29 August 2008

TD Bank Q3 2008 Earnings

RBC Capital Markets, 29 August 2008

TD's core cash EPS of $1.43 were close to our estimate of $1.45, representing a 10% YoY drop.

• Results were ahead of our expectations in the U.S., and slightly ahead in Canada, offsetting a weak quarter at TD securities.

• The quarterly dividend was raised from $0.59 to $0.61, which surprised us positively and is an indication of management's confidence in earnings for upcoming quarters.

• Aggregate provisions for credit losses of $288 million compared to our $255 million estimate. Impaired loans rose on both a gross and net basis during the quarter in Canada and the U.S., indicating likely continued pressure on provisions for credit losses.

We have lowered our 2009 estimated core cash EPS from $6.35 to $6.15 on lower estimated contributions from both wholesale banking and U.S. retail banking (a function of pressure on margins, as well as loan losses in 2009). Our 12 month target price per share remains $69, which is based on a P/BV multiple of 1.7x, which compares to the current multiple of 1.7x.

We maintain our Sector Perform rating on TD's shares (we currently rate half our Canadian bank universe as Sector Perform and half as Underperform). TD's NTM P/E of 10.4x compares to 9.9x for bank peers.

• (1) We like TD's domestic retail franchise, which delivered the second highest YoY revenue growth in Q3/08 and is well positioned to expand operating leverage, in our view. (2) We believe that uncertainty related to writeoffs for TD's wholesale division is lower than for peers with structured finance exposures. (3) We are not as worried about U.S. loan losses near term as we are for peers with U.S. exposures. (4) Cost synergies from the Commerce acquisitions should offset a portion of the rising loan losses we expect.

• We continue to prefer the shares of lifecos.


U.S. exposure did not lead to higher than expected specific loan losses

Aggregate provisions for credit losses of $288 million compared to our $255 million estimate, although specific loan losses were $25 million below our estimate.

• Specific loan loses were 63% higher than one year ago and 9% higher than in Q2/08.

• Impaired loans rose on both a gross and net basis during the quarter in Canada and the U.S., indicating likely continued pressure on provisions for credit losses. However, the YoY increase in impaired loan formations was lower than for all six peers but CIBC

• Gross impaired loans represent 0.45% of total loans, up from 0.43% in Q2/08 and 0.34% in Q3/07.

• Specific allowances as a percent of impaired loans were 29.2%, up slightly from 28.1% in Q2/08, but down from 35.8% in Q3/07.

• Impaired loan formations rose 55% YoY versus the 6 Canadian bank total of 124%.

The area most at risk of seeing deterioration for TD relative to peers is U.S. banking, as the bank has 25% of loans in the U.S., compared to 28% at Bank of Montreal, 14% at Royal Bank, 7% at Scotiabank and 3% at CIBC.

• TD's U.S banking business has not yet seen major problems in its loan portfolio as some other U.S. banks have. We estimate that non-performing loans represent 0.78% of total loans, up about 10 basis points sequentially. U.S. banks with assets of $50-$200 billion have non-performing loans averaging 1.41% of total loans.

• We believe that TD will will be a positive outlier relative to peers but the U.S. credit environment is worsening in our view given the moribund state of the U.S. economy and broadening of credit losses to sectors other than those tied directly to residential real estate.

• We expect quarterly provisions for credit losses of $75 million in Q4/08 and $125 million each quarter through 2009. TD Banknorth and Commerce Bancorp would independently have combined for loan losses of about $50-60 million per quarter a year ago.

• Issues in TD's loan book are more likely to arise in 2009 than 2008 as TD fair valued Commerce Bancorp's loan book as at the acquisition closing date (March 31). The bank would have had a fair bit of visibility on potential near term impairments, in our view, and would have fair valued the loans that had the potential to become impaired in the near term. Mitigating the impact on income of a probable increase in impairments in 2009 is reserves.

• Provisions for credit losses again exceeded write-offs in Q3/08. Provisions for credit losses of $75 million were $40 million larger than writeoffs as the bank built reserves ahead of what is likely to be a more challenging credit environment.

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

Capital ratios higher than expected; we still expect a drop in Q1/09

The Tier 1 capital ratio was 9.5%, up 40 basis points sequentially and 20 basis points above our estimate.

• Changes in capital calculations related to the investment in TD Ameritrade will lower this ratio by 130-140 basis points in Q1/09, which on a pro-forma basis would give TD the lowest ratio of the 6 Canadian banks, but well above the regulatory capital minimum of 7.0%.

• Other banks have Tier 1 ratios in the 9.5% - 10.0% range.

• TD has more room than other banks to issue innovative capital, which we expect will be acted upon to boost Tier 1 capital ratios. TD raised $500 million in non-cumulative preferred shares during Q3/08.

• We believe that TD can organically generate 20 basis points of Tier 1 capital ratios quarterly.

Retail banking should benefit from increased operating leverage

Domestic banking net income was slightly ahead of our estimate, rising 8% YoY.

• Revenue growth is second best among the 6 banks, driven by strong asset and deposit growth (real estate secured up 11%, personal deposits up 10%, consumer loans up 11%, business loans up 14% and business deposits 10%). We expect asset growth to slow in 2009, particularly in mortgages.

• Net interest income margins were down 8 basis points YoY in higher funding and deposit costs. We expect continued pressure.

• We expect operating leverage to increase in upcoming quarters (there was no operating leverage on a reported basis, although revenue growth outpaced expense growth by 1% if excluding the reallocation of some U.S. businesses to Canada). The reason for our optimism is that the year over year impact of the increase in staffing levels and extended hours, which started in Q4/07, should abate.

• Loan losses of $194 million were in line with Q2/08, but up from $151 million a year ago on higher retail volumes and business losses rising from $18 million to $37 million. We expect continued pressure on losses in business lending,w here losses have been low for quite some time.

Wholesale results weak; impact to total earnings mitigated by size

Wholesale core net income was $102 million ($37 million reported), below our $159 million estimate and well down from $253 million in Q3/07.

• The pre-released mis-marking of financial instruments had a $96 million negative impact on revenues and a $65 million impact on the bottom line.

• Securities gains were down, as were trading revenues.

• The mis-marking, as well as weaker than normal equity and credit trading offset good fixed income and foreign exchange trading results. Trading revenues of $43 million were down from $101 million in Q2/08 and $308 million in Q3/07.

• Securities gains, on a consolidated basis, were $14 million, down from $110 million in Q2/08 and $94 million in Q3/07. We got the sense that management was not looking for a major near term rebound in securities gains.

• Advisory fees were also down, as were corporate lending revenues on higher funding costs. TD is less dependent on wholesale income than its peers so the large shortfall in that division's income had a much lower impact on EPS. Just under 9% of core income came from wholesale activities in the quarter, compared to 10% in Q2/08 and 21% in Q3/07.

• We have lowered our 2009 forecast income for TD Securities from $634 million to $537 million, representing a 16% return on the $3.4 billion in excess capital.

• Management did not sound overly confident about the outlook for earnings and the bank has historically targeted a 20% return in normal times, and has outpaced that return in good times, but fallen short in the last two quarters as capital markets conditions slowed.

U.S. results ahead of our estimate

U.S. earnings of $273 million were ahead of our $240 million estimate, mainly because of lower than expected expenses.

• Comparisons to prior quarters are not meaningful since Commerce Bancorp results were included in TD's income for the first time.

• Provisions for credit losses of $75 million were in line with expectations, and $40 million larger than writeoffs as the bank built reserves ahead of what is likely to be a more challenging credit environment. As mentioned above, we expect quarterly provisions of $125 million in 2009.

• The bank reiterated its guidance for TD Commerce to contribute at least $750 million to earnings in 2008 and $1.2 billion in 2009 despite the tough economic environment and an expected increase in loan losses. Initiatives to grow earnings from the Q3/08 earnings of U.S. $270 million include organic balance sheet growth, improved spreads on loans and securities, expense initiatives and synergies from integrating TD Banknorth and Commerce. Total U.S. retail earnings made up about 24% of total earnings in Q3/08.

• Margin pressure is expected in upcoming quarters as management has raised deposit rates in certain markets to reflect competitive conditions. Some competing banks that have seen their cost of wholesale funding rise have increased their retail deposits rates as a way to raise alternate source of funds. Initially, TD did not follow suit but deposits declined during Q2/08 and management has reversed course and increased deposit pricing to protect market share. We expect margins to drop in the next quarter.

Other highlights

• Canadian wealth management net income of $122 million declined 3% from Q3/07, and was in line with our estimate. Revenue was up 4% but expenses were up 7% as the bank continued to invest and add new advisors (the bank is targeting 130 advisors this year, and currently has 1,267 advisors and planners or 140 more than a year ago).

• TD Ameritrade's contribution to TD's earnings was $79 million, up 15% YoY. The U.S. discount broker has reported good results with stronger growth than at E*Trade and Schwab in average trades per day (11% versus -8% and 9%, respectively) and client assets (4% versus -20% and 2%, respectively) in July.

• The Corporate segment generated a net loss of $40 million, in line with our estimated net loss of $43 million but compares to income of $11 million in Q3/07 because of higher unallocated expenses and lower securitization activity. Management has historically guided to a net quarterly loss of $20-40 million for this segment.

• Other comprehensive income will be negatively impacted by the U.S. mortgage backed securities portfolio in Q4/08, unless valuations improve. Management disclosed a $233 million decline in the value of its US$3.6 billion Alt-A RMBS portfolio in July (which will impact Q4/08). Declines likely continued in August and the value of other mortgage backed securities likely declined as well. TD's U.S. mortgage backed securities portfolio inherited from Commerce Bancorp is approximately $26 billion, including the Alt-A portfolio.

• $368 million in intangibles related to Commerce Bancorp (which would have been mostly brand-related) were transferred (tax effected) to goodwill as the Commerce brand will no longer be used.


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

Price Target Impediment

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

Company Description

TD Bank Financial Group is Canada's second-largest bank by market capitalization. TD currently has more than 1,110 retail branches in Canada, 1110 branches in the U.S. and 250 retail brokerage offices. Our estimated 2008 earnings mix is as follows: TD Canada Trust (54%), US Personal & Commercial (16%), TD Securities (13%), TD Wealth Management (10%), and TD Ameritrade (7%).
Scotia Capital, 29 August 2008

• Toronto-Dominion Bank (TD) operating earnings were strong at $1.43 per share, in line with expectations. Operating earnings declined 11% from a record $1.60 per share a year earlier. Reported earnings were $1.35 per share including a previously announced write-down on mispriced financial instruments of $96 million or $65 million after-tax or $0.08 per share.

• TD increased its dividend 3.4% to $2.44 per share.

What It Means

• Operating earnings continue to be driven by Canadian P&C which recorded a solid 8% increase, with Ameritrade earnings strong increasing 25% YOY. U.S. P&C earnings increased 150% to $273 million due to the Commerce Bancorp (CBH) acquisition. U.S. P&C represented 23% of TD's operating earnings. Domestic Wealth Management earnings were flat YOY with Wholesale Banking earnings extremely weak down 60%.

• We maintain our 2-Sector Perform rating on the shares of TD based on its strong retail franchise and high quality earnings. We consider TD, along with RY, the high quality, high growth banks.
Financial Post, John Greenwood, 28 August 2008

With Royal Bank, TD and National all posting strong third quarter-earnings with only limited losses from investments linked to subprime home loans, the worst of the structured credit debacle is probably over for the sector, said Dundee Securities analyst John Aiken.

"We are no longer overly concerned for [the banks] in terms of writedowns," Mr. Aiken said.

Royal, in particular, performed well, posting "the best earnings of the quarter," Mr. Aiken said. "That was the one bank that meaningfully beat [analysts'] consensus."

For the three months ended July 31, Canada's largest bank had a profit of $1.26-billion, or 92 cents a share, down nearly 10% from last year.

The results included a $498-million in writedowns related to structured credit investments that have fallen out of favour amid the credit crunch.

According to Mr. Aiken, the charge was in line with expectations and evidence that the bank is reducing its holdings.

As the bank with the lowest exposure to subprime mortgages, TD also reported a strong performance, though offset by loan losses in its U.S. Subsidiary Commerce Bancorp.

TD had a net profit of $997-million, or $1.21 a share, down 9% from last year.

The only player with a rise in profits was National Bank, which reported earnings of $286-million, or $1.73 a share, up 18% on higher results from its consumer business.

Results at the sixth biggest bank were "very good across all segments," Mr. Aiken said.

Now that all the banks have come out with earnings, investors are breathing a sigh of relief as the negativity that gathered over the sector last week dissipates.

Many feared that the losses from investments in structured credit products such as CDOs and SIVs would be a lot higher and that the pain would be spread into 2009.

Canadian Imperial Bank of Commerce and Bank of Montreal -- which reported earlier this week -- have so far posted the biggest writedowns on structured credit investments, but even they are now seeing light at the end of the tunnel.

"I think the pessimism going into the quarter was a little bit overdone," said Juliette John, lead manager of the Bissett Dividend fund. "In the banks that reported yesterday as well as today, the worst-case scenario has not materialized. CIBC was not as bad as it could have been and with Royal and TD, their businesses are actually in very good shape. Across the board capital levels are all very strong."

Ms. John predicts that next fiscal year will see a return to more normal times with dividend growth and stronger earnings.

That does not necessarily mean the banks will be enjoying the kind of heady profits common in the days of the credit bubble. With the U.S. mortgage market continuing to decline and rising unemployment south of the border, the Canadian economy is starting to feel the pinch. Analysts warn that means banks must brace themselves for a jump in loan losses and a general slowing of business typical in a struggling economy.

"That's the next shoe to drop," Mr. Aiken said.

RBC Q3 2008 Earnings

RBC Capital Markets, 29 August 2008

Royal Bank's EPS were ahead of our estimates on both a GAAP and core basis.

• GAAP EPS of $0.92 were well ahead of our estimate of estimate $0.75, although they were down 13% YoY.

• Core cash EPS of $1.14 were ahead of our estimate of $1.06 on better than expected performance from capital markets and insurance, offsetting weaker than expected results from the U.S. and international division. Core cash EPS were up 6% YoY.

• Separately disclosed write-offs of $498 million pre-tax were $102 million lower than our estimate. The bank netted off $105 million in compensation adjustments when disclosing the impact of write-offs, which we had not accounted for in our estimate.

• Provisions for credit losses of $334 million were slightly below Q2/08, but much higher than the $178 million booked in Q3/07. As expected, most of the increase came from the U.S. banking division.

• We have increased our estimated core cash EPS slightly in 2009 to $4.60 (from $4.55), reflecting higher expected capital markets profitability, offset by lower expected U.S. and international banking revenues.

Raising 12-month target price by $1/share

We have raised our 12-month target price per share to $50 from $49, reflecting a higher estimated book value following the smaller than expected net writedowns in Q3/08. Our target is based on a P/B of 2.2x, which compares to the current trading multiple of 2.4x. We maintain our Sector Perform rating. (We currently rate half of our Canadian bank universe as Sector Perform, half as Underperform).

• We like the bank's stock in 2009 but believe that it is too early to buy the bank's shares as we believe that exposures to U.S. lending will lead to continued increases in loan losses for the bank in the next few quarters, and exposures to capital markets-related issues remain an overhang in our view. Looking out to 2009, the bank should benefit from recent investments in its retail franchise, a strong funding base, an expanding global wealth management platform and capital markets profitability that has upside on a reported basis.
Scotia Capital, 29 August 2008

• Royal Bank (RY) Q3/08 cash operating earnings increased 5% year over year to $1.14 per share, versus our estimate of $1.12 per share and consensus of $1.06 per share.

• Reported earnings were $0.95 per share, which included $498 million ($263 million after-tax or $0.20 per share) in writedowns on trading and securities portfolio and $14 million ($9 million after-tax or $0.01 per share) in gains on the increase in fair value of held-for-trading liabilities as the result of credit spreads widening. Therefore, net writedowns were $484 million ($254 million after-tax or $0.19 per share), slightly higher than expected

• Operating ROE was 23.8% versus 24.9% a year earlier. Reported ROE was an impressive 19.6%.

• Earnings were driven by strong Canadian Banking earnings increasing 19% from a year earlier followed by 15% growth in RBC Capital Markets (excluding writedowns), 10% growth in Wealth Management with Insurance increasing 33% to $137 million. The operating performance in the U.S. was disappointing as earnings declined 63% to $37 million (excluding writedowns) from $101 million a year earlier due to higher loan loss provisions. U.S. retail represented only 3% of total earnings.

• Overall bank operating leverage was impressive at 10.4%, with revenues (excluding writedowns) increasing 13.7% and non-interest expenses adjusted for insurance and VIEs increasing a modest 3.3%.

Canadian Banking Earnings Increase 19%

• Beginning this quarter, RY is reporting Canadian Banking earnings excluding Insurance.

• Canadian Banking earnings were up 19% to $710 million from $597 million a year earlier due to strong volume growth partially offset by narrower spreads and higher loan loss provisions.

• Revenues in the Canadian Banking segment increased 5.4% with non-interest expenses declining 2.7%, resulting in positive operating leverage of 8.1%.

• Loan loss provisions (LLPs) increased 7% to $204 million from $190 million a year earlier reflecting portfolio growth.

Canadian Retail NIM Declines 5 bp

• Retail net interest margin (NIM) declined 5 basis points (bp) sequentially and 20 bp from a year earlier to 2.95% due partly to mix shift as the bank focuses more on secured lending.


• Insurance earnings were strong this quarter at $137 million versus $104 million in the previous quarter and $103 million a year earlier.

Wealth Management Earnings Increase 10%

• Wealth Management cash earnings increased 10% to $201 million from $183 million a year earlier.

• Revenue increased 1% with operating expenses increasing 1% with taxes and minority interest declining 10%.

• U.S. Wealth Management revenue declined 9% with Canadian Wealth Management increasing 4% and Global Asset Management revenue increasing 28%.

• Mutual fund revenue increased 8% from a year earlier to $414 million. Mutual Fund assets (IFIC) increased 10% from a year earlier to $108.6 billion including PH&N.

International Banking Earnings Decline

• The operating performance in the U.S. was disappointing as earnings declined 63% to $37 million from $101 million a year earlier due to higher loan loss provisions. LLPs increased sharply to $137 million from $17 million a year earlier and up from $91 million in the previous quarter relating primarily to U.S. residential builder finance.

• Revenue and expense growth were high at 21% and 25%, respectively due to the Alabama National and RBTT acquisitions. Operating leverage was negative 4%.

• Net interest margin improved 14 bp from a year earlier and 22 bp sequentially to 3.72%.

U.S. Banking Loan Portfolio

• RY provided additional disclosure on its loan portfolio in the U.S. The loan portfolio totals $23.1 billion with $15.8 billion in wholesale loans and the remaining $7.3 billion in retail loans. The U.S. residential builder finance loans total $2.0 billion representing 7% of the total U.S. loan portfolio. RY also has an additional $1.2 billion of exposure in a wholly-owned subsidiary set up to manage the wind up of loans in out of footprint states.

RBC Capital Markets Earnings Increased 15%

• RBC Capital Markets earnings increased 15% (excluding writedowns) to $415 million from $360 million a year earlier due to strong trading revenue.

Underlying Trading Revenue Very Strong

• Trading revenue was very strong at $717 million (excluding writedowns) versus $786 million in the previous quarter and $544 million a year earlier.

Capital Markets Revenue Solid

• Capital markets revenue was solid at $588 million versus $472 million in the previous quarter and $677 million a year earlier.

• Securities brokerage commissions declined 6% to $345 million from $368 million a year earlier, with underwriting and other advisory fees at $243 million, declining by 21%.

Security Gains Negligible

• Security gains were $5 million or nil per share versus a loss of $0.01 per share in the previous quarter and a gain of $0.02 per share a year earlier.

• Unrealized security surplus was a deficit of $546 million versus a deficit of $304 million in the previous quarter and a surplus of $89 million a year earlier.

Loan Loss Provisions Stable

• Specific loan loss provisions (LLPs) were stable at $334 million or 0.47% of loans from $178 million or 0.29% of loans a year earlier but were stable versus $349 million or 0.53% of loans in the previous quarter. LLPs in Canadian Banking increased 7% to $204 million from $190 million a year earlier but were down modestly from $224 million in the previous quarter. LLPs in International Banking increased sharply to $137 million from $17 million a year earlier and up from $91 million in the previous quarter relating U.S. residential builder finance.

• Our 2008 and 2009 LLP estimates are unchanged at $1,300 million or 0.47% of loans and $1,500 million or 0.54% of loans, respectively.

Loan Formations

• Gross impaired loan formations increased to $753 million versus $867 million in the previous quarter and $377 million a year earlier. Net impaired loan formations increased to $605 million, up from $737 million in the previous quarter and $274 million a year earlier, reflecting mainly higher impaired loans in the U.S. residential builder finance portfolio.

Tier 1 Ratio Solid at 9.5%

• Tier 1 capital (Basel II) was 9.5% versus 9.5% in the previous quarter.

• Risk-weighted assets increased 1.6% at $254.2 billion from a year earlier. Market-at-risk assets declined 7% to $17.6 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 10.4%, versus 9.5% in the previous quarter and versus 9.0% a year earlier.

Additional Disclosure on High-Risk Assets

• The bank provided additional disclosure on its exposure to U.S. subprime, Auction rate securities, Municipal GICs, CMBS, U.S. Insurance and Pension solutions, and U.S. subprime and Alt-A mortgages. The notional and fair value exposure to these areas as well as year-to-date writedowns are detailed in Exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.

RY Expanding - Taking Advantage of Market Fallout

• RY has taken advantage of the fallout in the U.S. by recruiting over 100 senior bankers from different U.S. and global institutions in order to build its own platforms. On June 24, 2008, RY hired two senior executives from Citigroup to add to its U.S. credit-trading platform. On July 5, 2008, RY hired five senior municipal bankers from UBS after UBS announced the closing of its municipal bond department. In addition, RY hired eight investment bankers from Bear Stearns, seven to work in its municipal finance healthcare group and Jim Wolfe, to lead its U.S. leveraged finance group. Lastly, on August 7, 2008, RY agreed to purchase ABN Amro's Canadian Commercial Leasing division, adding scale to the bank's existing platform and solidifying its leading position.


• Our 2008 and 2009 earnings estimates remain unchanged at $4.45 per share and $4.90 per share, respectively.

• We are trimming our 12-month share price target to $70 from $75 per share due to fatigue in equity markets and weaker economic outlook. Our new share price target represents 14.3x our 2009 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.
Financial Post, Jonathan Ratner, 28 August 2008

Royal Bank of Canada’s third quarter results beat expectations on strong revenues that were partially offset by higher expenses and a higher tax rate.

It’s $498-million writedown ($263-million after tax and compensation adjustments) was in the middle of most analyst expectations, according to Blackmont Capital’s Brad Smith. This was linked to MBIA hedges, CDOs and subprime securities.

Meanwhile, Royal’s earnings from personal and commercial banking rose 19% year-over-year, which is well ahead of its “more challenged peers,” Mr. Smith told clients.

“Overall, we believe Royal had a good quarter as it continues to position itself well in the face of weaker global competition,” he said, reiterating a “buy” recommendation and $55 price target on the stock.
Bloomberg, Doug Alexander, 28 August 2008

Talks between Royal Bank of Canada and U.S. regulators over the bank's role in the $330 billion market for failed auction-rate securities have been ``unproductive,'' the New York attorney general's office said.

``Hopefully we can avoid litigation, but that remains unclear right now,'' Alex Detrick, spokesman for Attorney General Andrew Cuomo, said today in an interview.

Royal Bank Chief Operating Officer Barbara Stymiest said today in an interview that there's ``ongoing discussions'' over the bank's role in selling the failed debt securities. The Toronto-based bank also said in an earnings report that it's currently in discussions with U.S. regulators.

Eight financial firms have settled claims in the last three weeks that they misled investors by fraudulently marketing the long-term securities as easy to buy and sell. Merrill Lynch & Co., Goldman Sachs Group Inc. and Deutsche Bank AG agreed last week to pay $160 million in fines and buy back as much as $15 billion in debt.

Buybacks "are the precedence for the other firms and we certainly have been communicating internally with our advisers that we're looking for ways to provide a liquidity facility to our investors," Stymiest said.

The Toronto-based bank said in its report that it couldn't estimate the impact of potential losses from such a program. Royal Bank also said other legal actions are pending, and that the liability from these proceedings won't be material.

"They'll take a hit for it, but they can withstand it," Dundee Securities Corp. analyst John Aiken said. "It's not going to be huge for Royal's standards, and from a shareholder value perspective, it'll likely be neutral to positive because you're eliminating an additional overhang."

Banks are settling claims stemming from an investigation into allegations they peddled auction-rate securities as investments that were as liquid as cash. The $330 billion market seized up in February, when the credit crisis prompted banks to stop supporting periodic auctions at which the long-term securities were bought and sold.

Royal Bank had C$3.5 billion ($3.3 billion) of auction-rate debt on its balance sheet as of July 31, down from about C$4.5 billion in January.

National Bank Q3 2008 Earnings

TD Securities, 29 August 2008


Yesterday, National reported core cash FD-EPS of C$1.52 vs TD at C$1.47 and consensus C$1.39.


National turned in a decent quarter in our view with some progress in P&C and help from Financial Markets. The operating trends are largely in line with what we view as our conservative expectations for 2009. The stock has been a top relative performer, but remains at an attractive relative valuation; Reiterate Buy.


P&C banking balancing act. Key to the story in our view is management's ability to successfully implement its various strategic initiatives to accelerate the P&C banking business. This will require balancing expense growth against fairly modest top-line trends. The last few quarters have been reasonably successful and management remains optimistic on Q4. However, we are holding what we view as a conservative outlook for 2009 on the view that expenses will expand and are awaiting clearer signs that revenue efforts are gaining traction.

Credit trends holding in well. The bank has benefited from its domestic/regional focus on the credit front and to date has enjoyed fairly steady trends. Management feels very good about its corporate book with almost no watch items, and the retail/commercial book is seeing very manageable deterioration. In a worsening credit cycle, we believe National stands to benefit from its potentially cleaner credit picture.

Maintain By rating. The stock has been the second best performing bank in the group over the last 12-months in a weak tape for financials. As a result, the relative valuation discount has closed materially (moving from - 2.4x to -1.6x on a fwd PE basis), but remains wide relative to its historical relationship (Exhibit 1).

P&C Banking. The results were decent in our view with NI +2% on the year. The quarter was lifted by positive operating leverage with expenses down approximately 3%. Management suggested additional investment in 2009, but will be closely monitoring expense levels relative to revenue growth. The segment also saw decent volume growth, with personal loans +7%, personal deposits +6%, commercial loans +6% and commercial deposits +10%.

Financial Markets. Q3 saw good results from Financial Markets with NI up 14%. Despite volatile markets, the quarter was driven by stronger trading revenues in fixed income and commodity/foreign exchange and mostly client driven equity trading revenues. NI growth was also helped by lower variable compensation costs.


We have updated our full year estimate to C$5.80 (up from C$5.72) to reflect the beat on the quarter. We have not changed our 2009 estimate of C$6.00.

Justification of Target Price

We believe National Bank deserves to trade at a discount to the group, reflecting slower growth in its core operating trends and its geographic concentration. We base our target price on 10.5x forward earnings, a discount to our outlook for the group.

Key Risks to Target Price

These include: 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

In our view, the key to this story is management’s ability to drive growth in their P&C banking platform. Q3 posted a decent round of results, with underlying business trends in line with our arguably conservative expectations for 2009. Reiterate Buy.

28 August 2008

CIBC Q3 2008 Earnings

RBC Capital Markets, 28 August 2008

CIBC's GAAP EPS of $0.11 were much better than our $(0.81) estimate, but core cash EPS of $1.65 was short of our estimate of $1.77.

• Writedowns of $885 million pre-tax on structured credit-related activities were less than our $1.5 billion estimate.

• The 9.8% Tier 1 capital ratio was in line with our estimate, as smaller than expected writedowns were offset by higher risk weighted assets to reflect credit risk in the bank's trading book.

• The 25% increase in provisions for credit losses versus Q3/07 was as expected.

• The shortfall in core earnings versus our estimate was from both retail and wholesale businesses.

We have revised our forward earnings estimates down to reflect the Q3/08 core EPS miss, lower expected profitability in CIBC World Markets to reflect lower risk appetite, and lower retail profitability. We lowered our core cash EPS estimates to $6.90 in 2008E and $7.15 in 2009E (down from $7.22 and $7.40, respectively). Our 12-month target price remains $62 per share. It is based on a P/BV multiple of 1.9x versus the 2.1x current multiple.

We maintain our Underperform rating

CIBC's stock is cheap relative to bank peers on a forward P/E basis (8.6x versus 10.0x) and we do not expect CIBC to need to raise capital or cut its dividend, but we do not believe that the stock will necessarily perform well against bank peers in the next 6 months.

• CIBC's exposures to structured finance assets and financial guarantors remain material, with little visibility on ultimate mark to market valuations. The exposure to financial guarantors, for example, remains $2.9 billion, in spite of over $800 million in incremental valuation adjustments taken during Q3/08.

• We expect retail banking growth to continue to lag the peer group, as was the case again in Q3/08. The 1% YoY revenue decline was worst of the banks that have reported so far, and net income was down 3%.

• Visibility on wholesale earnings is even cloudier than for peers given risk reduction initiatives, exposure to merchant banking assets (which likely need more buoyant equity markets to realize material gains) and U.S. commercial real estate finance, which would be facing a difficult revenue outlook.
Scotia Capital, 28 August 2008

• CM reported a decline in underlying cash operating earnings of 33% to $1.65 per share, below our estimate of $1.72 per share. Year-over-year comparisons were extremely difficult versus record earnings of $2.45 per share a year earlier. Earnings were weaker than expected at CIBC Retail Markets and CIBC World Markets due to weaker revenue.

What It Means

• Reported earnings were $0.13 per share, due to net charges totalling $1.52 per share. Total charges included $885 million ($596 million after-tax or $1.56 per share) on structured credit run-off activities, in line with expectations, and additional net gains of $14 million after-tax or $0.04 per share.

• CIBC Retail Markets earnings declined 7% from a year earlier on a comparative basis (excluding Visa gain) with CIBC World Markets declining 67% from a record quarter a year earlier.

• Revenue declined 13.8% with expenses declining 10.4% from a year earlier for negative operating leverage of 3.4%.

• Maintain a 2-Sector Perform rating on shares of CM as the P/E discount is offset by expected lower near term and longer term growth prospects.
Reuters, Lynne Olver, 28 August 2008

More charges lie ahead for Canadian Imperial Bank of Commerce even as it cuts exposure to risky U.S. securities and hedges that prompted multibillion-dollar writedowns in the past year, analysts say.

CIBC shares had rallied 5 percent on Wednesday after reporting less severe third-quarter charges than expected, and its stock gained a further 4.7 percent Thursday, closing at C$62.90 a share, after other Canadian banks reported strong quarterly profits.

CIBC, the No. 5 Canadian bank, posted a profit of C$71 million, the lowest among Canada's large banks.

It took a pre-tax hit of C$855 million on structured credit, mostly related to U.S. bond insurers, adding to a string of writedowns in previous quarters for the sliding value of sub-prime mortgage securities.

"We are reducing our estimates for the fourth quarter to include an assumption of another C$1 billion charge," BMO Capital Markets analyst Ian de Verteuil said in a research note on Thursday.

Mario Mendonca, analyst at Genuity Capital Markets, said he still sees downside risk in CIBC stock, if investors are pricing in belief that structured credit writedowns are over.

Settlements between U.S. bond insurers and their various counterparties "are likely to result in still further charges -- likely over C$1 billion," Mendonca said in a research note.

Gerry McCaughey, CIBC's president and chief executive, said on a conference call late Wednesday that recent settlements involving U.S. bond insurers -- also known as financial guarantors or monolines because they specialize in a single type of insurance -- were positive.

"Developments within the financial guarantor industry over the past few weeks have generally been encouraging and positive, with several corporations announcing results in terms of restructurings and/or tariffs," McCaughey said.

He also said rating agencies have generally been positive.

"We are actively managing our structured credit positions and continue to assess all opportunities to reduce contingent risk in this portfolio," McCaughey said.

In early August, CIBC and other institutions reached a deal with ACA Capital Holdings, parent of bond insurer ACA Financial Guaranty, to terminate contracts in exchange for cash.

ACA was the first bond insurer to run into trouble when its credit ratings were cut to junk status in December.

CIBC has contracts with other bond insurers as well.

"We expect further write-downs if credit markets remain under pressure ... but the bank remains well capitalized to handle further material hits," TD Securities analyst Jason Bilodeau said in a report.

Even if most of CIBC's writedowns are behind it, many analysts wonder where the bank's growth prospects will come from, particularly with Canadian economic growth slowing.

CIBC's per-share profit excluding its big charges fell short of market expectations for C$1.75.

The latest results "provided ample evidence of the continuing struggle facing management in their effort to manage down their legacy credit derivative exposures while defending their domestic retail market share," Blackmont Capital analyst Brad Smith said in a research note.
Financial Post, John Greenwood, 28 August 2008

Bay Street breathed a sigh of relief after Canadian Imperial Bank of Commerce yesterday reported lower-than-expected writedowns on money-losing credit investments, fuelling expectations that the storm in credit markets is finally abating.

Compared with its Canadian peers, CIBC has taken the worst pummelling from exposure to risky derivative debt securities, announcing nearly $7-billion in charges over the past nine months. Analysts had predicted the country's fourth-largest bank would follow suit with further charges of up to $2-billion. Instead, the number was a comparatively modest $885-million.

And after two consecutive quarterly losses, CIBC moved into the black. For the three-month period ended July 31, it had net income of $71-million or 11¢ a share, a drop of 91% from the same period last year.

The earnings were slightly below consensus estimates "but clearly people think it could have been much worse, and the consensus view is that things are improving for CIBC," said John Stephenson, a portfolio manager at First Asset Funds Inc., which has about $1.5-billion under management. Mr. Stephenson doesn't own any CIBC stock.

"I think, generally speaking, for the Canadian banks [problems from subprime-related investments] are pretty much passed," he said.

Shares in the bank had their best day in nearly five months, surging $3.04 to $60.10 and sparked buying in the other big Canadian banking stocks.

Still, some analysts warned it may be far too soon to declare that the credit crunch is waning.

According to Genuity Capital Markets analyst Mario Mendonca, CIBC still has a distance to go before it resolves its problems with so-called structured credit derivatives.

"I don't think everyone appreciates they are not done with their settlements," said Mr. Mendonca, who anticipates a further $1-billion in writedowns in the next few quarters.

On the retail side, CIBC had a profit of $572-million, down 4% from last year, mainly because of lower treasury revenue allocations and higher loan losses.

On the wholesale and corporate banking side, CIBC World Markets reported a loss of $538-million, including a loss of $596-million associated with structured credit investments.

"While the current environment continues to be challenging, CIBC's franchise is solid," Gerald Mc-Caughey, the chief executive, said in a statement. "CIBC's capital position is strong and our core businesses are well-positioned for better performance and growth."

On a conference call with analysts, bank executives said several times that despite the ongoing difficulties with structured credit products, the bank's tier 1 capital ratio remains strong at 9.8%.

Like many of its U. S. and European competitors, CIBC is paying the price for bets on risky credit products that it made during the credit bubble. The bank attempted to hedge that exposure by taking out insurance with bond insurers called monolines, but in the wake of the credit crunch many of those monolines are struggling and expected to fail, leading many to question their ability to fulfill their contracts.

"There's certainly a lot more room for writedowns," said one analyst, adding that the question hinges mostly on what happens to the U. S. housing market.

In recent months CIBC has been cutting back its credit-derivatives operations and selling off assets underlying its structured investment trusts.
The Globe and Mail, Tara Perkins, 27 August 2008

Canadian Imperial Bank of Commerce sparked a rally in its shares Wednesday by managing to eke out its first profit of the year, raising hopes the bank had finally put the bulk of its troubles with risky investments to bed.

The domestic bank most battered by the U.S. subprime mortgage crisis posted a $71-million third-quarter profit that missed analysts' expectations and were a 91-per-cent tumble from earnings of $835-million one year earlier. The results included an $885-million writedown on risky U.S. exposures.

But CIBC's stock popped because the writedown was less severe than many analysts had expected, increasing expectations CIBC is turning a corner and won't need to raise equity.

The stock closed up 5.33 per cent on the Toronto Stock Exchange, and traded as high as $61.19 during the day.

Gerald McCaughey, who stepped in as chief executive officer three years ago with a mandate to extract risk in the wake of CIBC's embarrassing Enron losses, said Wednesday that the quarter's results were hurt by the difficult environment and the bank's continuing efforts to exit risky areas in favour of concentrating on consumer banking.

“Our capital position is strong and prudent and will remain an area of focus during this period of uncertain market conditions,” he said, adding that the bank made progress in “getting back on track to deliver consistent and sustainable performance.”

CIBC has taken $6.8-billion in writedowns over the last three quarters.

Many analysts had been expecting a higher degree of pain for the bank this quarter. Dundee Securities Corp. analyst John Aiken upgraded his rating on CIBC's stock to “neutral” Wednesday, noting that he had expected a writedown of more than $1.5-billion.

Merrill Lynch analyst Sumit Malhotra said: “To the extent that this diminishes the probability of another equity raise, this will be seen as a positive.”

CIBC tapped the market for $2.9-billion earlier this year to shore up its balance sheet.

Only a tiny proportion of this quarter's writedown came from the obvious culprit, U.S. subprime mortgage exposure, the issue that's caused CIBC massive headaches in recent quarters and was expected to do so again this quarter.

Rather, more than 85 per cent of the $885-million hit came from collateralized loan obligations and corporate debt securities that are not directly tied to subprime, but are guaranteed by bond insurers.

That had a couple analysts fearing that some writedowns have been effectively delayed by market events but are still likely.

Near the close of the quarter, Security Capital Assurance Ltd. (SCA) – one of the bond insurers that guarantees a significant portion of CIBC's risky investments settled with another bank, Merrill Lynch in a deal that gave the bank about 20 cents on the dollar to cancel its contracts.

That gave bond insurers a lift by raising hopes they would be able to convince more banks to take steep discounts to settle their exposure.

CIBC is in discussions with some bond insurers, and when it strikes deals, “the subprime charges will be large, and we suspect that's next quarter,” Genuity Capital Markets analyst Mario Mendonca said.

Bond insurers still owe CIBC about $2.9-billion. The bank would only lose the full amount if all of the bond insurers it is exposed to fail and it receives nothing for its contracts.

Mr. McCaughey said developments with respect to bond insurers in recent weeks have generally been positive.
Financial Post, John Sturgeon, 27 August 2008

Canadian Imperial Bank of Commerce reported its first profit in three quarters on Wednesday, but still took a massive charge from the bank's exposure to securities tied to the reeling U.S. subprime residential mortgage market.

CIBC said earnings fell 91% year-over-year to $71-million (11 cents a share), compared with $835-million ($2.31) in the same period of 2007.

Profit was squeezed by an $885-million before-tax loss from its structured credit business. "Problems originating in the U.S. subprime mortgage market last year continued to impact the conditions for credit and liquidity globally," the bank said.

But the pre-tax loss was much lower than expected, according to Dundee Capital Markets analyst John Aiken, who had called for writedowns to range between $1.5-billion and $1.9-billion.

The news lifted CIBC shares almost 5%, or $2.74 to $59.80 in early trading on the Toronto Stock Exchange on Wednesday.

"This should relieve much of the near-term concerns regarding its balance sheet and shift valuation more towards its earnings outlook," said Mr. Aikens in a morning note to clients. He raised his rating on CIBC shares from 'sell' to 'neutral.'

Mr. Aikens added a caution, however: "We have not waded all the way through [CIBC's] various counterparty and structured credit related disclosures yet, but note that the bank does remain exposed to additional potential writedowns."

Excluding the structured credit charge and other one-time items, diluted earnings came in at $1.63 per share, still below Dundee's estimate of $1.72. The consensus view among analysts was slightly higher, at $1.74 earnings per share.

"Our results this quarter were affected by the volatile, and generally difficult, environment that persisted over much of the third quarter, as well as by the impact of our ongoing run-off activities and the refocusing of our core businesses, particularly in CIBC World Markets," said Gerald McCaughey, CIBC's chief executive.

CIBC is by far the worst afflicted among Canada's big banks by the collapse of the U.S. subprime mortgage business in the past year, taking a total of $7.58-billion in writedowns related to the bank's exposure in the market. The bank took $2.48-billion in writedowns in the last quarter.

A $1.75-billion lawsuit filed by Canadian shareholders in late July asserts that the bank invested as much as $11-billion in hedged and unhedged investments in the market.

CIBC World Markets reported a net loss of $538-million tied to structured investments, the bank said.

On the plus side, CIBC said it further reduced notional exposure to deteriorating financial guarantors and bond insurers by about $3-billion "through a combination of the termination and amortization of credit derivative contracts."

Still, market and economic conditions relating to the financial guarantors may change in the future, "which could result in significant future losses," the bank said.

In a move to further de-leverage itself of U.S. exposure, CIBC has sold most of its American investment banking and trading businesses to Oppenheimer Inc. over the three quarters, it said, prompting an $80-million charge. Further asset sales located in the U.K. and Asia to Oppenheimer will close in the fourth quarter, CIBC said.

Difficult market conditions also hurt the bank's retail business, historically its strongest component. CIBC Retail Markets reported net income of $572-million, down 4% from a year ago. Retail loan losses totalling $196-million were partly to blame, CIBC said.

"Overall, CIBC's retail business remains well positioned. CIBC achieved strong volume growth and has maintained market share ... though CIBC is taking a measured approach to credit given the current environment," the bank said.

Scotiabank Sets-up Fund Manager with Chinese Bank

Financial Post, Duncan Mavin, 28 August 2008

Bank of Nova Scotia is joining forces with a Chinese bank to launch a new fund manager, marking the Canadian bank's first foray into China's burgeoning wealth-management industry.

Scotiabank was named yesterday by Bank of Beijing as its partner in a planned joint venture in documents filed to the Shanghai Stock Exchange.

The Canadian bank has agreed to take a 33% stake, valued at about US$15-million, in a China-based joint venture that, pending regulatory approval, will be called Bank of Beijing Scotiabank Asset Management Co. Ltd. The firm will design and market a wide variety of mutual funds to retail and institutional customers through the Bank of Beijing's growing national branch network.

"This is an exciting opportunity for Scotiabank to grow our operations in China by partnering with one of China's leading banks," Rob Pitfield, executive vice-president, international banking, said in a statement.

China's fund-management industry is forecast to expand at an annual rate of 25% over the next few years, reaching US$1.4-trillion of assets under management by 2016, according to consultants McKinsey & Co.

Some local fund managers have been battered by steeply declining stock prices of late -- the Shanghai composite index has lost almost two-thirds of its value since peaking last October. That makes Scotiabank's timing pertinent, said Peter Alexander, head of Shanghai-based fund management consultancy Z-Ben Advisors.

"In China, when the timing looks a bit trying, that's the best time to get in," Mr. Alexander said. The Chinese fund-management industry will suffer fluctuating fortunes as it develops but in the long term China's demographics and rising wealth will support significant growth, he added.

Sino-foreign fund-management joint ventures were first authorized by China's regulators six years ago. They now account for half of the China's 60 fund-management firms, and include Fullgoal Fund Management Co. Ltd,, in which Scotiabank's domestic rival Bank of Montreal is a minority partner.

Almost all of the sino-foreign joint ventures are successful, said Mr. Alexander, even though they usually run into problems at some stage either because the shareholders fall out or because of operational difficulties. "It's the nature of the joint-venture beast," Mr. Alexander added.

Scotiabank, which has made no secret of its attempts to beef up its Canadian wealth-management capabilities, already has a small stake in China's financial-services industry, including an investment in a bank in Xi'an, in western China. The Canadian bank has also been trying for several years to negotiate a position in the Bank of Dalian in northeast China; so far Scotiabank has succeeded in signing a "strategic cooperation memorandum" with the Bank of Dalian, outlining the Canadian bank's intention to "explore a strategic partnership by way of a minority investment."

The bank's fund-management joint venture with Bank of Beijing could also face some challenging regulatory hurdles. It is too early to tell when the fund manager will be operational and when the first fund may be launched, said a source close to the negotiations between the two banks. The joint venture has yet to be given approval by regulators, the source added. Chinese rules do not explicitly permit banks from setting up fund-management joint ventures, though a handful of banks have been given special dispensation to do so.

Bank of Beijing is a city commercial bank -- one of the 114 smaller city-based banks in China's multi-layered banking industry -- operating mostly in the Chinese capital, as well as nearby Tianjin and also Shanghai. The bank, in which Dutch financial services giant ING Groep N. V. has a 16% stake, has total assets of about 363-billion yuan (US$53-billion) and is China's biggest city bank in terms of assets. Yan Zhubing, the chairman, said this week Bank of Beijing is planning to expand its branch network nationwide, according to Xinhua news.

Sources said executives of the Chinese bank have been casting around the idea of a fund-management joint venture for the past year.

In its statement to the Shanghai Stock Exchange, it said the bank's directors resolved to establish a fund-management company with registered capital of 300-million yuan (US$44-million). In addition to Scotiabank, there may be another as-yet-unnamed third partner in the joint venture, the Bank of Beijing's statement indicated.

By the Numbers:
• China's asset-management market
• 138 million investor accounts.
• $380-billion in assets under management.
• 230% compound annual growth rate over the past three years ending Dec. 31, 2007.
• 8.2 million Bank of Beijing customers hold co-branded mutual-fund products.
Source: Bank of Nova Scotia

27 August 2008

Scotiabank Q3 2008 Earnings


BMO Capital Markets, 27 August 2008

Scotiabank reported third-quarter cash earnings of $987 million, or $0.99 per share, compared to $966 million, or $0.97 per share, last quarter and $1.0 billion, or $1.03 per share, in the same quarter of last year. This was another clean quarter for Scotiabank. The bank earned over 20% ROE, side-stepped problems in structured credit markets and showed superior credit management skills. We are confident that it will outperform its peers over the course of this cycle.

One thing that does concern us is Scotiabank’s apparent lack of patience in building its domestic Wealth Management business. Over the past year, the bank has done two deals that in hindsight may indicate a degree of desperation: the decision to buy 20% of Dundee Wealth and the purchase of E*Trade Canada. The former resulted in an awkward period of uncertainty regarding a possible bid for Dundee overall, and the latter set the new high watermark on pricing of discount brokerage deals. Given management comments on the conference call, they appear to be prepared to give up control (or a clear path to control) of their mutual fund business for a non-controlling stake in a larger entity. We are not sure that short-term gain is sufficient pay-off for longer term complexity and cross ownership.

Domestic Banking earnings, which include wealth management, were $469 million, up a solid 10% from last quarter and 17% from the same quarter of last year. Year over year loan growth was a very strong 14%. Spreads remained stable versus the previous quarter. On the wealth side, fee revenues were strong and were only partially offset by the slowdown in new issuance and trading activity.

International Banking reported earnings of $337 million, flat with last quarter but up 22% over the same quarter of last year. This quarter’s results included a $40 million (pre-tax) gain on the IPO of the Mexican Stock Exchange, which was largely offset by a contingency liability and securities and trading losses in Latin America. Strong loan and deposit growth and higher contributions from recent acquisitions in South America account for the year-over-year growth.

Scotia Capital had a very strong quarter. Earnings of $298 million were up 16% from last quarter and 6% over the same quarter of last year due to a more attractive corporate lending environment and strong advisory and trading results. Trading revenues of $247 million were slightly above expectations due to strong derivative and fixed income activity. The segment posted a $4 million provision for credit losses this quarter. We expect earnings to trend lower into 2009. The Other segment reported a loss of $85 million, caused as much by transfer pricing as the widening spreads on bank funding. We assume that the loss will be more modest in 2009 as funding costs improve.

On the credit front, loan losses of $159 million came in lower than our expectations. Impaired loan formations continued to track up this quarter to $377 million. Net impaired loans (after general allowance) continued to decline but remained well in negative territory. Management indicated it expects provisions to move moderately higher in the medium term. We are assuming provisions of $1 billion next year.

Management provided further information about its GMAC auto lending program. Of the $7.1 billion exposure, 97% are auto loans and the remaining balance is leases. Credit enhancement is based on a discounted purchase price and is reset based on recent performance for each new pool purchased. Given the structure of the deal, management remains comfortable with this transaction.

Scotia’s capital position remained sound again this quarter. The bank’s Tier 1 ratio was 9.8%, up 20 bps from the second quarter as good internal capital generation and the issuance of $350 million of preferred shares more than offset growth in RWAs. Scotia was the only bank to participate in its share buyback program this quarter, indicating the confidence management has toward its balance sheet. Payout ratio is modest and the bank has the capacity to raise its dividend.

Projections and Valuation

We are leaving our 2008 and 2009 EPS estimates unchanged. Despite material headwinds, the bank has largely earned though the credit turmoil without significant “unusual” items. Scotiabank has a superior balance sheet and growth strategy, however the credit environment is deteriorating. We believe the next wave of problems will likely come from increased signs of pressure on Canadian loan books. Scotia is at least as well prepared as its peers to deal with this. We are maintaining our Outperform rating, and our target price of $52.50, which uses a 12.5x multiple on our forecast for 2009.
RBC Capital Markets, 27 August 2008

Scotiabank's core cash EPS of $0.99 were short of our estimate of $1.04 and consensus of $1.03.

• Net income in the Canadian and wholesale businesses was ahead of our expectations, which was offset by lower than expected income in the international and "Other" segments. Loan losses of $159 million were in line with our expectations and the prior quarter, but up 73% versus Q3/07. Capital remains strong, with the Tier 1 ratio at 9.8%.

We have lowered our 2008 EPS estimates from $4.15 to $4.00 and our 2009E EPS from $4.25 to $4.15. Our 12-month target price per share remains $49.

We maintain our Sector Perform rating on Scotiabank shares. (We currently rate half our Canadian bank universe as Sector Perform and half as Underperform).

• Near term, we believe that Scotiabank's share price should benefit relative to peers from (1) stronger asset growth in domestic banking, international banking and corporate lending; (2) less exposure to U.S. lending than some of its peers (the area most impacted by deteriorating credit for now); (3) less exposure to structured finance and off balance-sheet conduits than most; and (4) greater exposure to a Canadian dollar that has weakened against the U.S. dollar.

• We believe that BNS will maintain its industry high valuation (forward P/E of 11.2x versus 8.9x for Canadian peers, P/B of 2.4x versus 1.8x) as long as credit problems remain centered on U.S. exposures and visibility on structured finance exposures/off balance sheet vehicles remains clouded.

• We believe that BNS' relative valuation will be more at risk in 2009 as concerns spread from the above-mentioned issues to the impact of a slowdown in economies on loan growth and credit losses.

• Our 12-month target price of $49 is based on a P/BV multiple of 2.25x, and it implies a P/E on NTM EPS of 11.7x.
TD Securities, 27 August 2008


Yesterday, Scotia reported Q3/08 core cash FD-EPS of C$1.01 vs TD Newcrest at C$1.05 and consensus at C$1.03.


Reiterate BUY. EPS came in a few pennies shy of expectations on the back of some heavier expenses along with some funding pressures in Corporate. However, again we note several encouraging trends 1) Domestic P&C/Wealth continues to make solid progress 2) Credit is trending as expected and Scotia remains well reserved and 3) International remains on track despite headwinds. All told, Scotia is weathering the current environment well, and holds one of the best medium-term operating outlooks in the group in our view.


Credit worries manageable. Concerns have been building around potential credit risks in Scotia's corporate loan book, International segment and exposure to the auto sector. Management again expressed confidence in its management of credit risk, including these specific exposures, and we note that many of the bank's coverage ratios remain comfortably ahead of their peers. We do expect rising credit costs (reflected in our estimates), but the trends appear well managed at this point.

International prospects on track. International delivered 18% bottomline growth despite higher credit costs, higher operating spend and currency impacts. With strong volume growth, ongoing integration benefits and future acquisition prospects this segment continues to display strong potential to deliver superior medium-term growth in our view even with the headwinds of today's more challenging environment.

Domestic delivering. One of the most encouraging developments for Scotia over the past year in our view has been the acceleration of its Domestic business helped by concentrated efforts and some smart acquisitions. As a result, Scotia is evolving from a notable laggard, to posting some of the strongest operating trends in the group we expect to see this quarter.

Solid story deserving of premium. No bank is without issue in this environment, and Scotia is no exception. However, the bank is faring better than most and is exceptionally well positioned to capitalize on the eventual recovery with good operating momentum, strong capital position and competent management. We expect the stock to continue to trade at a premium valuation.

Q3/08 Conference Highlights

Credit exposure. A key focus on the call, management stressed that it is very comfortable in its overall credit exposure. Specifically it reiterated that its auto loan exposure is diversified and manageable. The GMAC program is performing inline with expectations and is well structured with credit enhancements to Scotia's benefit. Management expects moderate PCL growth over the coming year.

Mutual Fund deal. In our view, management clearly left the door open to a range of possible deal structures around its Mutual Fund business. Management remains focused on getting scale and growing the earnings contribution.

U.S. banking market. Conversely, in our view, management significantly downplayed any interest they would have in acquiring a U.S. P&C banking platform.

Domestic competition. The mortgage market is becoming very competitive, but Scotia is still gaining share. Deposits also remain hotly contested and Scotia has been able to gain market share (helped by Dundee Bank acquisition), but has not been 'buying' deposits with aggressive rates. Q3/08 Segment Highlights

Domestic. Another encouraging quarter in our view. Good volume growth in key products (mortgages +15%) and continued deposit growth (+13%). NIM improved +3bp quarter over quarter. Overall, revenue growth of 9% and NI growth of 17% should compare favorably with the best in the industry this quarter.

International. International continues to manage well despite some challenges. The group reported 25% revenue growth and 18% NI growth including the negative impact of FX (C$17M) and 20% NIX growth, reflecting recent acquisitions and strong organic growth. Credit costs are also on the rise reflecting largely portfolio growth and mix.

Capital Markets. The quarter was soft as expected with just 1% revenue growth, but good cost control (NIX - 5%) helped to deliver NI +6%.

Corporate. Typically volatile, corporate was a key source of the lower EPS on the quarter. The segment reported a NI loss of C$79 million compared to a gain of C$81 million in Q2/07. Higher liquidity, funding costs (run through Treasury) and hedging costs weighed materially on NII, while lower gains in non-trading securities hit Other Income. Ex corporate, NI was up 12%.


We updated our 2008 estimate to reflect Q3/08 actual results and no change has been made to our 2009 estimate. We continue to see encouraging trends in Domestic, while International continues to progress as expected and credit costs remained in line.

Justification of Target Price

We expect Scotiabank to hold its premium valuation relative to the Big-Five Canadian banks, reflecting superior growth prospects, strong return on equity and healthy excess capital. We base our target price on 12.50x forward earnings, a premium to our outlook for the group.

Key Risks to Target Price

These include: 1) the continued weakening of the U.S. dollar, 2) country and political risk in its international markets such as Mexico, 3) integration challenges associated with its recent and future acquisitions and 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

Scotia’s Q3 results provided some encouraging core operating trends and good volume growth. We continue to view the bank as having one of the best medium term operating outlooks and reiterate Buy.
Financial Post, John Greenwood, 27 August 2008

Given the ongoing economic turmoil and rising level of regulation, the United States is no place for a Canadian bank to be making acquisitions, Rick Waugh, Bank of Nova Scotia chief executive, said yesterday.

Speaking on a conference call with analysts, Mr. Waugh said that despite the collapse in share prices across the financial sector, banks there still face "a lot of issues" that could end up hurting potential buyers.

"We are aware of the significant change in valuations that we have seen over the past year," he said, adding that prices are still high.

"And the regulatory environment is getting worse rather than better. The U. S. has been through a major upheaval," he said.

In the wake of the collapse of former giants such as Bear Stearns Cos. Inc., regulators have launched a string of lawsuits, forcing players to pay out billions of dollars in fines and settlements.

"The legal system down there is reacting in many ways, creating problems for participants," Mr. Waugh said.

The bottom line for Mr. Waugh is that the United States is a hostile place for doing business and things will likely get worse. The bank, which has significant operations in the Caribbean, Mexico and Latin America, says it will continue to look elsewhere for acquisitions.

Contrast that with the view expressed by Bill Downe, Bank of Montreal chief executive, in a similar conference call. BMO yesterday surprised the Street with higher-than-expected loss provisions and a steep decline in third-quarter earnings, largely due to its substantial U. S. operations.

Analysts were particularly concerned by the bank's exposure to off-balance sheet investments that hold large amounts of credit derivatives linked to sinking U. S. real-estate loans such as the BMO-sponsored Parklands structured investment vehicle. But Mr. Downe dismissed such concerns.

"It is good news that U. S. housing starts are at the low level they are, [because] at some point people are going to come out of rental housing and move back into purchased housing," Mr. Downe said.

The major hurdle in the way of a recovery is the situation at mortgage giants Freddie Macand Fannie Mae, but they will be restructured, Mr. Downe predicted, and when that happens, "I think the U. S. housing market will become a much more orderly place."

Mr. Downe and Mr. Waugh may disagree about the state of the U. S. economy and the market for Canadian banks looking to expand there, but the fact that the rift is so big is illustrative of a general shift in perception in corporate Canada.

For years the United States was regarded as the place to be for business, especially banks, and only lofty valuations would keep them from expanding into world's most lucrative market.
Financial Post, John Greenwood, 27 August 2008

While still quite strong, Bank of Nova Scotia reported a drop in profit for the third quarter in the face of higher credit provisions and languishing capital markets.

For the three months ended July 31, Scotia posted net earnings of $1.01-billion, or 98¢ a share, down 2% from last year.

"It looks like a good quarter," said Mario Mendonca, an analyst with Genuity Capital Markets. "It was pretty much in line with what we were expecting."

The numbers came in slightly below analysts' consensus estimate of $1.02 a share.

In the context of the bloodletting going on in the sector globally, Scotia's performance is regarded by many analysts as proof that prudence and strong management can enable a bank to avoid the credit turmoil that has claimed so many victims in the United States and Europe.

"Scotiabank's strategy of diversifying across business lines and geographies has enabled the bank to continue to perform well during a challenging period for the global financial services industry," said chief executive Rick Waugh.

One of the few ominous notes in the results was a warning by Mr. Waugh that the bank is "unlikely" to hit its earnings targets set at the end of last year. While Scotiabank's main businesses continued to make strides in the quarter, slow global growth is expected to weigh down future results, he said.

Nevertheless, Mr. Waugh stressed that the bank remains on the lookout for acquisitions, noting that its recent US$442-million purchase of E-Trade Canada will double Scotiabank's footprint in the online investing market.

The bank is also rumoured to be mulling over the potential acquisition of a large equity stake in fund manager CI Investments Inc.

Total revenue grew by 5% during the quarter over the period, while assets swelled by $54-billion, or 13%, thanks to healthy performance in domestic and international banking operations along with investment banking.

Despite signs of a slowing Canadian economy, Scotiabank's domestic banking revenue grew by 9% in the quarter, helped by increased mortgage activity and rising consumer deposits.

"Scotia Capital had a strong quarter, benefiting from its diversified portfolio of businesses," Mr Waugh said in a statement.
Dow Jones Newswires, Monica Gutschi, 26 August 2008

Bank of Nova Scotia was expected to do reasonably well in the third quarter, and delivered.

Buffered by its international operations, the Toronto-based bank escaped any fallout from the U.S. subprime crisis. In contrast to Bank of Montreal, which also reported its third-quarter earnings Tuesday, its credit provisions rose by a less significant amount. And it missed analyst forecasts by only a few pennies.

Bank of Nova Scotia earned C$1.01 billion or 98 Canadian cents a share in the latest quarter versus C$1.03 billion or C$1.02 a year earlier. On a cash basis, earnings came in at 99 Canadian cents a share.

Bank analysts expected third-quarter cash earnings of C$1.03 a share.

"Things being what they are, holding your own is pretty good, I think," said David Baskin, principal at Baskin Financial Services, who counts Scotiabank as his favorite among Canadian banks.

Still, the bank's shares are being battered in afternoon trading in Toronto. Bank of Nova Scotia is down C$1.18 or 2.5% to C$46.45.

By contrast, Bank of Montreal is off 40 Canadian shares or 0.9% to C$43.66. And Canadian Imperial Bank of Commerce, which is widely expected to announce another huge writedown on its U.S. structured credit portfolio, is down only 36 Canadian cents or 0.6% to C$57.55.

Baskin said it was a "mystery" to him why the shares were under pressure, although he noted Scotiabank's stock has not fallen as far this year as many of the others.

John Aiken of Dundee Securities said the earnings were a "very positive comparison" to BMO, with manageable credit losses. Scotiabank's loan-loss provisions for the third quarter were C$159 million, above the C$92 million reported a year earlier and in line with analyst estimates. Bank of Montreal's provision for credit losses soared to C$484 million in the latest quarter from C$91 million a year earlier. Analysts had only expected an increase to C$195 million.

But Brad Smith at Blackmont Capital noted Scotiabank's loan portfolio had deteriorated over the quarter, while provisioning rose only slightly. That could imply, he said, that Scotiabank may fall behind in credit-loss provisions and have to make up for it later.

As well, he said, Scotiabank's earnings include a 3-Canadian cent gain from the initial public offering of Mexican Stock Exchange shares. Excluding that gain, he said, puts the bank 7 Canadian cents short of forecasts.

Blackmont has no investment-banking conflicts with Scotiabank nor does the analyst own the bank's shares. Dundee has an investment-banking relationship with Scotiabank and the analyst or a member of his household owns its shares.

There was more mixed news in Scotia's results. Return on equity, a measure of profitability, was 21.0%, down only marginally from 21.7% a year earlier.

Expenses rose 8% in the quarter, mainly on acquisitions and a big marketing push. Net income from its key international division rose 19% from a year earlier, but fell 2% from the second quarter, foreshadowing slower growth ahead.

"The bloom seems to be coming off the rose in the emerging marketplace," said Ian Nakamoto, market strategist at Macdougall, Macdougall and MacTier. He noted the recent strengthening in the U.S. dollar may indicate concerns that "cracks" are beginning to show in other regions of the world.

Analysts expected the Canadian banks as a group to report lower quarterly earnings, with UBS Securities predicting a 9% overall decline year-over-year, as they contend with the ongoing fallout from the credit crunch, weak capital markets and a slowing economy.

Bank of Montreal kicked off the third-quarter earnings season for the big six Canadian banks earlier Tuesday, posting a 20% drop in earnings on sharply higher credit provisions and another charge for valuation adjustments in its capital-markets division.

Analysts have said that Canadian banks' domestic retail business is increasingly important due to declines in capital-markets businesses and rising risk in U.S. platforms.

Nonetheless, Scotia Capital, Bank of Nova Scotia's capital-markets business, had a strong quarter, the bank said, benefiting from record revenue in Scotia Waterous and fixed income, continued strong contributions from ScotiaMocatta and foreign exchange operations and an increased contribution from its lending businesses.

The domestic-banking business, which includes wealth management, reported a record quarter, with mortgage growth recorded in all sales channels and a 12% increase in personal deposits.

Grupo Scotiabank, the bank's Mexican arm, contributed about C$104 million to earnings, including a C$40 million gain recognized in relation to the IPO of the Mexican Stock Exchange.

The second half of 2008 is showing improvement compared to the first two quarters of the fiscal year, the bank said, with continued asset growth in all three business lines and a rebound in capital markets activity. Nonetheless, the bank reiterated that it isn't likely to meet its fiscal 2008 earnings growth target set at the end of the last year.
Dow Jones Newswires, Ben Dummett, 26 August 2008

Bank of Nova Scotia declined Tuesday to comment specifically on rumors it's in talks to sell its mutual fund business to CI Financial Income Fund in exchange for a significant equity holding in the big Toronto mutual fund company.

However, bank officials didn't rule out this type of transaction as a possible way of growing its relatively small mutual fund arm.

"One formula doesn't fit all," Rick Waugh, Bank of Nova Scotia's president and chief executive, said during the bank's fiscal third-quarter earnings conference call. Waugh made the comment in response to questions about the bank's strategy to grow its wealth management business.

Behind the question is market speculation that Bank of Nova Scotia is in talks to sell its mutual fund business to CI, a much bigger mutual fund operator, in exchange for a significant equity stake in CI. Late last week, CI confirmed it has held talks with a number of undisclosed parties about possible strategic combinations, but said there was no certainty a deal would be completed.

Bank of Nova Scotia has declined to comment on the rumors.

On the conference call Tuesday, Bank of Nova Scotia's Waugh reiterated the bank's strategy of growing its wealth management business. While the bank is pleased with the division's organic growth rate, Waugh also said the bank doesn't necessarily need to own 100% of the business to achieve this goal. It would consider owning a minority stake as long as the resulting transaction contributed to the bank's long-term strategic goal and made financial sense.

Waugh noted his firm initially expanded its banking operations in Mexico, Peru and Chile by taking minority stakes in the countries' local banks and then over time increasing these holdings to control positions.

If it sold its mutual fund business to CI under the rumored transaction, Bank of Nova Scotia would gain a meaningful equity stake in a larger mutual fund business that would further benefit by allowing CI to tap Bank of Nova Scotia's distibution network to grow sales.

Mutual fund companies seek scale in order to expand their sources of fee income while cutting costs.

In turn, Bank of Nova Scotia would be in a better position to acquire CI if and when it came for sale. The bank is already in a good position to acquire money-management firm DundeeWealth Inc. if its controlling shareholder, the Goodman family, ever puts the business up for sale, because of its existing 18% stake.

Still, Bank of Nova Scotia could face a bidding war for CI if CI's existing major shareholder Sun Life Financial Inc. has a similar plan.

Some observers suggest this prospect, in addition to the bank giving up the immediate control and brandname of its mutual fund business, are reasons why a deal with CI is unlikely.

However, others argue the bank doesn't have much of choice under current circumstances. The number of independent mutual operators in Canada is dwindling, and those with any significant size such as AGF Management Ltd. have controlling shareholders that don't want to sell.

Still, many industry watchers believe the consolidation trend of Canada's mutual fund sector will continue because of the importance of scale. By holding minority positions in mutual fund companies now, Bank of Nova Scotia could gain an edge over rival bidders when particular assets come up for sale. In the meantime, the bank potentially lowers its ultimate transaction costs for any deals, if the value of potential targets rise as they become increasingly scarce.
The Globe and Mail, Tara Perkins, 22 August 2008s

CI Financial Inc. says it has been talking with a number of financial institutions about various strategic possibilities.

“Over the last several months, we have had discussions with a number of financial institutions about a number of combinations including CI and its subsidiaries,” chief executive Bill Holland said in an interview Friday as the company put out a similar statement.

There is no formal strategic process in the works, he said, adding “we're always talking to everybody. We have knocked on every single door in Canada. There's never been a door we haven't knocked on.”

Sources said Bank of Nova Scotia is among the companies CI has informally talked to, as a report said that CI was in talks to buy Scotiabank's mutual fund division in exchange for giving the bank an equity stake in CI.

CI said it would not comment further on speculation. Scotiabank spokesperson Frank Switzer declined to comment on the report.

Mr. Holland said that, over the last several months, the mutual fund giant has held discussions with several financial institutions about various different forms of combinations that might make sense. That is “very consistent with what we always do,” he added.

“Over the last eight years or something we've done 10 acquisitions, and for every acquisition [that] we do, we kind of lose five of them.”

Mr. Holland said there's no assurance that any of the informal talks that CI is holding with industry players will lead to a deal, but “we really believe it's important to take advantage of the scale that this business offers, and in a business that's dominated by a few big players you want to be big and bring down your costs.

“We believe that this is a bulge bracket game,” he said, and bulk will be key to success over the next decade.

CI's largest shareholder is Toronto-based insurer Sun Life Financial. A spokesman for the insurer, Michel Leduc, also declined comment on any talks. He did say “I can confirm that Sun Life is very committed to its strategic position in terms of its stake in CI.”

Sun Life holds roughly a 37 per cent stake in CI. One source familiar with the situation said the insurer would be actively involved in any major strategic process involving the fund company. Significant transactions often require approval from two-third's of a company's shareholders.

In a note to clients Friday, BMO Capital Markets analyst Ian de Verteuil said he believes the odds of Scotiabank selling its mutual fund operation in exchange for an equity stake in CI “are very low.”

“CI would certainly benefit from owning and managing Scotia's mutual fund business [which has about $19 billion in assets under management],” he wrote. “Improved access to a bank's distribution network would be desirable for any mutual fund company.”

But the potential deal would be far less attractive for Sun Life and Scotiabank, Mr. de Verteuil added. “Both are well capitalized, want to be bigger in wealth management and generally want to control their core businesses,” he wrote.

“Simply put, Canada's larger financial institutions typically don't share their ‘toys' well with others,” he wrote.

Last fall, CI attempted a run at DundeeWealth Inc., which sold an 18 per cent stake to Scotiabank, which has put a major emphasis on beefing up its wealth management capabilities. This summer, it announced a $444-million takeover of E*Trade Canada.

CI Financial Income Fund is the third largest investment fund company in Canada, and had fee-earning assets of $102.2-billion at June 30, down 5 per cent from $108-billion a year earlier.

BMO Q3 2008 Earnings

RBC Capital Markets, 27 August 2008

Bank of Montreal's GAAP EPS of $0.98 were well below our $1.20 estimate on much higher than expected loan losses.

• Offsetting the higher loan losses were better than expected revenues in Canadian retail banking and the wholesale division.

• The Tier 1 of 9.9% was up from 9.4% in Q2/08, which is a strong capital position in our view.

Lowered EPS estimates; Maintain Underperform rating

We do not expect loan losses to be this high in Q4/08 and in 2009 but have nonetheless lowered our core cash EPS estimates to $4.70 in 2008E and $5.15 in 2009E (from $4.90 and $5.20, respectively) to reflect the Q3/08 shortfall versus our estimates and model tweaking.

Our 12-month target price of $44 is unchanged. It is based on a P/BV multiple of 1.35x, versus the current 1.5x multiple, and it implies a NTM P/E of 8.6x, whereas the stock currently trades at a NTM P/E of 8.8x.

We maintain our Underperform rating on Bank of Montreal's shares. We believe that BMO's share price is likely to lag its peers' given:

• Our outlook for greater deterioration in credit quality near term, based on the bank's U.S. exposures (although we do expect Q4/08 provisions for credit losses to be lower than in Q3/08);

• Domestic retail banking results that are likely to continue lagging those of the leading banks on a combination of revenue and bottom-line growth (Q3/08 revenue YoY growth was 3% and core earnings were flat);

• Greater concerns over the sustainability of wholesale earnings than most peers as the bank will likely reassess risk appetite; and

• Continued overhang from off-balance sheet exposures (Links, Parkland, Apex, Fairway).
Scotia Capital, 27 August 2008

• BMO cash operating earnings were $1.06 per share versus $1.49 per share a year earlier. Operating earnings were well below our estimate of $1.23 per share and consensus of $1.21 per share due to a $247 million or $0.33 per share credit charge related to two real estate loans purchased from Fairway (BMO sponsored U.S. ABCP conduit) in Q2/08.

What It Means

• Underlying earnings adjusted for U.S. ABCP related LLPs, unusual items and higher trading revenue were strong in the $1.30 per share range. Earnings declined 29% YOY and even on an underlying earnings basis earnings were down 13% YOY. Operating leverage was a negative 1.2%.

• Private Client Group earnings increased 8% with P&C U.S. earnings improving 9% and P&C Canada earnings declining 4% year over year. BMO Capital Markets declined 7% excluding net charges.

• Operating ROE was 14.9% with underlying operating ROE of 17.8%.

• We maintain our 3-Sector Underperform rating on BMO based on lower earnings growth outlook, lower profitability, higher off balance sheet risk, higher dependence on wholesale (36%) and relatively weak operating platforms.
Dow Jones Newswires, Monica Gutschi, 26 August 2008

Bank of Montreal's third-quarter earnings sank by more than 20% in the third quarter, as the lender sharply raised its credit provisions and posted yet another charge for valuation adjustments in its capital-markets division.

The Toronto-based Canadian chartered bank reported third-quarter net income of C$521 million or 98 Canadian cents a share, down from C$660 million or C$1.28 a share a year earlier.

The bank said its cash earnings (a non-GAAP measure) amounted to C$1.00 a share versus C$1.30 a year earlier.

Bank analysts on average had expected Bank of Montreal to earn C$1.21 a share in its latest third quarter.

The results, which were badly hurt by the battered U.S. housing market, bode poorly for the remaining Canadian banks that will report their third-quarter financials this week.

"This is not a very auspicous start to the third-quarter bank earnings," said Fred Ketchen, managing director of stock trading at Scotia Capital Markets. "It does not set things off on a pleasant footing for the rest."

Bank of Montreal is the first of the big six Canadian banks to report third-quarter earnings. It will be followed later Tuesday by Bank of Nova Scotia. Canadian Imperial Bank of Commerce reports Wednesday, and Royal Bank of Canada, Toronto Dominion Bank and National Bank of Canada will release results Thursday.

Shares of all banks were down in early trading in Toronto. Bank of Montreal, which lost 3% at the start, is now off 76 Canadian cents or 1.7% to C$43.30.

Dundee Securities slashed its outlook on Bank of Montreal to sell from neutral, noting the bank "no longer wears the crown of 'low provision bank.'"

Bank of Montreal said its provision for credit losses soared to C$484 million in the latest quarter from C$91 million a year earlier. Analysts had only expected an increase to C$195 million. The bank said C$247 million of those provisions were for two corporate accounts related to the U.S. housing market that were identified as impaired.

That will "obviously raise concerns" about credit provisions at Royal Bank and TD, the other Canadian banks with large U.S. retail operations, Dundee analyst John Aiken said in a note. While there are regional differences in the banks' various exposures, he said speculation would likely hit Royal's and TD's shares "despite the fact that each has reported meaningful increases in provisions over the past few quarters."

Bank of Montreal had also sharply increased its provisions in the first and second quarters and said in May that provisions for the balance of the year would be above the C$170 million recorded in the first quarter given the continued deterioration in the credit environment. It had initially set a target for the year for credit-related provisions of C$475 million; so far, provisions have totaled C$755 million.

The bank also fell short of its goal for return on equity of 18-20%. ROE, a key measure of bank profitability, was 13.5% in the third quarter, while cash ROE was 13.7%. Those results compared with ROE of 18% and cash ROE of 18.2% a year earlier.

Still, the news may not be all bad. Blackmont Capital noted that stripping away all charges and the credit-related provisions, the bank's core cash earnings came in at C$1.42 a share, mainly on strong trading results and better net interest margins.

Aiken at Dundee also noted the bad headline news overshadowed some key improvements in the bank's operations.

"What is truly disappointing is that the operations outside of capital markets and its U.S. real estate business appeared to have performed quite well, generating enough earnings to almost offset the substantial increase in provisions," Aiken said. "However, with little hope that credit issues will fade in the coming months, this positive is unlikely to provide much support as cracks continue to appear in BMO's loan portfolio."

Neither Blackmont nor Dundee have any investment-banking conflicts with Bank of Montreal, nor do the analysts own the bank's shares.

Bank of Montreal said P&C Canada, its Canadian personal and commercial banking unit, had one of its best quarters ever even though earnings of C$343 million were down C$13 million from a year earlier. After adjusting for a recovery of prior years' income taxes in 2007, it said net income in the division improved slightly from a year earlier and was up 3.4% from the second quarter.

Analysts have pointed out that, due to weakness in the capital-markets business and rising risk in the U.S. platforms, the importance of the Canadian banks' domestic retail operations has increased.

Bank of Montreal's U.S. personal and commercial banking operations showed improvement, with earnings up 12% from a year earlier on "solid" volume growth and early signs of spread stabilization in both loans and deposits.

The bank said its private client group delivered record net income in the quarter.

Meanwhile, BMO Capital Markets' results were up from a year earlier but continued to reflect current market conditions with low activity levels in some of its investment-banking businesses. The bank recorded a charge of C$134 million, (C$96 million or 19 Canadian cents a share after tax) in the latest quarter related to the capital-markets environment.

Citing the challenging economic environment, the bank reiterated that it doesn't expect to achieve its annual earnings target, which was for earnings-per-share growth of 10-15% in fiscal 2008.