market in Canada remain a key risk around the stock. Efforts have been underway for over a year now, and several difficult hurdles have been cleared (i.e. legal challenges etc). However, the final paper work has yet to be completed. Management, and other proponents of the deal, suggest that progress is being made and they are confident that it will be completed (National is explicitly giving it a 95% probability), suggesting the latest delays are merely housekeeping issues. Our visibility is limited, but the turbulent market conditions and the challenges across a number of counter-parties involved suggest continued risks in our view.

The failure of the restructuring process would be a significant negative development for the stock in our view in terms of its likely impact on capital. We consider the sensitivities around the potential outcomes in Exhibit 1.

Q4/08 Segment Highlights

P&C Banking. The segment continues to make progress along the lines of our modest expectations. Net income growth of 4.4% came on the back of decent volume growth and well controlled expenses (NIX +0.3%). Credit costs are trending higher, coming in ahead of expectations on cards/personal loans. We continue to expect modest progress going forward as management implements its strategic initiatives to drive revenue in the context of a challenging operating environment.

Wealth Management. A surprisingly strong quarter with net income +17.5%, helped in part by the contribution from recent acquisitions in the mutual fund operations. The quarter was also helped by very good cost control. The segment will remain highly market sensitive, but structural changes (cost cutting, acquisitions etc) should provide some help over the coming year.

Financial Markets. The reported numbers indicate the segment was down -20.5% to C$70 million of net income. However, taking out C$45 million after-tax gain on AMF and adding back investment losses of C$61 million (including C$23 million in write-offs for exposure to Lehman Brothers, AIG and Washington Mutual) would result in C$86 million in net income; flat with last year.

Justification of Target Price

Reflecting lower earnings and a lower book value, as well as compressed valuation multiple, we have reduced our Target Price from C$62 to C$55.

Our Target Price reflects a discount to our estimate of equity fair value 12 months forward (based on our views regarding sustainable ROE, growth and cost of equity), implying a P/BV of 1.7x (down from 2.0x).

Key Risks to Target Price

1) Substantial ABCP losses, 2) weakening economic conditions in Quebec, 3) the inability to compete on scale and flexibility, 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

On the view that the ABCP restructuring plan is ultimately successful, we see good upside on the name even on slightly lower earnings/Target Price.

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Banks' Tier 1 Capital Ratios

Scotia Capital, 4 December 2008

• Canadian banks and other financial services companies are being pressured to raise capital as we re-enter the "capital/arms race" to have the most and highest capital ratios regardless of what is the appropriate amount of financial leverage. We believe regulators and markets are destined to overreact.

• We expect some banks and managements will resist the "panic," others will "capitulate." We believe the mismanagement of global leverage came from the asset side of the balance sheet (primarily unregulated and misregulated), not the capital side. The risk weighting of AAA securities as prescribed by Basel, in our opinion, was not the problem; rather it was the ratings placed on these securities.

• In terms of Canadian bank capital levels we are seeing modest declines in Tier 1 ratios in the fiscal fourth quarter (Exhibit 1), although they remain very solid, generally above the 9% level. The fourth quarter was particularly difficult on Tier 1 ratios given the spike in risk weighted assets due primarily to the C$ depreciating 19% against the US$, as well as charges to OCI (Other Comprehensive Income) from mark-to-market on the Available for Sale Securities (AFS) portfolio due to major widening in corporate spreads (temporary impairment, holding to maturity).

• Canadian banks have excess capital capacity to issue Preferred Shares and Innovative Tier 1 capital that would increase Tier 1 ratios a further 140 bp. We believe the preferred share market is somewhat full at this time and Innovative Tier 1 is relatively expensive. However, over the next year we would expect issuance in these markets to bolster capital. We expect further Tier 1 capital build from internally generated capital in the 75-100 bp range. Thus we believe Tier 1 capital can be increased to over 10%, and perhaps to 11% over the next few years with some patience. Canadian banks' capital ratios have absorbed the October meltdown whereas international banks with a December 31 year end have not.

• Canadian banks' capital positions (without government assistance) remain very solid. However, if banks feel compelled to "battle for capital" at this stage, whether they need it or not, we have attached exhibits indicating what equity would be required to boost capital immediately via equity only in three scenarios: (1) 50 bp increase (Exhibit 2); (2) Tier 1 9.5% (Exhibit 3); (3) Tier 1 10.0% (Exhibit 3).

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Scotiabank Q4 2008 Earnings

RBC Capital Markets, 3 December 2008

Core cash EPS of $0.94 were in line with our estimate of $0.93 and the $0.94 reported in Q4/07.

• GAAP EPS of $0.28 were negatively impacted by write downs relating to certain trading activities and valuation adjustments which had largely been pre-released.

• Provisions for credit losses of $207 million were 118% ahead of Q4/07, and 25-30% ahead of our expectations and Q3/08. Formations of new impaired loans were in line with Q3/08 and did not witness acceleration in the quarter. However, we expect formations to increase in 2009.

• The Tier 1 ratio of 9.3% was down 0.5% sequentially, in line with our expectations.

Management is targeting a 2009 EPS range of $3.26-$3.42, which is well-below what street estimates were going into the quarter ($3.94 per share).

• We believe that the cautious earnings outlook is a reflection of rapidly deteriorating global economies, which has negative implications for banks, particularly loan losses.

• Our 2009 EPS estimate going into the quarter was $3.45, and we have lowered it by $0.20 to reflect higher expected loan losses. We believe that the street's estimates will have to come down by a larger amount.

Our Underperform rating on Scotiabank's stock has primarily reflected our view that the high valuation multiple leaves little room for disappointment.

• We believe that Scotiabank is not as well positioned to outperform its peers from an operating perspective in 2009 compared to 2008, because: (1) We believe that structured finance/off-balance sheet conduit issues are likely to cause lower writeoffs for the bank's peers than in 2008. (2) We expect the credit cycle to broaden to areas beyond U.S. residential real estate/U.S. consumer/U.S. residential construction lending, into areas where Scotiabank has more exposure such as traditional business lending in the U.S., Canada, Latin America and the Caribbean. (3) The economic environment in Latin America has deteriorated rapidly, which has negative implications in our mind for both earnings risk and the bank's multiple relative to peers. (4) Capital ratios are likely to decline to the low end of the Big 6 bank range after the close of the acquisition of a stake in CI Financial.

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Dow Jones Newswire, 3 December 2008

Analysts applaud Bank of Nova Scotia for "creative" approach to raising capital by issuing equity to Sun Life Financial to fund stake in CI Financial Income Fund. But some say bank could still issue common equity to the public, if markets continue their move lower. Desjardins Securities says all Canadian banks will see decline in traditional sources of capital -- unrealized equity gains and surplus allowances -- amid a depressed earnings environment. Meanwhile, the bar for capital at banks has been raised, analyst says. Quality of capital also key, an issue to watch at Bank of Montreal and CIBC.

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Ther Globe and Mail, Tara Pekins, 3 December 2008

Bank of Nova Scotia is changing the way it will pay for its $2.3-billion stake in mutual fund firm CI Financial Income Fund in order to boost its capital levels.

Scotiabank announced back in early October that it would be paying $2.3-billion in cash to insurer Sun Life Financial to pick up its 37-per-cent stake in CI Financial. On Wednesday, Scotiabank announced that it plans to close that deal next week, but it will only hand over $1.55-billion in cash. The remainder of the purchase price will be paid for with $500-million worth of common shares and $250-million in preferred shares.

By preserving cash, the bank will bolster its capital levels, keeping more of a financial cushion that buffers it from unforeseen events.

The move “enables us to keep some capital available for future initiatives,” said Scotiabank spokesman Frank Switzer.

“What the deal does is adds $750-million to Scotiabank's regulatory capital, improving the bank's ratios,” Dundee Capital Markets analyst John Aiken wrote in a note to clients. “This will alleviate some of the concerns surrounding the bank's capitalization that arose out of its quarterly earnings released yesterday and should remove on of the pressures on its valuation.”

Scotiabank announced a 67-per-cent drop in fourth-quarter profit Tuesday, after being hit by a $642-million after-tax writedown.

While Scotiabank might still issue preferred shares to continue to shore up its capital ratios, there is no longer a sense of immediacy, Mr. Aiken wrote.

National Bank Financial analyst Robert Sedran said Scotiabank's Tier 1 capital ratio, the key measure that regulator's watch, had been expected to dip to 8.8 per cent if the deal for the stake in CI had been all-cash. With the changes, Scotiabank's Tier 1 ratio will now be about 9.1 per cent, he said. Regulators require the ratio, which is a measure of a bank's capital against its assets weighted by the risk they pose, to stay above 7 per cent.

Scotiabank said it will issue $500-million in common shares to Sun Life at $34.60 per share, and $250-million in 6.25 per cent rate reset preferred shares.

The $34.60 equity price is almost 7 per cent higher to yesterday's closing price, Mr. Aiken noted.

Scotiabank is purchasing the stake in CI Financial, which is the country's No. 3 mutual fund company by assets under management, to bolster its Canadian wealth management operations, which are a key priority for the bank.

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Dow Jones Newswires, 3 December 2008

Analysts now worrying about capital levels at Bank of Nova Scotia as credit conditions deteriorate. BMO Capital Markets notes BNS " has grown its risk-weighted assets quite aggressively in recent quarters" and ratios have declined. BMO says after buying CI Income Fund stake, BNS Tier 1 capital ratio will fall to 8.8% -- too low for investor comfort in these uncertain times. BMO suggests BNS could issue capital, likely innovative Tier 1 hybrids. If so, BNS follows Manulife Financial and Toronto-Dominion, which sold common equity, and RBC and Bank of Montreal, which issued preferreds. BMO says BNS could issue up to C$1.25B of hybrids.

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Financial Post, Eoin Callan, 3 December 2008

Bank of Nova Scotia is pulling back on lending to consumers and warning investors to brace for softer earnings next year as the economy slides into recession.

The third-largest bank in the country provided the clearest signal yet of any major Canadian financial institution that it is reining in offers of loans to customers for big-ticket items like homes.

Rick Waugh, chief executive, said the bank was becoming increasingly cautious amid profound economic uncertainty and worsening credit conditions.

Senior executives said the bank had stopped competing with Bay Street rivals to increase the bank's share of mortgages issued to Canadians.

"We lost a little bit of market share, and we've done that consciously," said Chris Hodgson, head of Canadian banking.

The disclosures indicate the bank has made a major strategic decision that separates it from Toronto-Dominion Bank. In particular, chief executive Ed Clark has promised investors he will dramatically increase the bank's share of the retail market.

The retreat by Scotia could leave the field open for TD and BMO to compete most aggressively to offer Canadians new loans, if RBC and CIBC follow Scotia's lead and ease back next year.

Rob Pitfield, the head of international banking at Scotia, said managers were also becoming "very circumspect" in providing consumer loans in Latin America and had "taken alot of action to tighten up."

In some respects, Scotia's executive team is putting into words what many bank executives around the world have been reluctant to say publicly, for fear of drawing political ire at a time when policymakers are encouraging financial institutions to ease the supply of credit.

The chief executive said interference from politicians was emerging as a major headache for international banks that had been compelled to turn to their governments for capital injections amid one of the worst financial crises of the century.

"I don't think government capital comes cheap," said Mr. Waugh, citing pressure on banks to make more loans to mitigate the impact of a recession.

"Politically, it comes with a true cost," he added, saying some foreign banks had been forced by governments to take capital they "didn't want" to guard against potential future losses.

Yet despite the warnings about the after-effects of state interventions, Scotia appears likely to be a beneficiary of moves by the Federal Reserve and United States Treasury to supply extra liqudity to the auto finance industry.

Scotia has more than $20-billion in exposures to the auto finance industry, mainly in the form of loans to consumers to buy cars and to auto dealers to keep their lots filled with vehicles.

The bank has extended about $5.2-billion in loans to consumers, parts manufacturers and dealers, plus exposures of $7.8-billion in off-balance sheet vehicles and another $7.8-billion in an on-balance sheet portfolios made up of securitized credit.

The exposures are a source of "concern" but have so far been managed without unexpected losses, said Peter Routledge, a senior credit officer at Moody's, the ratings agency. "If we have a normal turn in the credit cycle tied to a recessionary period, then that would suggest they would not have difficulties managing credit losses. If it is an unusually bad cycle and credit losses are much higher, than conceivably it might put some negative pressure on the [credit] rating," said Mr. Routledge.

Brian Porter, Scotia's chief risk officer and a rising force within the bank, said the next year "is going to be a focus on credit, credit and credit."

But he said while there would be a rise in loan losses across the board, he did not anticipate any nasty surprises.

The chief executive said Scotia would not raise capital by issuing common equity, but had ample scope to take advantage of new looser capital rules by selling preferred shares.

Analysts said they expected the bank to act soon to pad its capital base in this way, as its reserves appeared set to dip below the level of 9% of risk-weighted assets, a trigger for other institutions to raise cash.

Scotia Tuesday said profit fell 66% due to a worse-than-expected charge of $642-million incurred amid turbulent markets. The bank said net income for the quarter ended Oct. 31 was $315-million (28 cents) compared with $954-million (95 cents) in the year-earlier quarter.

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The Globe and Mail, Steve Ladurantaye, 3 December 2008

Bank of Nova Scotia shares were hit hard yesterday after the bank reported a 67-per-cent drop in fourth-quarter profit, with bad investments leading to a $642-million after-tax writedown.

"Clearly, 2008 was a difficult year, particularly with the writedowns we took in the fourth quarter," chief executive officer Rick Waugh said. "While Canadian banks have fared better than their counterparts in other parts of the world, none of us have been immune to the forces buffeting global markets."

The company's shares fell 7 per cent as analysts warned that the bank faces more difficulties, despite its relatively upbeat forecast and a prediction that it could increase earnings per share by up to 12 per cent in 2009.

"Surprisingly, BNS did provide targets for 2009, but we are taking them with a grain of salt, given that we see much more volatility in and less visibility for earnings in the upcoming year," said Dundee Securities Corp. analyst John Aiken, who reiterated his "sell" rating on the shares in a note to clients.

Profit was $315-million or 28 cents a share, compared with $954-million or 95 cents in the same quarter last year. Total revenue fell to $2.49-billion from $3.08-billion.

The $642-million writedown was 7.9 per cent higher than the $595-million charge the bank warned investors to expect when it prereleased earnings in late November. Without the writedown, Canada's third-largest bank said it would have earned 93 cents a share.

The bank's Scotia Capital division took the biggest hit in the fourth quarter, with profit down 80 per cent to $44-million from $229-million. International banking revenue was off 15 per cent, with profit at $227-million, down from $359-million a year ago.

However, the Canadian banking division saw profit increase by 6 per cent, helped by the acquisitions of Dundee Bank, Travelers Leasing, TradeFreedom and E*Trade Canada. Profit was $466-million in the division, up from $439-million last year.

"In 2009, we will be emphasizing two of our traditional strengths as key additional priorities: risk management and expense control," Mr. Waugh said. "These priorities will be key success factors in the current environment."

Calling the bank's performance "remarkably good despite charges on certain structured credit instruments, settlement losses on the Lehman Brothers bankruptcy and generally weak capital markets," Mr. Waugh said the bank's 49-cent quarterly dividend will remain unchanged.

With the bank's shares closing at $32.38 on the Toronto Stock Exchange yesterday, they yield 6 per cent.

"Our dividend remains well supported by both our earnings and high capital levels, which remain strong by global standards," Mr. Waugh said.

Provisions in the quarter for credit losses of $207-million were 118 per cent higher than a year ago, reflecting the problems facing consumers and business as the economy has worsened.

"Management expects loan losses to be higher in 2009 but within risk tolerances," RBC Dominion Securities Inc. analyst André-Philippe Hardy wrote in a note. "Slowing economies and lower recoveries are likely to drive loan losses higher."

For the full year, the bank said it took $822-million in writedowns. Profit fell 22.5 per cent to $3.14-billion or $3.05 a share from $4.05-billion or $4.01 a share.

"The financial sector and the global economy will likely continue to experience significant uncertainty in 2009," Mr. Waugh said.

"However, Scotiabank's diversity - by business line, by product and by geography, including our presence in higher-growth emerging markets - leads us to anticipate moderate overall growth for the bank in 2009."

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Dow Jones Newswires, 2 December 2008

Turns out Bank of Nova Scotia is less bullish on 2009 than it first seemed. Some observers thought BNS was being aggressive with its outlook of 7%-12% earnings growth for a year in which North American economy's likely to sink. But CEO clarifies that growth rate based on reported EPS -- which includes C$822M in after-tax charges. That means F2009 EPS will be closer to C$3.35/share than the current C$3.94 mean estimate.

John Aiken at Dundee Securities is taking Bank of Nova Scotia's 2009 forecast with a "grain of salt." He sees "much more volatility in and less visibility for earnings" next year than BNS appears to. Key worry is credit quality weakening faster than expected, a theme also seen with Bank of Montreal. But BMO gave no 2009 guidance, citing uncertain outlook for markets. BNS also surprised with write-downs C$50M higher than when bank warned a few weeks back. That news seems to offset strong performance in domestic and investment banking units.

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Manulife Expects Q4 2008 Loss of $1.5 Billion

The Globe and Mail, Tara Perkins, 3 December 2008

Expecting to suffer its first loss as a public company, Manulife Financial Corp. is reluctantly tapping the market for equity, the second Canadian financial institution to do so in as many weeks because of investor pressure to boost softening capital levels.

Chief executive officer Dominic D'Alessandro said in an interview yesterday the equity move is "not what I would have preferred to do, but like everybody else, when the facts change maybe it's an indication you should change your position."

The move will put Manulife in a position to not be left out of the race for acquisitions as the global life insurance industry goes through a round of consolidation.

Manulife is issuing at least $2.125-billion of common equity to raise its capital levels, which have been walloped because of the company's large exposure to stock markets.

It now expects to lose $1.5-billion in the fourth quarter, the first time it has not earned a profit since going public in 1999.

On a mid-October conference call, Mr. D'Alessandro told analysts that the insurer remained very well capitalized and "we have no intention to issue equity capital, contrary to speculation that came to our attention." Instead, Manulife went on to arrange a $3-billion loan from the big banks to bolster its financial cushion.

But stock markets continued to tank, eating away at the large investment portfolio that Manulife holds in its variable annuity and segregated funds business. As those investments sink, Manulife is required to put more money aside as capital. Its shareholders weren't satisfied.

"We thought the $3-billion facility that we put in place had allayed the concerns that were out there, but it didn't do the job," Mr. D'Alessandro said in yesterday's interview. "Our stock price kept suffering from weakness and we kept hearing from investors and other people close to the company that maybe we should just bite the bullet and put it behind us because no one knows how long these uncertain times are going to be with us."

The company would not have changed its tune if it were convinced that this was "a passing storm," he said. "But it may endure for a while and we don't want to be in a position where there are all kinds of things happening in our business and we're on the sidelines."

Shane Jones, managing director of Canadian equities at Scotia Cassels, which owns Manulife shares, said the company should have taken action sooner. "Now they've come to market at the bottom. If they had raised equity a month ago they would have done it at a better price."

Raising more equity will safeguard the insurer from further declines in stock markets as well as boost Mr. D'Alessandro's ability to snap up more assets before he leaves his post in May.

Manulife chief investment officer Don Guloien, who will replace Mr. D'Alessandro when he retires next year, has met with bankers to examine parts of American International Group Inc., sources have told The Globe and Mail. Manulife is also believed to be keeping an eye on U.S. rivals whose share prices have been battered by the financial crisis.

Last week, Toronto-Dominion Bank CEO Ed Clark decided to issue $1.4-billion of common equity, days after suggesting he would do no such thing. Like Mr. D'Alessandro, Mr. Clark also said he faced pressure from investors.

The sudden death of massive financial institutions such as Lehman Brothers has caused the market to attach a new importance to capital, which provides firms with a buffer in times of trouble. The capital ratios of all of Canada's largest banks and insurers have remained well above the minimum levels that regulators require, but that's no longer good enough.

Mr. D'Alessandro believes that the capital requirements for Canadian life insurers, dictated by the Office of the Superintendent of Financial Institutions, are still too strict. OSFI changed the rules in late October to give Manulife and its rivals more breathing room. But Manulife is still required to put aside large amounts of capital each time stock markets drop.

"Markets go down 10 per cent and you've lost 15 points of your elbow room," Mr. D'Alessandro said.

With the new equity, the insurer's capital ratio (called the MCCSR, or Minimum Continuing Capital and Surplus Requirements) will be about 235 per cent, one of the highest levels in the company's history. Manulife aims to keep the ratio between 180 and 200 per cent, and OSFI requires that it remain above 150 per cent.

Manulife will now pay back $1-billion of its bank loan and sell $1.125-billion of equity by way of a private placement to eight existing institutional investors such as the Caisse de dépôt et placement du Québec, the investment arms of big banks including Royal Bank of Canada and Toronto-Dominion Bank, and Jarislowsky Fraser Ltd. A further $1-billion is being sold to the public in a bought deal. The new equity is being issued at $19.40 a share.

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Financial Post, Eoin Callan, 3 December 2008

Manulife Financial is moving to shore up its capital base after falling into a loss for the first time in its history as a public company.

Canada's largest insurer will issue $2.125-billion in common equity at a discount after seeing its capital base eroded amid extreme volatility in financial markets.

The bid to raise cash underlines how the ongoing financial crisis is draining reserves from the country's financial system.

The insurer expects to lose $1.5-billion this quarter, as revenues decline and investments lose value in the face of a global economic slowdown.

Dominic D'Alessandro, chief executive, said: "We are disappointed with this poor performance."

A key reason for the poor performance is the need for the insurer to back stop losses on investments made to support financial products sold to Canadians and Americans that guaranteed minimum returns.

Manulife enthusiastically joined in an industry craze selling segregated funds or variable annuities to customers the promised them investment income as they prepared for old age.

But that business model has broken down amid the seize up in credit markets, and Manulife said on Tuesday it will be forced to set aside an extra $4.5-billion on Dec. 31 to cover these "guarantees".

This move comes even after Ottawa loosened accounting rules at the behest of the insurer, allowing it to set aside less reserves than under the old system.

The bid to raise capital is a climb down for the chief executive, who retires in the spring after 14 years and had insisted the company would not need to issue common equity.

The shares will be sold in a public offering at a heavy discount at $19.40 per share.

The share issue will include $1.125-billion sold by way of private placement to eight existing institutional investors and $1-billion to a syndicate of underwriters.

The move comes after the company signed an agreement to borrow $3-billion from the country's top banks only weeks ago.

That credit line will now be reduced to $2-billion.

Manulife shares are expected to slide at the open to close to $20 per share, according to analysts.

TD Bank Financial Group made a similar move to shore up its own capital position last week. TD said it was being forced to brave extremely volatile markets with a bid to raise up to $1.2-billion in cash, after coming under pressure from investors to take action over its shrinking capital base.

The TD action led one analyst to suggest Manulife also turn to equity the markets. John Reucassel, an analyst at BMO Capital Markets, said that TD had done the insurer a favour by testing the market and proving investors were willing to back share issues.

"We believe that this could provide Manulife with an opportunity to also raise equity and strengthen its capital position in the face of volatile equity markets," the analyst said in a note to clients.

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Reuters, Lynne Olver, 2 December 2008

Manulife Financial Corp explored various options to boost its capital levels before announcing a big equity issue on Tuesday, which it went ahead with partly to stay in the acquisition game, Chief Executive Dominic D'Alessandro said on Tuesday in an interview.

A C$3 billion ($2.4 billion) loan facility that Manulife arranged in early November was not sufficient to shore up capital when stock markets were getting increasingly volatile, D'Alessandro told Reuters, making it "prudent" to issue common shares. A preferred equity issue would have been too small, he added.

"We wanted to be in a strong position to participate in any of the restructuring activities that may happen," he said.

The credit crunch and ensuing financial crisis, which has walloped many insurance companies' stock prices, has made Manulife the largest insurer in North America. It may also be the catalyst for consolidation of the fragmented U.S. industry, he said.

"Had we not done this issue, we might have been constrained in what we could look at or what we could entertain."

Earlier on Tuesday, the company said it would raise C$2.1 billion by issuing common stock at a price of C$19.40 a share.

The stock closed at C$19.89 a share, down 2.8 percent.

The CEO said he regrets having to issue shares, but that most people understood the company's dilemma -- as stock markets fall, it is forced to set aside more money to cover future obligations to certain policyholders.

"I'd like to say I'd rather have cut off a leg than issue equity at these prices, but on the other hand, we are where we are and the markets remain very volatile," D'Alessandro said, referring to Monday's steep stock-market plunges.

"You saw what happened yesterday, and you have to adjust your thinking for events as they unfold."

D'Alessandro said on a conference call in mid-October that Manulife was not contemplating an equity issue.

At that time, "we were feeling that maybe the worst of the storm was already upon us," he said.

"The events since October have been, if anything, even more dramatic. It's a case of changed circumstances. If I had my druthers, I'd rather not issue equity at these prices."

Manulife sold C$1.125 billion of shares by way of private placement to eight existing institutional investors and C$1 billion to a syndicate of underwriters in a "bought deal" public offering, both led by Scotia Capital Inc.

The company also said it expects to report a fourth-quarter loss of C$1.5 billion ($1.2 billion) due to the effects of falling stock markets.

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Blackmont Capital's Brad Smith is One Tough Analyst to Surprise

• Brad Smith (BS) on National Bank's $237 million writedown for Q4 2008, as reported by Bloomberg on 26 November 2008

“The ABCP writedown comes as no surprise given recent credit market deterioration,” Blackmont Capital Inc. analyst Brad Smith wrote in a note to investors. Smith, who rates National Bank shares a “hold,” said that the preliminary results are 5 cents a share higher than he was expecting.

• BS on TD Bank's $500+ million writedown for Q4 2008, as reported by Bloomberg on 20 November 2008

"We're not surprised by any of this, and we think there's more to come from TD," said Blackmont Capital analyst Brad Smith.

• BS on Scotiabank's $890 million writedown for Q4 2008, as reported by Dow Jones Newswires on 18 November 2008

Brad Smith at Blackmont Capital said Scotia's fourth-quarter write-downs were "a relatively small amount of money" that probably will shave about 60 Canadian cents a share off its earnings in the period. "If that's all there is, then there's nothing to worry about."

He said he wasn't surprised to see the write-downs, as he expects Canadian banks to view 2008 as a "lost year' and enter 2009 with a cleaner slate.

• BS on CIBC's possible writedown from its exposure to SCA, as reported by Financial Post on 18 November 2008

CIBC has a net fair value exposure of US$1.2-billion to the bond insurer and a net notional exposure (excluding subprime) of US$2.6-billion, according to Blackmont Capital analyst Brad Smith.

He is not surprised by the recent developments at SCA despite the US$1.8-billion capital injection it got from Bermuda-based insurance firm XL Capital Ltd. in July. Mr. Smith said management’s concession that the future of SCA is in doubt will likely pressure other monoline credit default swap spreads and increase writedowns at CIBC.

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National Bank's $237 Million Writedown for Q4 2008

Scotia Capital, 27 November 2008

• NA pre-released operating earnings of $1.09 per share below our estimate of $1.35 per share and consensus of $1.31 per share.

What It Means

• Reported earnings are expected to be $0.37 per share including a moderate $237M (0.99 per share) in net charges. Net charges include a $117M ($0.49 per share) charge against ABCP, a $66M ($0.27 per share) restructuring charge related to the transformation plan announced in September and $54M ($0.23 per share) writedown of tangible assets.

• Reported earnings also include a $65M ($0.27 per share) gain on sale of AMF Corp. to Credit Suisse previously announced on August 26, 2008.

• The charge against ABCP includes a valuation adjustment bringing total writedowns to 32% of the original notional value up from 25%.

• Tier 1 ratio is expected to remain solid at 9.4% versus 10.0% in Q3/08.

• We are reducing our 2008 earnings estimate to $5.48 per share from $5.74 per share due to lower fourth quarter results. We are reducing our target price to $55 from $65 due to investors' fears, not underlying value or earnings and dividend sustainability.

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Bloomberg, Sean B Pasternak, 26 November 2008

National Bank of Canada, the country’s sixth-largest bank, reported fourth-quarter profit of about C$70 million ($56.6 million) after posting C$237 million in pretax writedowns for asset-backed commercial paper and other investments.

Excluding the costs, profit was C$1.36 a share, the Montreal-based bank said today in a statement releasing preliminary results. That compares with the C$1.34-a-share average estimate of 13 analysts surveyed by Bloomberg News. National Bank reported a net loss a year earlier.

The costs, which add to C$685 million in debt writedowns taken in the last five quarters, include C$117 million related to frozen commercial paper that hasn’t traded since August 2007.

“The ABCP writedown comes as no surprise given recent credit market deterioration,” Blackmont Capital Inc. analyst Brad Smith wrote in a note to investors. Smith, who rates National Bank shares a “hold”, said that the preliminary results are 5 cents a share higher than he was expecting.

There will also be C$54 million in charges to write down assets, and C$44 million in costs related to a business plan announced by Chief Executive Officer Louis Vachon in September aimed at trimming expenses, the bank said.

As part of that plan, 120 jobs have been cut since September, spokesman Denis Dube said in a telephone interview. About half of those positions are in the bank’s financial markets unit, which includes investment banking.

National Bank plans to add a “few hundred” employees to its consumer-banking unit over the next 12 to 24 months, Dube said. The bank has about 17,000 employees.

National Bank is the fourth Canadian lender to report preliminary results before their scheduled earnings date to reflect rising writedowns and credit losses. The bank will provide full results on Dec. 4.

Royal Bank of Canada, the biggest lender, said this week that profit probably fell 15 percent to C$1.1 billion, driven down by C$360 million in trading losses and writedowns.

Last week, Toronto-Dominion Bank reported preliminary results that missed analysts’ estimates after incurring a C$350 million trading loss. Bank of Nova Scotia said it had a C$890 million pretax writedown tied to trading and declining investments.

National Bank fell C$1.40, or 3.5 percent, to C$39.04 at 4:10 p.m. in trading on the Toronto Stock Exchange. The stock has fallen 25 percent this year, compared with a 33 percent drop for the nine-member S&P/TSX Banks Index.

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BMO Q4 2008 Earnings

TD Securities, 26 November 2008

Event

Yesterday BMO reported core cash FD-EPS of C$1.00 (including C$0.19 increase in General Allowances) versus TD estimate at C$1.10 and consensus of C$1.07.

Impact

Slightly Positive. BMO delivered a decent bottom-line number (relative to recent fears) with a steady result in its domestic P&C operations, but was helped by lower taxes and strong trading results offsetting a material pick-up in credit costs. The bank remains well capitalized, and maintains a healthy dividend. Going forward the bank continues to face slippage in its credit book/mix and managing down some specific exposures. We see upside across the group, but think there are stronger names than BMO.

Details

Domestic holding in reasonably well. BMO’s domestic P&C operations continue to make progress and delivered a steady quarter amid a challenging environment. We continue to believe the worst is behind us, but building on the progress will be a challenge as the environment slows and competition tightens. In particular, we believe the bank has much work to do in accelerating its residential mortgage business.

No longer the clean credit bank. BMO has historically been viewed as a high quality credit bank. That image appears to be diminishing with continued sizeable growth in impaired loans (largely in the bank's U.S. credit book). Further, despite rising PCLs, the bank’s reserve levels are eroding, setting up the risk of higher costs in the coming quarters. Finally, credit cards, commercial and wholesale loans (typically higher risk credits) are leading the bank's loan book growth, suggesting a potentially higher risk mix going forward.

Ongoing risks/exposures. BMO was forced to take another mark on its Apex/Sitka exposure this quarter and current values seem to suggest the bank is underwater on its loans in support of its SIVs. Management maintains that the risk of realized losses is remote on both fronts. Nonetheless, they remain lingering issues for us in an unsettled market, fixated on capital levels.

Conference Call Highlights

Guidance. On the back of uncertain market conditions, management did not provide an outlook for 2009, but provided medium term guidance of +10% average EPS growth per year, ROE between 17-20%, cash operating leverage of at least 2% and maintaining a strong regulatory capital position.

Dividends. Dividends were unchanged at C$0.70 per share and management indicated future dividend growth near term is unlikely given market conditions and that BMO is currently operating above their dividend payout ratio target of 45-55%

Apex/Sitka. The bank recorded pre-tax losses of C$170 million on two exposures to the restructured conduits on MTM, however management views the chance of actual losses as remote given the performance of the underlying credits and structure/subordination in the structure.

SIVs. In Links, total senior notes outstanding and BMO's liquidity outstanding total US$7.6 billion while underlying asset fair values equal US$6.8 billion implying that at today's prices the protection from capital notes has been eroded. Over the coming 6 months, the bank's exposure is expected to grow to C$6.7 billion (effectively replacing the remaining senior notes). Management maintains that the underlying assets are sufficient to repay their loans at maturity and has not taken any marks or reserves against the bank's exposures.

Q4/08 Segment Highlights

Canadian P&C. A steady quarter with good revenue growth offsetting investment driven expense growth and higher credit costs. Margins were up 8bps year over year driven largely by interest collected on a tax refund. Volume growth was good (AIEA +6% year over year). However, growth is being driven by cards (+14%) and personal loans (+21%) and commercial lines in lieu of residential mortgages where growth was nominal. This is helping a higher margin mix, but should carry higher credit costs. In our view, invigorating the mortgage portfolio remains a key focus for 2009.

Private Client Group (PCG). Ex-items the group was down marginally year over year on softer revenues with total assets down 3% year over year and AUM down 6% with ongoing investment driven expense growth. U.S. P&C. Struggles continue here with modest Net Income of C$25 million. Recent acquisitions are helping to offset margin pressure in driving revenue growth, but NIX rose materially (even ex-items). A small portion of the overall earnings picture, it remains difficult to see how the bank's U.S. retail platform (inclusive of PCG and portions of Capital Markets) can be a meaningful driver.

Capital Markets. Another strong trading quarter (totaling C$496 million versus a Q4/07 loss of C$150 million) helped offset the expected weakness in some core wholesale businesses along with higher NIX and PCLs. We continue to note strong loan growth with balances +17% year over year and almost 9% asset growth (reflecting in part the weaker C$). While potentially profitable given the opportunity for wider margins, it does suggest heightened credit risk given the challenges the bank is facing in its U.S. credit book.

Credit. We are concerned about the deterioration in BMO's credit profile. Impaired loans jumped materially, while reserve builds were relatively modest, driving a decline in coverage ratios. Combined with what we view as a slightly higher risk loan growth mix (cards, personal loans, commercial and corporate) we continue to expect elevated PCLs through the coming year.

Capital. Notwithstanding some hits on the quarter, the bank remains well capitalized in our view at 9.77% at the end of Q4/08 (Exhibit 2) and BMO maintained its healthy dividend payout.

Outlook

We have revised our 2009 estimate down to C$4.25 (from C$4.60) reflecting primarily increased PCL costs and inline operating results from P&C.

Justification of Target Price

Our target price reflects our estimate of equity fair value 12 months forward based on our views regarding sustainable ROE, growth and cost of equity (implying a P/BV of 1.7x).

Key Risks to Target Price

1) Additional losses or write-downs from key risk exposures 2) significant competition in the Chicagoland market and 3) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

We see upside across the group, but in our view, we believe there are stronger names than BMO.

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Financial Post, David Pett, 26 November 2008

Bank of Montreal says its dividend is safe for now, but the Street isn't 100% sure that investors can count on the current payout down the road.

"BMO has a higher dividend payout ratio than peers and, if the economic slowdown proves deeper and longer than we expect, BMO has less flexibility, in our view, to maintain its dividend," said RBC Capital Markets analyst Andre-Phillipe Hardy in a note to clients, following Bank of Montreal's fourth quarter results.

In addition to reporting a 24% year-over-year increase in profit during the quarter, the bank reaffirmed to shareholders its 70¢ quarterly dividend, but also said it is unlikely they will see a dividend increase any time soon.

Mr. Hardy noted that Bank of Montreal's capital ratios are high, and it may need to strengthen capital. If it does, the analyst said he believes the bank would prefer to continue raising non-common equity as opposed to cutting the dividend or raising common equity.

"The bank's high dividend payout target of 45% to 55% means that its dividend burden would be higher than other banks if it issued more common shares," he wrote.

"For BMO to cut dividends, we believe that its earnings power would have to be threatened and/or equity capital would be needed to a degree that the increase in shares outstanding would make the quarterly dividend payment too large to support from income."

John Aiken, analyst at Dundee Capital Markets, echoed some of these thoughts, also telling clients in a note that he doesn't anticipate a dividend cut in the coming quarters. That is unless "the domestic economy deteriorates to a significantly greater degree than we forecast."

The Dundee analyst said Bank of Montreal's capital remains strong. While the bank will not likely need to raise additional common equity, he added that a dividend increase is out of the question for now, given the earnings headwinds facing the company.

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Financial Post, Eoin Callan, 25 November 2008

Bank chiefs on Bay Street are urging Ottawa to commit to making a major injection of cash into the economy to help stem a rising tide of bad loans, after internal bank figures showed Canadians were increasingly struggling to make payments on money they've borrowed.

Bill Downe, chief executive of BMO Financial, said strong and timely fiscal stimulus was needed from government, arguing it would be "positive for employment" and facilitate "constructive investment," while reviving growth for banks.

The appeal came as BMO Tuesday provided the first granular picture of Canadians' borrowing habits since the credit crisis developed into a full-blown economic crisis, revealing a sudden spike in credit defaults.

Figures from the bank's own books showed bad loans had already exceeded the peak reached in 2001 after the dot-com crash and were on the way to hitting levels not seen since the last recession almost two decades ago.

BMO said the amount of loans that had become impaired had jumped to $2.4-billion this year from $720-million last year, as it Tuesday jacked up the stash of cash it sets aside to cover credit losses to $1.1-billion.

Mr. Downe said he expected the value of loans sought by Canadians to drop "in the first half of 2009" amid rising borrowing costs, undermining one of the last areas of profit growth for banks buffeted by market turmoil.

While the executive expects the business environment to worsen after Christmas, he said in an interview that the economy, and banks' fortunes, could be turned around by the second half of next year if Ottawa and Washington acted decisively.

The demand for government intervention underlines the extent to which the banking system is counting on policymakers to jump start growth at a time when many financial institutions are being forced to conserve cash and scale back their ambitions.

The success of policymakers in halting an economic decline and staving off an unprecedented increase in consumer and corporate loan defaults is of great financial importance to BMO.

The bank is enmeshed in a complex web of investment vehicles with more than $35-billion in exposure to credit markets that are largely held off-balance sheet.

The investment portfolios are under duress because there is no appetite in the current environment to trade the holdings -- which include corporate bonds and mortgage backed securities -- thereby forcing BMO to commit to providing tens of billions in liquidity.

Executives argued Tuesday that their strategy of keeping the vehicles on life support with bank cash was proving manageable and that they could shield the bank from major losses and recover value for their clients by holding the assets until maturity.

But this strategy depends on repayments of the underlying loans to corporations, credit card holders, and homeowners in the U.S. and Canada holding up at a level roughly in line with other downturns in history.

By taking this approach, BMO has slowing won back a measure of confidence from investors that were initially spooked by the exposures, easing they way for the bank on Tuesday to seek up to $250-million in capital in the form of recallable preferred shares.

The bank sought to raise the funds even after it showed Tuesday it had managed to preserve capital and maintain earnings in the fourth quarter. The bank's pool of reserves dipped only slightly as it delivered a steadier performance than its larger rivals on Bay Street, despite recording a $500-million loss on investments in international credit markets.

"Capital remains strong," said John Aiken, an analyst at Dundee Capital Markets, adding that a 24% rise in quarterly earnings to $560-million was "much stronger than we had anticipated."

BMO's core capital held at a level above TD and Royal Bank of Canada, despite a slip to 9.7% from 9.9%, meaning the bank holds just under $19-billion of reserves to back up about $190-billion of assets judged to face varying degrees of risk.

TD Bank Financial Group on Tuesday finalized an emergency move to top up its reserves, raising an initial $1.2-billion from a mix of institutional and retail investors.

The sale of deeply-discounted shares by TD pulled down its stock price, but will help push its core capital reserves back up to a level of about 9%.

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The Globe and Mail, Tara Perkins, 25 November 2008

Bank of Montreal has stopped setting annual profit goals for the time being because the outlook for the coming year is too uncertain, but executives hope that government spending will lift the economy.

“I think there will be co-ordinated stimulus, and it makes sense. Canada is integrated into the North American economy to a very large extent,” BMO chief executive officer Bill Downe said in an interview Tuesday. “It is very sound economic policy.”

The bank's personal and commercial lending business in Canada is still seeing good numbers, but there is a lag effect, he said. “I think we do have the benefit of a delay in the slowdown, and the slowdown will come I think through the course of 2009 in Canada.”

The level of losses from bad loans will be an issue next year, chief risk officer Tom Flynn said on a conference call.

“Loss performance in the industry and for our bank will depend on how the economy does, what happens to unemployment, what happens to U.S. housing,” he said. “And the environment is a weak one and appears to be getting weaker. We are hopeful that the fiscal stimulus programs that governments are talking about introducing will be introduced and will have some positive impact in mitigating the downward economic trend late next year.”

The U.S. economy is sliding into a deeper recession, and Canada's has fared only modestly better because it has been supported by continued growth in consumer spending, Mr. Downe said.

“It too will face a downturn in coming quarters. Potential for a modest recovery in the second half of 2009 in response to aggressive monetary and fiscal stimulus and some stabilization in the U.S. housing markets could well be delayed until the end of next year,” he said.

BMO met one of its five performance targets for fiscal 2008, obtaining a strong capital ratio. It missed its goals for profit, return on equity, provisions for bad loans, and leverage, as it had cautioned earlier this year that it might.

While some of the bank's rivals have disclosed they will take writedowns in the fourth quarter, BMO was the first to give a full performance picture.

Fourth-quarter profit of $560-million was up 24 per cent from a year ago, and was much stronger than anticipated, said Dundee Securities Corp. analyst John Aiken.

The bank still has risky exposure to areas such as structured investment vehicles, but those have been previously disclosed and did not cause surprises. What was most concerning about the bank's results was a significant increase in its provisions for bad loans, which rose by $314-million from a year ago to $465-million. Less than $200-million of that related to Canada, while $269-million related to the U.S.

“Evidence of credit deterioration is clear,” said RBC Dominion Securities analyst André-Philippe Hardy.

Mr. Downe said the bank is aggressively managing the “watch lists” it keeps on loans that could potentially cause trouble, and is focused on maximizing its recoveries.

Royal Bank of Canada said Monday its provision for credit losses nearly doubled from the previous quarter, to about $620-million, and that its profit had fallen about 15 per cent from a year ago to $1.1-billion.

BMO issued $150-million of preferred shares Tuesday, a move that will help pad its already-strong capital levels.

In an interview Monday, Toronto-Dominion Bank CEO Ed Clark said he thinks the market is too focused on capital levels and it would be better for banks to put some of that money to work by lending.

Mr. Downe appeared to disagree. “In this environment, strong capital ratios give you the ability to be the decision maker about what happens next,” he said.

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RBC & TD Bank New Equity Issue

Dow Jones Newswires, 2 December 2008

TD Ameritrade is looking to grow its business through its relationship with Toronto-Dominion , which has 45% stake in the company. In comments made at FBR Capital Markets fall investor conference, AMTD CFO Bill Gerber says the online broker is looking for different ways to get new clients and assets from TD branches, specifically in the US where the Canadian bank has recently rebranded its Commerce Bancorp, retail subsidiaries.

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Financial Post, Zena Olijnyk, 25 November 2008

TD Bank’s announcement that it will issue common equity to enhance its capital position is a “pragmatic move,” says Credit Suisse analyst James Bantis, given the current market conditions.

By entering into an agreement with a syndicate of underwriters to issue 30.4 million common shares at $39.50 – for gross proceeds of $1.2-billion, TD’s pro-forma Tier-1 capital ratio has been boosted to about 9%, compared with 8.3% on Nov. 1, while the issuance will be about 4% dilutive to common shareholders.

Given the bank’s pre-announced fourth quarter credit trading losses, and the effects of Basel II on its investment in TD Ameritrade, TD Bank “was in an unfavourable position to deal with unexpected credit market or counterparty shocks going forward.” Now, however, Mr. Bantis says TD is “no longer a noticeable outlier to its Canadian banking peers.”

UBS analyst Peter Rozenberg said he expects the stock will respond favourably, due to reduced capital concerns which should narrow its current valuation discount.. “We think that a 9% Tier 1 is the new standard by which other banks will now be judged,” he said, maintaining his “buy” rating but lowering his target price to $65 from $67. The stock current trades at about $40.

Meanwhile, BMO Capital Markets analyst John Reucassel says that TD’s move to issue equity could “break the ice” for Manuife Financial Corp. “We believe that this could provide Manulife with an opportunity to also raise equity and strengthen its capital position in the face of volatile equity markets and a difficult credit environment in 2009,” he said in a note to clients. A $3-billion equity issue would be about 7% dilutive to earnings per share at Manulife.

A combination of new regulatory capital rules on segregated fund guarantees, a $3-billion bank loan, plus a $3-billion equity issue would provide Manulife with a strong capital position to meet anticipated challenges in 2009 and could help maintain valuation on the shares. He rates Manulife shares a “market perform” and a target price of $30. The stock now trades in the $20 range.

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Bloomberg, Andrew Harris, 25 November 2008

A Royal Bank of Canada home-mortgage unit will pay $11 million to resolve U.S. government claims it gave false information about borrowers’ creditworthiness to the Department of Housing and Urban Development.

RBC Mortgage Co.’s accord avoids litigation in the case, said Randall Samborn, spokesman for Chicago U.S. Attorney Patrick Fitzgerald. The government alleged that from 2001 to 2004, RBC Mortgage, formerly known Prism Mortgage, made 219 loans based on false statements, all resulting in foreclosure.

“Mortgage lenders should know that they must maintain the integrity of the lending process so that federally insured mortgages will be available to worthy borrowers,” Fitzgerald said today in a statement. The questionable loans were made in the Rockford and Freeport, Illinois, areas, he said.

Royal Bank of Canada, the biggest Canadian bank, has denied liability, Fitzgerald said. The Toronto-based institution acquired RBC Mortgage in April 2000. RBC Mortgage stopped originating loans in September 2005, the prosecutor said.

RBC spokesman Kevin Foster didn’t immediately return calls seeking comment.

Twenty-five people, including three RBC Mortgage loan officers, have been convicted on criminal charges related to the government’s civil case, Fitzgerald said.

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The Globe and Mail, Tara Perkins, 24 November 2008

Canada's two largest banks moved to boost their capital levels yesterday after revealing that they had dipped substantially.

The capital ratios at Toronto-Dominion Bank and Royal Bank of Canada remained well above the minimum amount required by regulators, but the market is demanding larger financial cushions because banks continue to take a pounding from the financial crisis.

TD chief executive officer Ed Clark said he thinks it's the wrong thing to do, but he decided to capitulate. The bank issued $1.2-billion of common equity late yesterday to increase its capital ratios.

High capital levels are the flavour of the day, Mr. Clark said in an interview.

“When the world settles down and people have more certainty, as they look out they will say ‘well, this is kind of ridiculous, we're trying to set too high a target, and frankly it would be better to have the industry lend out more money, even if that meant that the ratios came down,'” he said. “But that's not the current mood. And so, you can try to fight the market, but I would say in these times it's not a good idea to try fighting the market.

“So we said rather than fight, why don't we just do this so we can go back to running the company.”

The announcement came after Citigroup received a rescue package from the U.S. government that included a $20-billion (U.S.) capital injection.

Meanwhile, Bloomberg reported that Goldman Sachs Group plans to sell notes in the first offering of debt backed by the Federal Deposit Insurance Corp.

Handouts from the U.S. government to American financial institutions are inflating capital ratios and market expectations, Mr. Clark suggested.

TD's capital ratio fell significantly on Nov. 1 under global banking rules, Basel II, that require it to change the way it counts its stake in TD Ameritrade. The decision to issue equity is a dramatic about-face for Mr. Clark, who told analysts on a conference call just Thursday that “raising common equity would be extremely difficult” at the moment. He signalled that the bank would rather increase its capital levels using other methods, such as issuing preferred shares.

That's what RBC did yesterday, announcing a $225-million offering of five-year preferred shares. RBC issued $300-million of preferred shares earlier in the quarter, and the two offerings will add $525-million to its Tier 1 capital. The Tier 1 ratio measures a bank's capital against its assets, weighted by the risk they pose, and is the main capital measure used by analysts and regulators.

Canada's banking regulator requires that the ratio stay above 7 per cent, but investors have begun to demand more of a buffer. Capital ratios are a gauge of the financial cushion that banks have.

The new “well capitalized” cutoff point might well be 9 per cent as far as the market is concerned, CIBC World Markets analyst Darko Mihelic suggested in a note to clients.

Canada's regulator recently gave banks new leeway to count more preferred shares and other innovative securities as capital, raising the limit to 40 per cent from 30 per cent.

Earlier yesterday, RBC disclosed that its Tier 1 ratio had fallen to about 9 per cent from 9.5 per cent in the last quarter. The new level was “surprisingly low,” said Mario Mendonca of Genuity Capital Markets.

Rating agency DBRS said that while the level is reasonable for RBC, “it is prudent for the industry, as a whole, to maintain capital levels that are higher than historical levels, given the expectation of deteriorating credit quality and the potential for further writedowns to occur as capital markets remain uncertain.”

The other large banks have not yet disclosed their fourth-quarter Tier 1 ratios.

RBC's ratio for the period which ended Oct. 31 was affected by the sudden and extreme drop in the value of the Canadian dollar. Much of the bank's risk-weighted assets are denominated in U.S. dollars.

TD's capital ratio fell from 9.8 per cent on Oct. 31 to 8.3 per cent on Nov. 1 when new global banking rules that were issued long ago finally took effect. As a result, the bank had to count 50 per cent of its $4.6-billion stake in TD Ameritrade in its ratio. “That meant we immediately lost $2.3-billion of Tier 1 capital, and that's what brought our Tier 1 capital ratio down,” Mr. Clark said. TD had already raised $1.25-billion of Tier 1 capital during the quarter, Mr. Mihelic noted.

TD still has room to issue “more than a couple billion dollars of preferred shares under the rules,” Mr. Clark said.

The decision to issue common shares was made yesterday afternoon, because markets improved since Thursday and investors were signalling they wanted a higher capital ratio, he said.

TD last week disclosed a surprising $350-million after-tax writedown from credit losses and further investment declines that will not show up in results because of new accounting rules.

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