11 December 2009

Review of Banks' Q4 2009 Earnings

Scotia Capital, 14 December 2009


• We are downgrading the Canadian banks to marketweight from overweight due to their strong absolute and relative share price performance in 2009 and increased regulatory/political risk.

• Bank stocks have doubled off their 2009 lows and are up 51% year-to-date outperforming the TSX by 23% thus far in 2009.


• Banks just finished reporting strong Q4/09 earnings ahead of street expectations, however despite these strong and better-than-expected results bank share prices weakened. We believe this is a reflection of a tired bank rally, guarded management comments, and increased regulatory uncertainty.

• Bank valuations are expected to expand over the next five years; however we believe we are in a consolidation phase with a stalled bank rally in the near term.

• We believe the market needs to see dividend increases to generate further P/E expansion to 14x to 16x as well as a comfort level that the regulator is not going to unnecessarily handicap Canadian banks.


• We recommend a marketweight position for the Canadian banks.

Strong Absolute and Relative Returns

• We are downgrading the Canadian banks to marketweight from overweight due to their strong absolute and relative share price performance in 2009 and increased regulatory/political risk. Bank stocks have doubled off their 2009 lows and are up 51% year-to-date outperforming the TSX by 23% thus far in 2009.

Share Prices Weaken Despite Strong Fourth Quarter Earnings

• Banks just finished reporting strong fourth quarter earnings ahead of Street expectations for the third straight quarter. Earnings continue to be driven by robust wholesale earnings, solid retail and rebounding wealth management. Credit trends are turning positive with lower impaired loan formations and stable loan loss provisions that appear to have peaked. The net interest margin was also stable to improving. ROE was solid at 16.9% on large capital positions with Tier 1 capital at 11.8%. This was the first year-over-year increase in operating earnings (+2%) since the financial crisis began, however despite these strong and better than expected results bank share prices weakened. We believe this is a reflection of a tired bank rally, guarded management comments and increased regulatory uncertainty.

Canadian Banks - Long Term Outperformers

• We continue to view banks as long-term overweight investments given their sound fundamentals and business models and sector structure with a history of generating superior returns. We believe the banks remain poised to continue to generate these superior returns. Bank returns have been nearly double the market's return over the past 40 years with a beta materially less than one. Bank dividends have grown at a 10% CAGR over this time, an enviable record.

Banks Stocks in Consolidation Phase

• Bank valuations are expected to expand over the next five years; however we believe we are in a consolidation phase with a stalled bank rally in the near term. Thus rapid appreciation from these levels is difficult to see given the magnitude of the 2009 rally and the fact that banks appear to have been placed on hold with respect to capital management pending clarity from the regulator. In addition, a sharp acceleration in earnings is not expected until the later part of 2010.

Origin of the Strong Canadian Banking System - Green Paper 1984

• We do not believe it is any one individual or agency that should take credit for the performance of the Canadian banks in this recent financial crisis but rather, we believe, the strength originated from the structure and the foresight launched with the "Green Paper" in 1984. The history of the development of the "Green Paper" is on the OSFI website with the pertinent history section highlighted in Exhibit 16. Canada has to manage its banking success carefully going forward and not squander the opportunity.

Historical Share Price Performance Pattern Points to Consolidation

• Our downgrade to marketweight is also based on bank share price relative performance history. In terms of bank index performance, 2009 thus far is the second best year in history next to 1968 which benefited from the 1967 Bank Act. On a relative performance basis 2009 is the fourth best year since 1967.

• Bank stocks' major outperformance years were 1968, 1971, 1982, 1988 and 1991 which were all followed by neutral to very modest outperformance. The only years where banks outperformed solidly or sustained the major rally was the 1996, 1997 string and through the tech bubble bursting in 2001, 2002 and 2003. Thus it would seem that 2010, or at least the first half, will have muted relative performance unless commodities have a major pullback.

Banks Defer to OSFI - Dividend Increases on Hold - Stalls Bank Rally

• The bank P/E multiple has rallied off of 6x (global financial collapse/systemic risk) to a recent high of 12.6x trailing (current 12.3x). However the P/E rally has stalled, we believe, in the near term due to uncertainty about the timing of dividend increases as the banks appear to have deferred to OSFI as well as a general perceived increase in regulatory and political risk. The risk is that there will be an overreaction which places Canada at a competitive disadvantage or hinders Canadian banks' ability to take advantage of the strength of their banking system and operating platforms.

Dividend Increases to Drive P/E Multiples Higher

• We believe the market needs to see dividend increases to generate further P/E expansion to 14x to 16x as well as a comfort level that the regulator is not going to unnecessarily handicap Canadian banks. Dividend increase expectations have now been pushed back to late 2010. Thus with dividend increases on hold or pushed back several quarters bank share prices are likely to continue to consolidate in the near term.

• We continue to expect strong absolute 12-month returns for the bank group but they will most likely be in the back half. On a medium to longer term basis we expect that dividend increases (when they begin - not if they begin, in our opinion) will be sustainable in the 10% range which will drive P/E multiples towards our fair value range of 16x.
Financial Post, 14 December 2009

Barclays Capital analyst John Aiken is worried that employee bonuses could weigh on the future profitability of the banks if they continue to rise at historical rates.

In the most recent quarter all of the big banks but National Bank and Bank of Nova Scotia paid out less in variable compensation, but the overall decline is probably a blip rather than a new long-term trend, Mr. Aiken said in a recent note to clients.

In 2009 the big five banks paid out variable compensation of $8.43-billion. That compares to $7.25-billion in 2008 and $8.44-billion in 2007.

As long as profits continue to rise along with bonuses, there is no reason to be concerned. The problem is that they may not. In the face of an uncertain economy and proposed regulatory changes, many analysts worry that bank profitability could take a hit in the coming years. The regulatory front is the top concern, especially regarding ballooning capital levels.

“The market is becoming aware that the vast levels of excess capital carried by the Canadian banks may not be deployed in the near term, particularly as uncertainty exists with pending regulatory changes, Mr. Aiken said.

In a world where banks are required to hold more capital, the bottom line would almost certainly be pushed down. In that context, employee bonuses would become “additional earnings headwinds,” Mr. Aiken said.
Financial Post, 11 December 2009

The relative share price weakness for National Bank of Canada may be signaling more than just disappointment to its fourth quarter earnings miss.

Given the pronounced decline in the bank’s P/E ratio, Blackmont Capital analyst Brad Smith couldn’t help but look back to September 2007, when National’s collapsing P/E represented either a unique buying opportunity or a valuation that was simply falling to a new level ahead of its larger peers.

That latter theory ended up proving correct as within four months, the Canadian bank index was trading at below 10x trailing P/E.

National saw a similar relative value decline in the fall of 2008, which was again followed by a decline in the bank index P/E, Mr. Smith noted.

The relationship appears to work the other way too as National’s January 2009 P/E expansion preceded the huge sector P/E expansion that has lifted valuations back to pre-credit crisis levels.

“While there can be no assurance that the pattern will again repeat, we would note that as the smallest of the Big Six banks, National’s relative stock illiquidity does favour more exaggerated points of inflection,” the analyst told clients.

09 December 2009

Scotiabank Q4 2009 Earnings

TD Securities, 9 December 2009

Yesterday before market open, the bank reported core cash FD-EPS of C$0.89 vs TD Newcrest of C$0.86 and Consensus of C$0.87.


Slightly positive. Not one of the strongest results this season. However, key credit trends came in well below expectations with PCLs at C$420 million (vs TD Newcrest at C$505 million). Domestic continues to perform with good margin expansion (+10bp). International remains under pressure. Capital Markets continued to moderate as expected. In our view, Scotia deserves to trade at a premium valuation for having one of the best platforms with leverage to a recovery scenario (offering higher growth/high ROEs in the medium-term).


Credit turns for the better. PCLs were materially lower than expected, and supported by an improvement in GIL trends (Exhibit 3). We expect trends to be lumpy as we reach the peak of the credit cycle in 1H10, but the trends and commentary served to increase our comfort that credit problems are unlikely to spike higher in the coming quarters. Overall, we expect the peak situation to be very manageable. We believe the stage is being set for some material declines in late 2010 and through 2011.

International working through headwinds. The segment is working through pressure from currency, elevated credit costs, ongoing investment and an easing of credit demand. All that said, the segment delivered C$283 million in earnings. To us, that is not a bad downside case in a tough environment. Moreover, we continue to base our call around the medium-term prospects for superior growth and expansion in the region which we believe remain excellent, premised on 1) faster economic recovery/growth 2) an underserved/fragmented banking market and 3) Scotia's strong track record in the region.

Premium exposure to recovery outlook. In our view Scotia offers the best exposure to a recovery in the global economy, which we expect to unfold in 2010 and into 2011. Primarily through its sizeable emerging markets business, but also via its corporate lending activities where we see prospects for good growth/profits on reduced supply/competition and wider spreads. We expect the result to be higher medium-term growth and high ROE. On this view, the stock should command the premium multiple of the Large-Cap Canadian banks.

Conference Call Highlights

• NIMs. The bank has benefitted from increased margins in Canadian banking and the Corporate lending book in Scotia Capital. In 2010, margins are expected to increase further (on higher/wider spreads and lower funding costs), but at a slower rate than in Q4.

• Credit. The bank noted their portfolios have been performing better than prior downturns and are also showing signs of some stabilization.

• Credit outlook. Management believes the bank will likely face elevated provisions into 2010, but the bank should see a downward trend (and accelerating) in 2H10. Retail provisions are expected to remain high. However, corporate and commercial books should see a gradual decline next year.

• Capital Markets. Management expects performance in 2010 will be strong, but unlikely to match the performance in 2009. Looking specifically at trading revenues the bank will likely face continued normalization in 2010.

Quarterly Highlights (growth is year on year unless noted)

• Domestic P&C - steady overall results. Revenue was up 10% helped by continued margin recovery (NIM +10bp). PCLs remain elevated, and there was a bit of an uptick in operating expenses on the quarter (+5.5%). Volume growth was mixed with good growth on the retail side (Mortgages +7%, Personal +12%), while commercial loans declined 14% (clients have reduced borrowings/sought alternative forms of financing). In Wealth, the mutual fund, brokerage and trust business continue to grow/recover nicely (mutual fund revenues were +60%).

• International – still under some pressure. Net income was down 14%, largely reflecting elevated PCLs and F/X. However, PCLs did ease from the peak levels in Q3/09. Operating expenses ticked-up sequentially and NIM was also down 8bp on the quarter. Overall, underlying volume growth was still decent at 8% ex-F/X impact.

• Wholesale - moderated as expected. Results came basically inline with our expectations as Trading revenues moderated (down some -30% from Q3 levels), helped by a strong quarter for investment-banking revenues.

Operating Outlook. The quarter was not far off the pace we expect for 2010 and management guidance is generally consistent with our thinking. We have increased our 2010 estimate slightly to C$3.60 (up from C$3.55). We have PCLs remaining elevated and also slightly lower profitability in International. We expect 1H10 to be slightly softer, with a strong 2H10. We still see 2011 to be a material recovery year as PCLs decline. We have increased our Target Price to C$55 (up from C$53).

Segments. Domestic P&C turned in a good performance and should grow moderately in 2011 on volumes and slightly firmer margins. Lower PCLs may help through the year. International is a bit weaker on slowing volumes, F/X headwinds and elevated PCLs and non-interest expenses, but should also pick-up in 2H10. Wholesale should moderate from its recent pace.

Credit. To us credit was the big surprise on the quarter with lower than expected PCLs (TD Newcrest was at C$505 million and consensus at C$525 million) and improving trends in GILs particularly with lower formations in International. Going forward we expect things to get a bit worse, and we can see some lumpy results. However, supported by management color, we do not see a material risk of a further spike upward. On balance our PCL estimates are slightly lower (down from C$2,075 million for 2010). We expect 2011 to see a material decline.

Capital. We believe Scotia is comfortably capitalized, having one of the highest TCE:Asset ratios in the group. Also, the bank did not participate in any material equity issues diluting shareholders. We expect management will continue to manage capital conservatively as new regulations evolve.

Justification of Target Price

In determining our Target Price we establish a Fair Value P/BVPS multiple based on our expectations regarding long-term sustainable ROE, growth and COE. Our expectations currently stand at 17.5%, 4.5% and 10.0% respectively implying a Fair Value P/BVPS multiple on the order of 2.60x.

Key Risks to Target Price

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

We believe Scotia offers one of the best platforms with leverage to a recovery scenario and should command a premium valuation. Reiterate Buy.
Financial Post, 8 December 2009

Blackmont Capital analyst Brad Smith said he is "very encouraged" by signs that defaults in the Bank of Nova Scotia loan portfolio are leveling off.

Canada's third biggest bank reported fourth quarter net income of $902-million, a nearly three-fold increase from the same period last year as Scotia benefitted from near record results in investment banking that more than offset a decline in net interest margin.

Provisions for credit losses, essentially money set aside for loans that may not be repaid, were $420-million, up from $207-million last year but down $134-million from the prior quarter.

"While the shortfall in net interest margin was disappointing, we are very encouraged by the apparent stabilization in the bank's credit portfolios and view the reported results to be of above-average quality compared to peers," Mr. Smith said in a note to clients.

Andre-Philippe Hardy, an analyst at RBC Capital Markets, said the results were in line with his expectations despite lower-than-expected loan losses.

In a research note, Mr. Hardy said that aside from a few minor variations such as provisions for bad loans and better-than-expected domestic banking results, the quarter was as he expected.

He said the result would have a "neutral" impact on his view of the bank.

07 December 2009

RBC Q4 2009 Earnings

Scotia Capital, 7 December 2009

RY cash operating EPS increased 4% YOY to $1.06/share in line with our estimate and slightly above consensus. Operating ROE was 18.9%, with RRWA of 2.45% and Tier 1 Capital at 13.0%. Fiscal 2009 EPS was $4.45, an increase of 4% from $4.30 per share in 2008.


• Canadian Banking earnings increased 6% YOY. Insurance earnings declined 25% YOY with Wealth Management earnings increasing 4% and Capital Markets increasing 42% due to strong trading revenue. International Banking recorded a loss of $46M due to high loan losses.

• Our 2010E EPS remains unchanged at $4.80. We are introducing our 2011E EPS at $5.50. Our one-year share price target remains unchanged at $75 per share representing 15.6x our 2010E EPS and 13.6x our 2011E EPS.


• We maintain our 1-SO rating on the shares of Royal Bank based on its superior earnings growth given the strength of its retail and wealth management businesses and its uniquely positioned capital markets platform (U.K. and U.S. presence). In addition, the bank has significant earnings recovery potential from its U.S. retail business. RY has no meaningful premium despite its high ROE, and high capital bank.
The Globe and Mail, Tara Perkins, 4 December 2009

Royal Bank of Canada is now sitting on nearly $15-billion more than it needs to meet regulators' minimum capital requirements, and it's money that chief executive officer Gordon Nixon is in no rush to spend.

RBC is receiving more deal pitches than ever before from CEOs and investment bankers with businesses to sell, Mr. Nixon suggested Friday. But he has other ideas.

Canada's largest bank, which just posted a $3.86-billion profit for the fiscal year ended Oct. 31, has made more than two dozen acquisitions since Mr. Nixon took the top job in 2001.

But only three deals have been done since the financial crisis peaked, even though banks and other financial companies have become much cheaper – and Mr. Nixon is unlikely to increase the pace of acquisitions any time soon.

Why? Because as the banking sector moves from crisis to recovery, his strategy is to try to anticipate what regulators will demand, and stay ahead of the curve. And he knows that he could plump profits just by making more loans down the line, when conditions improve.

While he doesn't know exactly what the new capital requirements will be, he's confident RBC already exceeds them. That, he suggests, will give it an edge, because banking should become a lot more profitable in the next few years.

In fact, Mr. Nixon foresees a heyday for banking, complete with fatter lending margins. He wants to have plenty of funds to lend when that time comes, so RBC is content to sit on money that some analysts think should be put to use now.

“In the next five years, leaders in the financial services sector – in my view – will be defined by their ability to successfully manage through regulatory reform,” Mr. Nixon said Friday on a conference call with analysts after RBC reported fourth-quarter profits of $1.24-billion, topping the Street's estimates.

“Our capital strength, low leverage ratio and business mix combine to provide a great competitive advantage over other global competitors that will be required to shrink their balance sheets and change their business strategies in response to regulatory changes.”

The key measure of RBC's financial cushion, called the Tier 1 capital ratio, now sits at a whopping 13 per cent, up from 9 per cent a year ago. It's nearly double the Canadian regulator's minimum requirement of 7 per cent, and the highest of the big banks. And the proportion of RBC's capital that comes from plain vanilla common equity, the strongest form of capital, is higher than many peers.

Comparing Tier 1 ratios among banks in different countries is a bit of an apples-to-oranges issue, but Barclays Capital analyst John Aiken said he thinks RBC's capital position is arguably the strongest on a global basis as well.

“Navigating the regulatory environment over the next couple of years is going to be a major undertaking for all banks around the world, and we want to go into that in as ‘fortressed' a position as we possibly can, because we think it will provide us good opportunities to deploy capital in the future,” Mr. Nixon said, borrowing a phrase from Manulife CEO Don Guloien, whose strategy is also to build “fortress” capital levels.

Mr. Nixon expects RBC will be able to pick up new market share in Canadian, international, and investment banking down the line as a result of this strategy.

The crisis has damaged competitors, with a number of global banks exiting certain countries and businesses. Many financial institutions will be forced to shrink their loan books further to meet new capital and leverage rules, Mr. Nixon predicts, and the global flood of government stimulus money will dry up.

Prices for the bank's corporate loans have already risen significantly, with new loans being made at better prices than RBC could charge before the crisis.

The last couple of years have been characterized by aggressive pricing, “and I do think that we'll be settling into a different environment that will be very favourable going forward,” Mr. Nixon said.

That's not to say the bank isn't growing its loan portfolios right now. It holds $146.4-billion worth of mortgages, up from $136.2-billion a year ago.

And Mr. Nixon's still looking at potential wealth management acquisitions outside Canada. But he's not in any hurry.

“Our strong balance sheet and capital base will enable us to invest in key business areas, as well as explore potential acquisitions that meet our strict economic, strategic and cultural criteria,” he said.

04 December 2009

TD Bank Q4 2009 Earnings

Scotia Capital, 4 December 2009

Q4/09 - Strong Results, Better Than Expected

• Toronto-Dominion Bank (TD) fourth quarter operating earnings were strong, driven by record wholesale banking earnings, solid earnings at TDCT, partially offset by weak results from U.S. P&C and Wealth Management. Credit quality remained relatively stable.

• ROE was 14.3% with RRWA of 2.63%.

• TD’s cash operating earnings increased 20% to $1.46 per share, better than our estimate of $1.31 per share and consensus of $1.27 per share due to the unexpected strength in wholesale banking aided by resilient trading revenue and security gains versus security losses previously. Wholesale banking earnings tripled from a year earlier with TDCT earnings increasing 4%.

• Fiscal 2009 operating earnings declined 1% to $5.35 per share from $5.42 per share in fiscal 2008. Operating ROE for the year was 13.3%.

• Our 2010 earnings estimate is unchanged at $5.70 per share. We are introducing our 2011 earnings estimate at $6.50 per share.

• Our 12-month share price target is unchanged at $80, representing 14.0x our 2010 earnings estimate. We maintain our 2-Sector Perform rating.

Items of Note

• Reported cash earnings were $1.25 per share including $73 million after-tax or $0.09 per share loss on economic hedge related to reclassified AFS debt securities, $89 million after-tax or $0.10 per share restructuring charge related to Commerce Bancorp, and a $19 million after-tax or $0.02 per share loss in fair value of CDS hedging the corporate loan book.

Canadian P&C Earnings Increase 4%

• Canadian P&C (TDCT) earnings increased 4% to $622 million from $600 million a year

• TDCT’s solid performance was a result of strong volume growth in personal and business deposits and real estate secured lending, partially offset by higher provisions for credit losses and margin compression. Also, insurance earnings were weak this quarter with insurance revenue, net of claims, at $202 million versus $253 million in the previous quarter and $248 million a year earlier. Insurance weakness was due to high property and casualty insurance claims.

• Retail net interest margin declined 8 basis points (bp) sequentially and 1 bp from a year earlier to 2.88%.

• Revenues increased 6.6% year over year (YOY) to $2.4 billion, and expenses increased 2.0% to $1.2 billion.

• Card service revenue increased 7% YOY to $192 million.

• LLPs increased to $313 million from $290 million in Q3/09 and from $209 million a year earlier.

• TDCT earnings in fiscal 2009 increased a modest 2% to $2,472 million versus $2,424 million in 2008 as the bank absorbed a major spike in credit losses to $1,155 million versus $766 million as well as a 5 bp margin decline.

Total Wealth Management Earnings Decline 8%

• Wealth Management earnings, including the bank’s equity share of TD Ameritrade, declined 8% year over year in Q4/09 to $156 million.

Canadian Wealth Management Earnings Decline

• Domestic Wealth Management earnings declined 12% YOY to $97 million due to a significant decline in assets under management and administration, lower average fees earned, net interest margin compression, and lower margin loans.

• Operating leverage was negative 4.4%, with revenue declining 0.7% and expenses increasing 3.7%.

• Mutual fund revenue declined 4% to $197 million from a year earlier.

• Mutual fund assets under management (IFIC, includes PIC assets) increased 11.5% YOY to $58.2 billion.

• Canadian Wealth Management earnings in fiscal 2009 were $345 million versus $480 million in 2008.

TD Ameritrade – Earnings Decline 2%

• TD Ameritrade contributed $59 million or $0.07 per share to earnings in the quarter versus $68 million or $0.08 per share in the previous quarter and $60 million or $0.07 per share a year earlier. TD Ameritrade’s contribution represented 4% of total bank earnings.

• TD Ameritrade's contribution for fiscal 2009 was $252 million versus $289 million a year earlier.

U.S. P&C Earnings Decline 24%

• U.S. P&C earnings declined to $211 million or $0.25 per share from $276 million a year earlier, representing 16% of total bank earnings. Earnings were negatively impacted by high loan losses, a strong Canadian dollar, and relatively high expenses. Return on invested capital remains low at 4.5%.

• Loan loss provisions in the U.S. increased 18% QOQ to $216 million (includes $41 million in debt securities) or 1.33% of loans versus $183 million in the previous quarter and $78 million a year earlier.

• Net interest margin increased 6 bp from the previous quarter and declined 35 bp from a year earlier to 3.46%.

• In fiscal 2009, U.S. P&C earnings increased to $909 million versus $806 million in 2008 mainly due to the full year's inclusion of Commerce Bancorp's earnings versus two quarters a year earlier. However, the $900 million in earnings was 25% less than the banks' previous goal of $1.2 billion.

U.S. Platforms Combine to Represent 20% of Earnings

• U.S. P&C and TD Ameritrade contributed $270 million or $0.32 per share in the quarter, representing 20% of total bank earnings in the fourth quarter, down from a high of 29% in Q1/09.

Wholesale Banking Record Earnings

• Wholesale banking earnings were extremely strong at $372 million, tripling from $122 million a year earlier and increasing 14% sequentially from $327 million the previous quarter.

• Wholesale Banking earnings in fiscal 2009 more than doubled to $1,137 million from $480 million in 2008.

Trading Revenue – Resilient

• Trading revenue remains strong at $560 million versus a record of $633 million in the previous quarter and a weak $107 million a year earlier, driven by very strong fixed income trading.

• Interest rate and credit trading revenue was solid at $300 million versus a loss of $565 million a year earlier and a gain of $440 million in the previous quarter. Equity and other trading revenue increased significantly to $172 million from $1 million a year earlier and from $39 million in the previous quarter. Foreign exchange trading revenue declined to $88 million from $146 million a year earlier and $154 million in Q3/09.

• Trading revenue in fiscal 2009 more than quadrupled to $2,227 million from $544 million in 2008. We believe TD's Moody's Aaa credit rating is a major factor in the rebound in TD's trading platform.

Capital Markets Revenue

• Capital markets revenue was $343 million versus $342 million in the previous quarter and $276 million a year earlier.

• Capital Markets revenue for fiscal 2009 was $1,303 million versus $1,184 million a year earlier.

Security Gains

• Security gains were $26 million or $0.02 per share versus a loss of $90 million or $0.07 per share in the previous quarter and a gain of $55 million or $0.04 per share a year earlier.

Unrealized Surplus – $207 million

• Unrealized surplus was $207 million at quarter end versus $177 million in the previous quarter and $310 million a year earlier.

Securitization Revenue and Economic Impact

• Loan securitization revenue increased to $135 million in the quarter versus $92 million in the previous quarter.

• Securitization economic impact was a positive $74 million pre-tax, or an estimated $0.06 per share after-tax, versus $0.04 per share in the previous quarter. Securitization activity is recorded in the Corporate segment.

Loan Loss Provisions

• Specific LLPs increased to $521 million or 0.79% of loans versus $492 million or 0.76% of loans the previous quarter. The $521 million Q4/09 LLPs included $41 million related to debt securities. LLPs related to loans this quarter were $480 million, slightly lower than the $492 million in the previous quarter. Loan loss provisions have been restated for 2009 to included these debt securities provisions.

• Specific loan loss provisions in fiscal 2009 were $2,225 million or 0.85% of loans, including $250 million for debt securities, versus $1,063 million or 0.46% of loans in 2008. Total LLPs in fiscal 2009 were $2,480 million or 0.94% of loans including $255 million in general provisions.

• Our 2010 LLP forecast is unchanged at $2,100 million or 0.75% of loans. We are introducing our 2011 LLP forecast at $1,600 million or 0.54% of loans.

Loan Formations Stable

• Gross impaired loan formations before debt securities were stable at $974 million versus $969 million in the previous quarter. U.S. gross impaired loan formations increased moderately to US$412 million from US$387 million in the previous quarter. Gross impaired formations were $1,215 million in the quarter including $241 million in debt securities classified as loans versus $969 in the previous quarter.

• This quarter the bank reclassified $10.8 billion in securities (AFS & HTM) to loans in accordance with the CICA Handbook Section 3855. The August 2009 amendment changed the definition of a loan such that certain debt securities may be classified as loans if they do not have a quoted price in an active market and it is not the banks intent to sell the securities immediately or in the near term.

• Gross impaired loans increased to $2,311 million or 0.88% of loans from $1,947 million or 0.76% of loans in the previous quarter due primarily to debt securities classified as loans. Net impaired loans were negative $328 million.

Tier 1 Capital – 11.3%
• Tier 1 ratio was 11.3% versus 11.1% in the previous quarter. Total capital ratio was 14.9% versus 14.7% in the previous quarter.

• Tangible common equity to risk-weighted assets (TCE/RWA) was 9.9% versus 9.5% in the
previous quarter, while common equity to RWA increased to 18.6% from the previous

• Book value per share increased 12% from a year earlier to $41.13.

• Risk-weighted assets declined 10% from a year earlier to $189.6 billion.
Financial Post, 4 December 2009

Picking through the aftermath of a big earnings day on Thursday for Canadian banks, the markets seemed decidedly more enthused with CIBC's results compared with those of TD Bank and National Bank.

Shares in CIBC rose 2.22% yesterday as the company beat market expectations, while both TD (-2.52%) and National Bank (-5.85%) tumbled.

However, while TD Bank actually put out better-than-expected numbers it also made some very cautious outlook statements, Peter Rozenberg, analyst with UBS, noted.

"TD had a better than expected quarter, but management remained cautious regarding its 2010 outlook with U.S. PCLs (provisions for credit losses) expected to remain extended longer till the end of 2010," he said. "The current outlook is dependent on lower U.S. PCLs and higher returns which will take some time."

Mr. Rozenberg maintains a Neutral rating for TD while nudging the target price to $71 from $70.

This is still more bullish than Brad Smith with Blackmont, who is negative on the bank's U.S. business, noting its income fell 13% to $211-million.

"Given our less optimistic view with respect to the return potential of the U.S. strategy, we are maintaining our Underperform rating and $58 target price," he said in a note.

Meanwhile, both analysts are ambivalent on National Bank, which slightly missed consensus expectations.

"The bulk of the miss from our estimate ($1.40 versus $1.45) came from the net of increased minority interest and decreased taxes, while provisions for credit losses of $54-million were up 18% from last quarter and $4-million ahead of our estimate," Mr. Smith said.

"National Bank has done a good job of managing credit, driving good Capital Markets results, and managing expenses. While valuation is attractive, we think there is better leverage in other banks with trading profits expected to normalize, and credit leverage also higher at other banks," Mr. Rozenberg said.

Mr. Smith maintains a Sector Perform and $65 target price for National Bank, while Mr. Rozenberg has a Neutral rating while upping the target price to $65 from $63.

CIBC Q4 2009 Earnings

TD Securities, 4 December 2009

Yesterday, the bank reported core cash FD-EPS of C$1.41 vs. TD Newcrest at C$1.25 and consensus at C$1.33.


Positive. The bank turned in a solid quarter as credit trends improved, which helped to deliver strong retail profits. One quarter is not a trend, but it is consistent with our suspicion that operating trends could start to build through 2010 as credit eases. We raised our 2010 estimates, but more importantly our standing C$6.90 number for 2011 looks more achievable. Our Target Price increases to C$75. The stock has already moved nicely, and we need to build a stronger fundamental case for 2010/2011 to argue that the stock is materially undervalued here. Maintain HOLD.


Card trends topping out. Following several quarters of material acceleration, losses in the cards portfolio turned down in Q4/09. This is consistent with 1) previous color from management 2) early delinquency trends and 3) our expectation that unsecured personal credit would be early to recover. It is too early to sound the all clear, but this underscores the potential for material earnings leverage from declining PCLs through 2010. Overall, commentary suggests that aggregate PCLs should be flat to down in 2010 (see below).

Retail still needs to accelerate. Reported NI was helped by the improvement in PCLs, and a modest lift in revenues. The expected decline in PCLs should help lift 2010. However, volume growth remains fairly modest at around 5%. We noted some slight lift quarter-on-quarter which is encouraging, and consistent with management commentary that they will accelerate businesses, but trends will need to strengthen further in 2010 to build the case that CM has a solid, competitive retail franchise; this will be difficult to do amid expected modest industry growth.

Structured products holding steady; may hold future promise. The bank's run-off portfolio of structured products turned in a modest net gain again this quarter and overall remain fairly steady (relative to the turmoil of 2008).

Over the coming 2-3 years, we see potential recoveries as these positions mature and/or credit markets continue to improve. Combined with the release of related RWAs, this dynamic can be materially favorable for the bank's capital position.

Results validate stock's recent move. The stock has recovered nicely in anticipation of a potential favorable turn in credit. We think it is warranted. We moved our estimates and Target Price up and we see some moderate upside, but we need a stronger case around the bank's core retail business to argue for materially higher levels.

Conference Call Highlights

• Acquisition strategy. The bank's primary opportunity at this time is to gain a top three standing in each of its core Canadian business lines. The bank continues to look at opportunities outside of Canada. The bank’s criteria include: 1) familiarity with the region potentially gained through an initial partnership 2) new pools of management talent 3) exposure to a different cycle/market. The bank has not, at this point in time, found any acquisitions that fit this criteria. This would appear to rule out the potential that they have identified and expressed an interest in AIB.

• PCL trends. U.S. CRE - PCLs expected to be below those of 2009 (C$102 million), U.S. leveraged finance - PCLs expected to be below those of 2009 (C$36 million), European leveraged finance - no material PCLs expected, Cards - PCLs are expected to be better than the elevated level of 2H09, Other Personal and Wholesale - should be better than 2009.

Quarterly Highlights (growth is year on year unless noted)

• Retail - better than expected bottom-line. Revenue was flat year-on-year, but improved sequentially on stronger Personal Banking volumes, flat margins and higher fees. Wealth Revenues also improved from Q3. NIE remain well controlled, but the biggest driver was the decline in PCLs related to improvements in the Cards book. NI was still down from Q4/08 on higher PCLs, but improved materially from Q3 levels. Volume trends remain relatively modest at +4.8%, but we note some lift from Q3 levels (+1.5%).

• Wholesale - moderating as expected. NI was down to C$124 million from C$179 million in Q3. Trading remained healthy, actually up slightly from Q3 on an adjusted basis, while advisory was down materially.

Operating Outlook. We have raised our 2010 estimates. The change reflects primarily a lower estimate for peak 1H10 credit costs consistent with the Q4 results and guidance. We continue to assume modest underlying volume growth, flat to slightly higher margins and moderating capital markets trends. Significant recovery/improvement in the bank's Retail and Wealth management revenues is likely the biggest potential upside relative to our numbers.
Financial Post, 4 December 2009

CIBC appears to be on an upswing coming out of a robust earnings week for Canada's big banks.

James Bantis, analyst with Credit Suisse, has upped his ratings and estimates for the bank, which has been one of the hardest hit during the recession.

"Assuming no further surprises, it appears that the worst has been largely priced into CIBC's valuation. Specific issues such as the oversized credit card portfolio, run-off loan portfolios, CRA tax dispute have been largely addressed and discounted by investors," Mr. Bantis said in a note to clients. "Turning around its struggling retail banking franchise (against larger and surging peers) remains management's number one priority and biggest challenge."

Retail Markets posted earnings of $474-million, an improvement after two quarters of disappointing results. Mr. Bantis also has concerns about the bank's "outsized" credit card portfolio of $14-billion and the fact that loan losses have risen 57% year-over-year.

"When the economy eventually recovers, it's not clear how easy it will be for CIBC to turn on the credit tap for growth as retail customers may have looked elsewhere during this cautious period," he said.

Still, loan loss provisions of $424-million were below Credit Suisse's forecasts ($475-million) Mr. Bantis noted the bank did see its gross impaired loans rise 15% sequentially to $1.91-billion.

Meanwhile, CIBC's operating EPS of $1.41 is also ahead of Mr. Bantis's forecast of $1.32.

Mr. Bantis has raised CIBC to Neutral from Underperform, while bumping his target price to $66 from $52. 2010 EPS estimates have also nudged higher, to $6 from $5.60.

National Bank Q4 2009 Earnings

Scotia Capital, 4 December 2009

• National Bank of Canada (NA) fourth quarter operating earnings increased 3% YOY to $1.40 per share, below expectations. Operating earnings were lower than expected due to negative sequential swing of $0.18 per share from securitization, lower security gains of $0.04 per share, and other charges of $0.12 per share as well as higher-than-expected salaries & benefits (including variable compensation). Underlying earnings were relatively strong. Operating ROE was 16.9%.


• Financial Markets earnings doubled to $140 million from a year earlier but declined from the record $167 million in the previous quarter. Trading revenue was extremely strong at $197 million versus $168 million in the previous quarter.

• Retail earnings disappointed, declining 8% YOY and 16% QOQ mainly due to higher operating expenses and credit costs. Wealth Management earnings were $26 million up slightly QOQ but down 42% YOY.


• Our 2010E EPS is unchanged at $6.40. We are introducing our 2011E EPS at $7.00. Share price target is unchanged at $75.

25 November 2009

BMO Q4 2009 Earnings

Scotia Capital, 25 November 2009

Q4/09 - Earnings Very Strong - Large Beat

• Bank of Montreal (BMO) reported a 4% decline in cash operating earnings to $1.13 per share, in line with our estimate but significantly above consensus of $0.96 per share. Operating ROE was 14.2% with Tier 1 at 12.2%. This is the first clean quarter since the financial crisis began.

• Fiscal 2009 operating earnings declined 11% to $4.20 per share from $4.70 per share in fiscal 2008. Operating ROE for the year was 13.5%. Reported earnings were $3.14 per share down 18% from $3.83 per share a year earlier. Reported ROE was 10.0% for fiscal 2009.

• Fourth quarter earnings were driven by a 22% YOY increase in P&C Canada with P&C U.S. earnings increasing 55% and Private Client earnings increasing 8%. BMO uses expected loan loss provisions. BMO Capital Markets earnings declined 3% due to lower trading revenue. The loss in the Corporate and Other segment moderated due to lower balance sheet carrying costs. Credit losses were in line remaining below Q3/08 and Q1/09 levels reinforcing our view that they have peaked. Impaired loan formations did increase QOQ due to one large account but remained lower than previous highs.

• Our 2010 earnings estimate is unchanged at $4.80 per share. We are introducing our 2011 earnings estimate at $5.50 per share. Our 12-month share price target is unchanged at $65 representing 13.5x our 2010 earnings estimate. We maintain our 1-Sector Outperform rating based on strong earnings momentum from retail banking as the bank restores its retail brand and franchise. In addition, the bank has a solid wholesale platform, strong capital, and leverage to improving credit.

P&C Canada Earnings Increase 22%

• P&C Canada earnings increased 22% to $394 million from a year earlier, driven by volume growth and improvement in the retail net interest margin (NIM). BMO uses expected loan loss provisions and not actual. If we used actual loan loss experience of $124 million, P&C Canada earnings would have increased 20% versus 22%.

• The retail NIM in Canada improved 34 bp from a year earlier and 5 bp sequentially to 3.22% due to higher deposit growth rate versus loan growth and securitization of low-margin mortgages. The retail NIM improved 29 bp in fiscal 2009 to 3.13%.

• Personal loan growth was strong at 13%, however, market share declined YOY. Personal deposits were also up 13% from a year earlier, resulting in a market share gain from a year earlier.

• Fiscal 2009 P&C Canada earnings improved 15% to $1,395 million from $1,212 million a year earlier.

P&C U.S. Earnings Increase YOY

• P&C U.S. cash earnings increased 55% from a year earlier to $31 million using expected loan loss provisions. If we use actual loan loss provisions of $149 million versus $15 million, P&C U.S. earnings would have been a loss of $60 million.

• The P&C U.S. retail NIM improved 26 bp year over year and 13 bp sequentially to 3.26%.

• P&C U.S. earnings increased 10% in fiscal 2009 to $137 million from $124 million a year earlier.

Overall Net Interest Margin - Flat In Q4/09; Improves in 2009

• The overall net interest margin for the bank was relatively flat at 1.78% versus 1.79% in the previous quarter and 1.77% a year earlier. The net interest margin for fiscal 2009 was 1.69% up 7 bp from 1.62% in 2008.

Private Client Group Earnings Improve YOY

• Private Client Group (PCG) earnings in Q4 improved 8% YOY to $112 million but declined sequentially from $120 million.

• Revenue increased 7.7% YOY, with expenses increasing 0.5%, for positive operating leverage of 7.2%.

• Mutual fund revenue declined 9% YOY to $128 million. Mutual fund assets under management. (as reported by IFIC) increased 9% YOY to $33.6 billion.

• Fiscal 2009 earnings declined 16% to $396 million from $474 million.

BMO Capital Markets Earnings Solid

• BMO Capital Markets earnings declined a modest 3% to $289 million from $298 million a year earlier, and 16% from Q3/09 levels of $344 million. If we used actual loan loss provisions of $93 million versus $41 million, earnings would have increased 7% from Q3/09.

• BMO Capital Markets earnings increased 42% to $1,489 million in fiscal 2009 from $1,049 million a year earlier.

Trading Revenue Declines

• Trading revenue declined to $262 million from $391 million in the previous quarter and from $283 million a year earlier.

• Fixed income trading revenue remained strong at $144 million. Equity trading revenue improved to $81 million in the quarter from $71 million in Q3/09. FX trading revenue was weak at $65 million versus $85 million in the previous quarter.

• In fiscal 2009, trading revenue increased a significant 70% to $1,493 million from $877 million.

Capital Markets Revenue

• Capital Markets revenue was $366 million versus $341 million in the previous quarter and $336 million a year earlier.

• Underwriting and advisory fees increased 76% YOY to $116 million, and securities commissions and fees declined 7% to $250 million.

• Capital markets revenue in fiscal 2009 declined 6% to $1,370 million from $1,458 million a year earlier.

Security Gains

• Security gains recorded in the quarter were a gain of $14 million or $0.02 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.03 per share a year earlier. Security gains for fiscal 2009 were a loss of $128 million or $0.16 per share.

• Unrealized security surplus increased to $655 million versus $381 million in the previous quarter and a deficit of $121 million a year earlier.

Loan Loss Provisions in Line

• Specific loan loss provisions (LLPs) were in line with expectations at $386 million or 0.91% of loans versus $357 million or 0.82% of loans in the previous quarter and $315 million or 0.67% of loans a year earlier.

• Specific loan loss provisions for fiscal 2009 were $1,543 million or 0.92% of loans versus $1,070 million or 0.57% of loans a year earlier. Total LLPs were $1,603 million or 0.96% of loans including $60 million in general provisions versus $1,330 million or 0.71% of loans including $260 million in general provisions.

• Our 2010 LLP forecast is unchanged at $1,600 million or 0.90% of loans. We are introducing our 2011 LLP forecast at $1,200 million or 0.63% of loans.

Impaired Loan Formations Increase Modestly

• Gross impaired loan (GIL) formations increased to $735 million from $549 million last quarter (one large U.S. financial services client, CIT) but remained below levels in Q4/08.

• Net impaired loan (NIL) formations increased to $719 million from $316 million in the previous quarter but declined from $976 million a year earlier.

• Gross impaired loans increased modestly in the quarter to $3,297 million or 1.96% of loans. Net impaired loans were also up slightly to $1,395 million or 0.83% of loans.

• The coverage ratio (ACLs as a percentage of GILs) deteriorated slightly to 58% versus 62% in the previous quarter and 73% a year earlier.

Capital Ratios Strong

• Tier 1 Capital increased to 12.2% from 11.7% in the previous quarter due to a 3% decline in risk-weighted assets sequentially. Tier 1 Capital was 9.8% a year earlier. TCE to RWA was extremely high at 9.2%.

• Risk-weighted assets declined 13% YOY and 3% QOQ to $167.2 billion. Market-at-risk assets declined 42% YOY to $6.6 billion.

• The total capital ratio was strong at 14.9% at the end of the quarter versus 14.3% in the previous quarter and 12.2% a year earlier.

BMO to Acquire Diners Club From Citigroup

• On November 24, 2009, BMO announced its intention to acquire the Diners Club North American franchise from Citigroup. The agreement would give BMO net credit card receivables of US$1 billion (mainly U.S.) and approximately US$7.8 billion in card transactions. These cards are corporate Travel & Entertainment and are accepted by Mastercard merchants. The loss ratio on this platform is relatively low due to nature of cards (corporate T&E). BMO acquired the brand plus travel & entertainment system which presents a cross sell opportunity with U.S. corporates. The details of the transaction were not disclosed. The transaction is expected to close before March 31, 2010 subject to regulatory approval.

SIVs – Exposure Declining

• The pace of asset sales remained slow this quarter. Links and Parkland structured investment vehicle (SIV) market value of assets were largely unchanged at US$5.5 billion and €0.63 billion, net of cash, respectively, versus US$5.6 billion and €0.60 billion in the previous quarter. BMO believes the first-loss protection exceeds future expected losses.

• Liquidity facilities extended by BMO for Links and Parkland as at October 31, 2009, declined to US$6.0 billion and €0.63 billion, respectively, versus US$7.9 billion and €0.69 billion at the end of July 2008.

Credit Protection Vehicle – Apex

• BMO provides a senior funding facility of $1.03 billion. As at October 31, 2009, $112 million had been advanced through BMO’s committed share of the senior facility to fund collateral calls. During the third quarter, BMO hedged the first $515 million of losses on the senior funding facility.

• BMO also has exposure of $815 million through investment in mid-term notes. In the fourth quarter BMO entered into an agreement to hedge its total exposure to the notes.

• BMO recorded $50 million of charges, comprised of a one-time $25 million cost to enter into the hedge on $815 million of notes and $25 million mark-to-market loss on the hedge on $515 million of exposure on the loan facility.

• BMO believes the credit quality of the trust is sound, with over 70% considered investment grade and a substantial first-loss protection in place. First-loss protection for the 10 tranches ranges between 13.0% and 29.4%, with a weighted average of 23.5%. Only two tranches have first-loss protection lower than the others.

Fairway – U.S. ABCP Conduit

• Fairway is a BMO-sponsored U.S. ABCP conduit. At the end of October, backstop liquidity facilities were US$5.7 billion, down from US$6.1 billion in the previous quarter.

Monoline Exposure

• BMO has direct notional exposure to monolines and credit derivative counterparties of $3.8 billion, with $256 million mark-to-market exposure. Counterparties: 28% rated AAA or better.

06 November 2009

Manulife Q3 2009 Earnings

Scotia Capital, 6 November 2009

Q3/09 Misses but Underlying EPS in Line

• A miss on larger reserve hits than expected (interest and lapse related) - but underlying EPS in line. As expected Q3/09 was noisy. Details are outlined in Exhibit 1. We were relatively impressed that the underlying EPS was in line with our estimate, and was 4% higher QOQ than the underlying EPS of $0.48 in Q2/09. Credit hits continue to be low and very manageable.

• Economic backdrop improves for Q4/09 - could finally be a "noiseless" quarter. With an annual detailed assumption review behind us (proactively putting the lapse issue to bed), long term interest rates rising (corporate yields are up 20 bp since Sep 30), equity markets generally less volatile, and credit hits diminishing ($0.07 EPS in Q3/09, versus $0.13 in Q2/09 and $0.29 in Q1/09), Q4/09 is shaping up to be a much welcomed "quieter" quarter, something all lifecos need to improve earnings visibility.

• Sales were mixed as MFC de-risks and rebalances product mix - we were encouraged by rebound in individual insurance sales - suggest brand and franchise remains strong. Individual insurance sales regained momentum, especially in the U.S., with sales up 19% QOQ (peers up 8%) and down 4% YOY (peers down 10%). In Canada momentum returned as well, with individual insurance sales down 2% YOY (top 4 up 7%) but up 5% QOQ (top 4 up 3%). Asia remains impressive with Japan individual insurance sales up 22% YOY and Asia (ex Japan) individual insurance sales up 11%. YOY. Wealth management sales excluding variable annuities were impressive, up 51% YOY in Asia and down just 2% YOY in Canada (slightly better than the industry). The U.S. and Japan VA sales remain weak as MFC de-risks its portfolio, down 63% YOY in the U.S. and down 68% YOY in Japan.

• 30% of total VA book is now hedged. MFC took advantage of attractive terms and hedged another $3.8B (in Canada), as the percentage of the total VA book now hedged climbed from 20% at Q4/08 to 30% as at Q3/09. We believe a 100% hedge undertaking is far too costly in this current environment, and essentially throws a lot of money at what could possibly be yesterday's problem. We believe the company is providing a far less costly and more shareholder friendly solution through de-risking the product mix, opportunistically hedging, and minimizing sensitivity of its capital base through a subsidiary reorganization. Maybe somewhere down the road up to 70% of the book may be hedged, but certainly not at these market levels.

• Sub-reorg reduces capital sensitivity. We estimate that after the sub-reorganization, the consolidated MCCSR would be 226% (including $1B at holdco), with each 10% move in equity markets hurting the MCCSR by 11 points. That means this consolidated MCCSR will not fall below 200% unless the S&P500 falls to 790.

• Decreasing 2010E EPS by $0.10 to reflect credit a modest expected $0.10 EPS credit hit. We've made similar credit adjustments across all the big three Canadian lifecos, as we're moving to a more conservative stance. Exhibit 2 outlines the development of our 2010E $2.20 EPS estimate. We essentially see a 2% quarterly increase in underlying EPS each quarter (conservatively less than the 4% in Q3/09) commensurate with a 2% quarterly increase in equity markets, with net experience gains of $0.05 in EPS, in part due to equity markets expected to be up 10% next year. Experience gains/assumption changes have generally averaged $0.59 annual EPS since 2004.

Sun Life Q3 2009 Earnings

Scotia Capital, 6 November 2009

Q3/09 Misses on Credit - Significantly lowering EPS

• A miss, once again on larger credit hits than expected. A noisy quarter, with credit hits $0.10 higher than expected and the gain from equity markets $0.07 less than expected.

• Underlying EPS somewhere between $0.67 and $0.72 - our estimate was $0.72. Details are shown in Exhibit 1. SLF management suggests the underlying may be closer to $0.72, claiming an investment underperformance of $0.05 in EPS, that should be made up in the near term as SLF enhances yield.

• Credit woes continue. EPS hits for credit continue to disappoint, but the pace declines, totalling $0.35 in Q3/09, down from $0.78 EPS in Q2/09 and $0.44 in Q1/09. Of concern is a $4.4B structured products portfolio (just 4% of invested assets) which accounted for about half the credit hits in the quarter. This portfolio was 96% investment grade in Q1/09, falling to 95% in Q2/09 and 90% in Q3/09, with a 5% decline in overall market value. Slippage is largest in the non-agency RMBS portfolio (MV $931 million, 83% investment grade, down from $1B and 89% investment grade in Q2/09), and the CDO/Other ABS portfolio (MV $749 million, 76% investment grade, down from $796 million and 85% at Q2/09).

• Significantly reducing 2010E EPS in light of a more conservative credit outlook and management's view of 2010 "normalized" EPS. Management's $2.50-$3.03 2010 "normalized" earnings exercise (which excludes experience gains and assumption changes, which together have averaged about $0.30 EPS annually since 2004) will likely force down consensus from its $3.10 level (in line with our estimate). We outline our approach to a $2.80 2010E EPS estimate in Exhibit 2, which assumes equity markets will end 2010 at S&P 500 of 1,150, up 10% over 2009. We've assumed experience losses of $0.30, primarily credit driven, and no assumption

• U.S. sales were strong - but expect U.S. VA sales momentum to decline as company de-risks product - Canadian sales mixed, but momentum improving. SLF's momentum continued in the U.S. with U.S. domestic VA sales up 128% YOY and 32% QOQ (we expect momentum to turn negative in Q4 as the company de-risks the product, Q3/09 sales were likely strong in anticipation of a price cut), and core U.S. individual life sales up 23% YOY. Canadian sales were somewhat mixed, but momentum is improving, with individual insurance sales flat YOY (top 4 were up 7%) and down 10% QOQ (top 4 were up 3%), and wealth management sales down 13% YOY and down 14% QOQ.

• Solid quarter for MFS. $7.7B in net sales ($1.9B retail and $5.8B institutional) and margins, at 28%, were up from 23% at Q2/09 and 21% at Q1/09.

• Capital position remains strong. We estimate the MCCSR for SLF's Canadian subsidiary, at 219%, can withstand a 35%-40% drop in equity markets before it hits 200%. That said, we can't say the same with confidence about SLF's U.S. subsidiary (about 1/4 the company's total capital and 40% of the company's total equity market risk) which required $1B in capital in late 2008/early 2009. We expect the holdco has some capital, although it will likely decline by $400 million in Q4/09 to pay for Lincoln's U.K. block.

Great-West Lifeco Q3 2009 Earnings

Scotia Capital, 6 November 2009

• EPS of $0.47, vs. our $0.43 estimate. In line with consensus of $0.48.


• Unlike the other big lifecos, GWO's limited equity market sensitivity and minimal interest rate sensitivity once again resulted in a fairly steady quarter - $0.04 above our estimate and $0.01 below consensus - underlying EPS at $0.49 in line with our estimate.

• Sales momentum continues in U.S. Financial Services, as several new cases propel the top line 50% YOY and 57% QOQ. As well, sales momentum continues in Canada, with individual insurance sales up 13% YOY and individual wealth management sales down just 3% YOY (better than prior quarters). Sales in the U.K. were down sharply (40%), but not as bad as the market (down 50%).

• While Putnam net sales, at negative US$1.8B, were much better than previous quarters, they were slightly worse than our negative US$1B - US$ 1.5B estimate. Putnam margins, at negative 11%, remain weak.


• With a much lower risk profile, significantly less EPS volatility, an excellent track record, attractive 10.6x multiple and 5.2% yield, we reiterate our 1-Sector Outperform rating.

02 November 2009

Barron's Article on Canadian Banks

Barron's, Dimitra Defotis, 2 November 2009

A Canadian native likes to give this quiz to his u.s. friends: What's the most boring word in investing? Answer: "Canadian." How can you make it even more boring? Put the word "banks" behind it.

But boring can be beautiful, especially when trouble erupts.

Yes, the shares of banks in the Great White North were badly bruised during last year's global meltdown, but they deserved better. Thanks to strict regulation, Canada's banks don't make subprime loans, and a typical mortgage term is only five years, greatly moderating balance-sheet risk. The largest banks have a virtual monopoly, controlling their regional markets for residential mortgages, credit cards, retail deposits and brokerage services. With their stout balance sheets and conservative bent, Canada's banks look healthy. Indeed, a recent World Economic Forum report rated the Canadian banking system as the world's soundest. In comparison, Switzerland was No. 16. The U.S. limped in at No. 40, just behind Germany (at No. 39) and ahead of the U.K. (at No. 44).

This isn't to say that Canada's financial system weathered the 2007-2008 financial debacle unscathed. Combined, the five largest banks -- Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Bank of Montréal, along with No. 6 National Bank of Canada -- have had more than $22 billion in write-downs in their securities and trading businesses since early 2007. But their American and European counterparts have fared far worse, and none of the Canadians has needed a government bailout. And now, RBC analyst André-Philippe Hardy argues, they are even less exposed to credit risk than in the past because loans make up 40% of assets, versus 45% in 2008 and 70% in the 1980s and 1990s.

Another positive: In Canada, when someone defaults on a mortgage, lenders have more recourse than do mortgage lenders in the U.S. What's more, RBC research views Canadian banks as well-insulated from some of the troubles to the south, even though they operate in the States. Through October 2008, the Canadians had only $16 billion in U.S. residential mortgages on their balance sheets -- a mere 3.5% of their total residential loans.

In some ways, anyone who invests in one of the five biggest Canadian banks -- all of which trade in both New York and Toronto -- pays a premium; in other ways, the stocks are bargains. Royal Bank of Canada, Toronto-Dominion and Bank of Nova Scotia are the group's most attractive members because they boast the most potential to boost profits through foreign growth. Each sells at more than two times book value, while some of their U.S. peers fetch less than book. But they all boast substantial dividends, rack up higher returns on assets and sell at lower multiples of current and expected earnings than their south-of-the-border rivals. The largest Canadian banks trade at an average of about 12 times estimated 2010 profits, compared with 13.7 times for JPMorgan Chase, 19.9 for Bank of America and 72 for Citigroup.

The northern banks are benefiting from a robust Canadian dollar that makes it easier to expand by buying foreign companies; operations abroad already account for about a third of their earnings. And they are being helped by the fact that Canada's recession has been somewhat milder than those in the U.S. or much of Europe.

"The next 12 months still look good," Rohit Sehgal, a money manager at Toronto's Goodman & Co. Investment Counsel, says of the Canadian banks, which he thinks should be helped by cost-cutting, a more favorable yield curve and a likely decline in nonperforming loans.

Based on normalized earnings projections, RBC estimates that TD and Scotiabank shares could rise more than 18% over the next year. Wall Street analysts see the pair climbing by a more modest 14% and 8%, respectively, and Royal Bank advancing by 10%. Add dividends, and the potential total returns look juicier.

Royal Bank of Canada, with a stock- market value of $70 billion, is Canada's titan. The bank also has the highest Tier 1 ratio -- a measure of capital ad- equacy -- at 12.9%. Royal Bank gets about a third of its earnings from the capital-markets division, which includes investment banking, trading and underwriting in the U.S. and Canada, and trading operations in London.

Dominic Grestoni, a money manager for Winnipeg-based I.G. Investment Management, says the bank is an accomplished asset manager and has had success selling mutual funds through its branches.

At its recent price of 51.81 (all the figures in this story are in U.S. dollars), Royal Bank is the group's most expensive member. But the stock historically has traded at a premium, and RBC's 15% return on equity is a bit above the group's average of 14%.

Analysts expect Royal Bank to earn $4.02 for its fiscal 2010 year, which ends next October, according to Thomson Reuters. That would be a decline of 3% from the $4.14 expected for fiscal 2009. (Twelve analysts surveyed by Bloomberg are looking for $4.35 next year.) Still, profit is expected to jump 18% in 2011, assuming the recession eases, global investment banking expands and U.S. operations recover. "Royal Bank globally [has] the opportunity to do better than the other banks," says money manager Sehgal. "You pay the highest multiple [see table on previous page] and get the lowest yield, but I am willing to do that because it ranks extremely well on any criteria."

Royal Bank's CEO, Gordon Nixon, tells Barron's that any large acquisition is likely to be in the company's wealth-management business, already the largest among its domestic peers. The bank has forked over $7 billion since 2000 to pick up U.S. retail banks, though its returns on acquisitions have been low. It has more than 430 branches in the States and, Nixon says, a U.S. acquisition is unlikely, "given balance-sheet weakness."

Toronto-Dominion Bank is likely to report only a slight increase in fiscal 2010 earnings, to $5.11 per share from the $5.07 expected for fiscal 2009, which ended in October. The company, which owns the TD Waterhouse and TD Ameritrade discount and online brokerages, has made a big push into the U.S., where it has more than 1,000 locations, about as many as it has at home.

Its Tier 1 ratio, at 11.2% as of the end of the third quarter, is in line with the average for U.S. competitors, and its return on equity, at 13.2%, is strong, but slightly below the average for the big Canadian banks. Since 2005, Toronto-Dominion has spent $20 billion on acquisitions, including Commerce Bancorp, whose U.S. branches are known for a high level of service.

Bank of Nova Scotia, in contrast, has been focused on Latin America in its global operations, which generate more than a third of its profits. Scotiabank, as it's known, has made retail-oriented acquisitions in the Caribbean, Mexico, Chile, Peru and other locales and is Canada's most international bank. The bank's return on equity, at 17.5%, is second only to National Bank's 20%. While its core business is retail banking, Scotiabank is expanding its wealth-management, brokerage and investment-banking operations. This year, it's likely to earn $3.30 a share. The figure should rise to $3.35 in 2010 and to $4.24 in 2011.

As for the other big banks, Canadian Imperial has made a foray into the Caribbean, while Bank of Montreal has expanded in Chicago and Milwaukee.

Grestoni, the I.G. Investment Management money manager, has made the three largest Canadian banks his largest holdings. He's sold some of his Bank of Montreal stake; he considers it a laggard in retail businesses, including mutual funds and wealth management. While the Montreal bank moved into the U.S. early, buying Harris Bank in Chicago more than a decade ago, and community banks also in the Chicago area, those operations struggled during the credit crisis.
In sum, if the markets sell off, Canadian bank shares won't be immune. And if the global economy doesn't recover as strongly as analysts expect, 2011 profits might not be as robust as forecast. But, at the least, boring can help investors sleep better, especially when it pays a nice dividend.

The Bottom Line: Shares of Canada's three largest banks offer potential upside of 8% to 18% over the next 12 months. And that doesn't count the substantial dividends that they offer.

26 October 2009

Where Do Bank Stocks Go From Here?

Financial Post, John Greenwood, 26 Octber 2009

Like their peers around the world, Canadian banks got clobbered on stock markets as the financial crisis raged. But as the gloom cleared, their shares -- unlike those of many foreign banks that had the misfortune of owning toxic credit investments -- rocketed skyward, leading the way in one of the most spectacular stock market rallies in decades.

By early August, they had regained nearly all the ground lost since the storm broke in September 2008, collectively rising about 65% from the lows of March.

But for nearly three months since then, bank shares have mostly treaded water -- the sole exception Royal Bank of Canada, which peaked at the end of August instead of the beginning. As the broader Toronto market ploughed ahead, investors have been left wondering if that's all there is for the bank rally.

Brad Smith, an analyst at Blackmont Capital Inc., said he's not surprised.

"More than anything else, what you are seeing is a natural period of consolidation that you would expect to occur after a significant advance driven by improved earnings multiples going forward," said Mr. Smith. "So it's not surprising we are seeing this temporary lull."

Shares in Royal Bank last week closed at $53.39, down 59¢. Bank of Montreal ended at $52.03, down $1.01. Canadian Imperial Bank of Commerce was $1.09 lower at $64.36. Toronto-Dominion Bank was down 67¢ at $64.97, while Bank of Nova Scotia finished at $46.34, down 53¢.

Mr. Smith said the market is still trying to decide if the early optimism around the Canadian banks and their lack of exposure to subprime mortgages justifies the spectacular rise in shares, arguing that the upcoming forth-quarter earnings --due in early November -- will provide a lot of the answers.

One concern is that much of the good news that analysts are expecting has already been factored into the shares, so unless the results include some positive surprises, it could be bad news for investors.

"The banks are trading at roughly 13 times expected 2010 earnings but the reality is that, historically, the range is between eight and 15 times earnings, so we are much closer to peak multiple levels than troughs," said Mr. Smith.

Another issue that will likely affect the banks is proposed new regulations that have come out of Group of 20 nations discussions. In recent weeks, the focus has been on executive bonuses but the rules are expected to cover everything from how much capital banks are required to hold to the amount of leverage they can take on.

"These are the kinds of things that really do affect profitability," said an analyst who asked not to be identified. "No one knows [what the regulations will ultimately look like], so until you get some clarification you just have to hold your breath."

For its part, the federal government has argued that since banks in this country didn't get mixed up in the kind of toxic investments and reckless risk-taking that brought down so many of their global peers, Canadian regulations aren't in need of the kind of overhaul they're getting in the United States and Europe.

But critics say that unless Ottawa follows suit with its fellow G20 countries, it risks upsetting the global balance and becoming a magnet for foreign firms that want to sidestep the rules in their home jurisdictions.

"Capital markets is a global business," said Mr. Smith. "You can't have pockets of regulation that are different from the rest because all the capital will tilt into those jurisdictions."

Another explanation for why bank shares haven't moved is that investment dollars are being drawn toward more attractive sectors such as energy.

At a time when there is so much uncertainty over financial services, the logic around oil and gas is simple. Against the backdrop of an improving global economy, oil prices have been moving steadily higher over the past few months.

"At the end of the day, a guy pulling oil out of the ground [in today's economy] has less risk than a guy sitting on a bunch of loans."

24 October 2009

TD Canada Trust Tests New Branch Format

The Toronto Star, Rita Trichur, 24 October 2009

Inside Toronto-Dominion Bank's corporate headquarters, its secret code name is "Bravo." But on the streets of Brampton, folks are calling it the "branch of the future."

Canada's second-largest bank has chosen this fast-growing GTA city as the testing ground for a daring new experiment that is set to revolutionize personal banking in this country.

Its new prototype branch, at 135 Father Tobin Rd., features an ultramodern design that could eventually become standard fare at all TD locations across Canada. The new "Bravo" branch resembles a cross between Starbucks and Ikea with plenty of high-tech banking gizmos.

Borrowing a page from those venerable retailers, TD's goal is to make its new branch a destination for consumers by giving them a trendy place to hang out with their family and friends.

Its open-concept layout includes marketing gimmicks like a lounge area with complimentary coffee-based beverages, a special kids' zone, a community room and a free coin counter that are also available to non-clients.

Executives are hoping that fresh approach to customer service will translate into more sales of financial products like mortgages, lines of credit and mutual funds. It is an unconventional business strategy made famous by Commerce Bancorp, the New Jersey-based bank that TD bought in 2007.

For the Canadian banking industry, however, the approach marks a dramatic shift from the late 1990s when banks were actively pushing consumers out of branches to lower-cost platforms like online, telephone banking and automatic teller machines.

Tim Hockey, president and chief executive officer of TD Canada Trust, says the new pilot branch is designed to take the "stress" out of branch banking for consumers.

"There was a concept that Starbucks used that I always thought was kind of interesting. And that is `the third place,'" Hockey said.

"And the concept there is you've got your home, you've got your work (but) everybody needs a third place. A place to go where, just like that old Cheers sitcom, `Everybody knows your name.'"

Old-fashioned relationship-building not only makes clients feel appreciated, but it also makes it easier for banks to sell them a wider range of products and services.

And while clients continue to use the Internet, telephone and ATM channels, nearly 85 per cent of TD Canada Trust's revenues "are still generated at the branch level," BMO Capital Markets analyst John Reucassel said in a report this week. He noted the "key" to TD's financial performance is its "focus on service and convenience."

TD's new pilot branch attempts to take customer service to the next level. There are state-of-the-art videophones that can be used to connect customers to live investment experts.

Clients can also use free computers to surf the web or relax in its lounge to catch up on their reading. The bank supplies a range of high-end magazines in addition to local community newspapers.

"You can just sit and have a coffee," said branch manager Nupi Dhillon, as she gestured to the free beverage machine. Children, meanwhile, are free to explore the adjacent kids' area that features an array of books, toys and a pint-sized computer.

In an effort to build stronger ties with the local community, both customers and non-customers alike are invited to use the branch's high-tech community room to hold meetings. The no-cost service is expected to be a hit with non-profit groups and small-business owners.

Other signature items include a document shredder and a free coin counter – an idea inspired by the Commerce's wildly popular Penny Arcade coin machine.

Commerce, established in 1973, based its business model on a stable of Burger King outlets also owned by its founder, Vernon Hill. Its banking strategy was based on a "Wow" culture that often included free treats for children and dogs.

TD has often mused about importing those ideas to Canada. It hopes its new branch experiment will succeed in generating priceless word-of-mouth advertising to attract new clients.

"Quite frankly, the average Canadian consumer doesn't feel all that warmly disposed to their average bank,'' Hockey said. ``So, we're trying to change that, one customer at a time."

Other banks also appear to be sharpening their focus on luring customers back to branches at a time when the recession has taken a bite out of their investment banking profits.

For instance, larger rival Royal Bank of Canada opened 25 new branches this year, while renovating and remodelling more than 100 others. Another 20 new branches are planned for 2010.

Canadian Imperial Bank of Commerce, Canada's fifth-largest bank, has accelerated its branch strategy. CIBC originally said it would open, expand or relocate 70 branches by 2011. It now plans to complete all 70 by the end of next year, with 41 of those branches ready by the end of 2009.

Christina Kramer, CIBC's executive vice-president of retail markets, said the bank has invested $280 million in its strategy. It is the biggest branch investment in CIBC's history.

"Clients do like coming into a branch to have a face-to-face discussion with an adviser," Kramer said. "It helps establish a relationship. It also helps us spend some quality time really understanding their personal goals and needs."

It is an industry about-face from the late 1990s when banks, especially those in concentrated markets, had an incentive "to lower branch-service quality" in order to steer consumers toward lower-cost online banking, suggests research from the Bank of Canada.

"Between 1998 and 2006, the top eight Canadian banks have on average reduced the number of retail branches they operate by 23 per cent, despite a 37 per cent increase in deposits," says the working paper authored by Jason Allen, Robert Clark and Jean-Francois Houde.

Customers, it seems, pushed back. While Canada is one of the "most developed" online banking markets in the world, banks are facing the stark reality that many older customers still prefer traditional teller service, according to ComScore Inc. That repudiation has helped make bricks-and-mortar branches all the rage again, proving the Internet has yet to render old-fashioned branch service obsolete.

"In the 1990s, everybody in the industry believed that branches – because the Internet was so hot – everybody believed that nobody would want to go in the branch anymore," Hockey said.

"Here we are 10 years later easily, and they're never more popular."

19 October 2009

Preview of Life Insurance Cos Q3 2009 Earnings

Scotia Capital, 19 October 2009

Canadian Lifecos – Another Noisy Quarter – Economic Backdrop Improving – Valuations Remain Very Attractive

• Another quarter with a lot of moving parts. As was the case in Q2/09, we expect the continued rebound in equity markets in Q3/09 will be offset to some extent by reserve increases, primarily related to declining long-term corporate rates, but also due to increasing policy persistency on lapse-supported products. Some have pre-announced, suggesting in Q2/09 earrnings releases that, given the pronounced market volatility, Q3/09 results would be affected by prospective actuarial assumption changes. In particular, MFC suggested in its Q2/09 release that preliminary information suggested a change in lapse assumptions for variable annuity/segregated fund guarantee business may result in a Q3/09 charge not to exceed $500 million ($0.30 EPS). MFC also suggested that changes in assumptions for other factors, which could not be estimated at that time, could result in additional charges to earnings. Our best guess is these charges, which we estimate to be $0.62 EPS, will be interest rate driven, as long corporate bond yields continue to fall. SLF also “pre-announced” at Q2/09, suggesting the company expects to take a Q3/09 charge of $350 million to $450 million ($0.80-$0.98 EPS) as it updates its stochastic economic scenario generator in accordance with updated professional guidance – guidance which we can gather applies only to SLF’s stochastic methodology, all others using a deterministic approach to which the revised guidelines do not apply. We’re somewhat uncertain as to whether IAG, the most sensitive of all the lifecos to interest rate changes, will book a charge for lower bond yields, in particular as they relate to long-term Quebec bonds (which generally support actuarial liabilities). However, our guess is that IAG will not, since it generally reviews this assumption at Q4, and the yields on these bonds have started to climb since the end of Q3/09. GWO, the least sensitive to changes in equity markets and interest rates, will likely have the least amount of noise in its results. Finally, we expect the Q3/09 to be marked with credit hits (although not nearly as high as in previous quarters) as companies continue to increase default provisions as bonds are downgraded and credit conditions – at least in the eyes of the rating agencies (often the last to move) – remain uncertain.

• Focus will be on underlying earnings. For Q3/09, we expect this to be $0.49 for GWO, $0.60 for IAG, $0.50 for MFC, and $0.72 for SLF. We expect SLF to provide some sort of clarification as to what the underlying earnings are/will be going forward.

• Modestly trimming 2010 EPS estimates – largely due to currency. We reduced our 2010E EPS estimates by $0.05 for MFC and SLF and $0.04 for GWO, largely to reflect the impact of currency. In keeping with Scotia Economics’ recent move, we bumped our average Canadian dollar estimate for 2010 to US$0.98 (from US$0.96) and £0.59 (from £0.56), and are keeping it at ¥87.

• While it could be argued to wait on the group until we get a quarter with good earnings visibility that further reinforces that underlying earnings are not only achievable, but more importantly beatable, we think it’s better to be early. We know lifecos are complicated enough as it is, and noisy quarters make it worse. And while it can be argued we need to wait for good earnings visibility, one could argue it’s better to be early, especially given the fact that equity markets continue to climb, and, perhaps even more importantly, long-term interest rates are climbing, which is clearly a positive for the group. In the last two weeks, U.S. long-term corporate A and AA yields have increased 25 basis points (bp), Canadian long-term provincial bond yields have increased 16 bp, and Canadian and U.S. long-term treasury yields have increased 20 bp. There are signs of momentum in the group as well. While Canadian lifecos have underperformed the U.S. lifecos and the Canadian banks by 30% and 5%, respectively, in the last three months, they have outperformed in the last 30 days, bettering the U.S. lifecos by 2% and the Canadian banks by 6%. And finally, they’re still very attractive relative to these other financials. There’s still a significant discount between the Canadian Lifecos (10x 2010E EPS) and where they historically trade vis-à-vis the U.S. lifecos (Canadian lifecos currently at a 4% premium on a P/E basis, well below the average 13% premium) and the banks (Canadian lifecos are at a 20% discount, well below the 1% discount average).

Great-West Lifeco Inc.
1-Sector Outperform – $31 one-year target, based on 2.3x 9/30/10E BVPS and 12.2x 2010E EPS
• We’re looking for EPS of $0.43 for Q3/09, $0.05 below consensus, with underlying EPS of $0.49. Our 2010 EPS estimate is $2.30, $0.02 below consensus.
• Should be a relatively clean quarter – unlike the other lifecos. GWO is the least sensitive in the group to changes in equity markets and interest rates
• Still some minor credit hits (we estimate $0.09 in EPS), largely related to U.K. hybrids, but should be of less concern as market values of these securities continue to climb.
• Good sales momentum in Canada likely to continue.
• Putnam margins likely to remain under pressure, but net sales could be encouraging (expect them to be negative US$1B-$US1.5B, the best they've been since early 2008)

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $33 one-year target, based on 1.5x 9/30/10E BVPS and 10.3x 2010E EPS
• We’re looking for EPS of $0.61 in Q3/09, $0.05 below consensus, with underlying EPS of $0.60. Our 2010 EPS estimate is $3.00, $0.16 above consensus.
• No credit hits expected, primarily based on IAG’s “Canada only” asset portfolio.
• Expect no Q3/09 EPS hit from declining interest rates (IAG is the most sensitive by far) – but keeping a close eye particularly on long-term Quebec bond yields – which have declined 28 bp in Q3/09. The fact that these rates have climbed 18 bp since Sep 30 is encouraging, but if they remain flat through Dec 31/09 we'd expect a $0.30 EPS hit.
• Sales likely to remain weak but could be plateauing.

Manulife Financial Corporation
1-Sector Outperform – $28 one-year target, based on 1.7x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for EPS of $0.34 for Q3/09, $0.04 below consensus, with underlying EPS of $0.50. Our 2010E EPS estimate is $2.30, $0.11 above consensus.
• A noisy quarter. We expect an estimated $0.81 EPS gain from equity markets will be offset by $0.92 EPS charge due to actuarial reserve assumption adjustments, which include $0.30 EPS in pre-announced lapse rate assumption changes on VA business and an estimated $0.62 EPS in reserve assumption changes related to declining interest rates
• The recent rise in long term Corporate rates (Corporate A rates up 23 bp since Sep 30) is very positive for MFC.
• We expect to hear more about steps the company is taking to mitigate the sensitivity of the company’s capital to changes in equity markets. The new structure we believe will reduce MCCSR sensitivity such that a 10% drop in equity markets will reduce the MCCSR ratio by 13% (new structure) as opposed to 20% (old structure).
• Sales will likely remain mixed. Strong in Asia but weak in the U.S.

Sun Life Financial Inc.
2-Sector Perform – $37 one-year target, based on 1.3x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for Q3/09 EPS loss of $0.06, $0.05 above consensus, with underlying EPS of $0.72. Our 2010E EPS estimate of $3.10 is in line with consensus.
• Another messy quarter – a lot of moving parts. We estimate a $0.90 EPS hit for reserve assumption changes related to new actuarial guidelines (affect SLF only), $0.06 EPS hit for declining interest rates, $0.25 EPS credit hits, offset by $0.36 EPS in equity market gains and $0.07 EPS gain from narrowing credit spreads.
• Company track record continues to make us a little nervous with respect to credit – we look for $0.25 EPS in credit-related hits.
• Looking for some “guidance” as to what is sustainable EPS.
• U.S. sales momentum likely to continue.

08 October 2009

Canadian Banks Rebound From Crisis Ahead of Rivals

Bloomberg, Matt Walcoff and Sean B. Pasternak, 8 October 2009

For Canada’s banks, it’s almost as if the financial crisis never happened.

The Chart of the Day shows bank stocks in Canada’s Standard & Poor’s/TSX Composite Index have recouped almost all of their losses since Aug. 8, 2007, the day before credit markets began seizing up. The nine stocks in the bank index trade at 91 percent of their level on that day, rebounding from a six-year low on Feb. 23. That compares with 53 percent for the MSCI World Bank Index and 35 percent for the S&P 500 Banks Index.

“It’s easier to be comfortable in the banking sector in Canada, because while they all have different strategies, they are all relatively conservative,” said Todd Johnson, who helps manage C$125 million ($115 million) at BCV Asset Management in Winnipeg.

Canada has the soundest banking system of the 133 countries surveyed in the Global Competitiveness Report of the World Economic Forum, which runs the Davos meetings of world leaders. The U.S. ranks 108th. No Canadian bank has failed since the early 1990s, and none of Canada’s 21 domestic banks has asked for a government bailout.

Royal Bank of Canada, the country’s largest lender, surpassed its August 2007 stock price on Aug. 27, and last week reached the highest price since July 2007. National Bank of Canada, the nation’s sixth-biggest bank, only needs to rise 1.3 percent to reach its Aug. 8, 2007, level. National Bank has surged 88 percent in 2009, the most among lenders in the S&P/TSX and S&P 500.

Analysts are betting the surge isn’t over. Canadian bank stocks with at least five analyst recommendations have an average rating of 3.49, with 5 as the top ranking. The average U.S. bank stock has a rating of 3.22 and the average European bank is at 3.03, according to Bloomberg surveys.

15 September 2009

Review of Banks' Q3 2009 Earnings

Scotia Capital, 15 September 2009

Earnings Stellar – Inflection Point – Outlook Improving

• Canadian banks reported stellar third quarter earnings, substantially better than Street estimates. This was the third straight quarter of beating estimates, but it was by far the largest beat. Based on the strength of third quarter earnings it appears that Q2/09 was the bottom for the cycle on an operating earnings basis, with Q1/08 the bottom of the cycle on a reported earnings basis, including all writedowns. The banks’ previous quarterly results (Q2) provided some optimism that earnings were near the cyclical bottom based on an improved outlook for the net interest margin, credit cost absorption, and sequential improvement in wealth management, which were all fully delivered in the third quarter with added strength from the continued high level of trading revenue.

• Thus, it appears the Canadian banks have weathered the banking siege in a strong fashion. The quarterly bottom in reported return on equity would be 10.5% in Q1/08 and 17.1% in Q2/09 on an operating basis. This reinforces the strength of the Canadian banking system and the banks’ business models.

• The most significant development this quarter, we believe, was the improvement in the net interest margin, which reversed an eight-year descent. The positive impacts of loan repricing, a steep yield curve, lower funding costs, and lowering of liquidity costs were instrumental in improving the banks’ NIM. This represents an important inflection point and bodes well for bank earnings going forward. The potential beginning of a trend of expanding bank net interest margins is not expected to be meaningfully interrupted in the event interest rates begin to rise, especially if they rise in a controlled and orderly fashion.

• Another potential positive inflection point this quarter was on credit, as gross impaired loan formations declined for the second consecutive quarter and loan loss provisions were flat with the previous quarter, suggesting loan losses may be peaking at the $10 billion annualized rate. Thus, we believe loan loss provisions should start to decline by the last half of 2010.

• The banks’ main earnings driver in the third quarter continued to be wholesale banking, with record results due mainly to the continued high level of trading revenue supported by very modest loan losses. Retail banking results were also solid in the quarter, although muted by relatively high retail loan losses, particularly in credit cards. Wealth management earnings rebounded sequentially and are expected to show strong momentum off the bottom.

• The banks reported a fully loaded return on equity after all writedowns and adjustments of 16.3%, with operating return on equity of 18.6% despite what we believe are near-peak loan losses.

• The market, we believe, has discounted bank earnings strength in the first two quarters of 2009, citing low quality due to high trading and securitization revenue. However, if we balance this out somewhat with the probability that a portion of the very strong trading revenue has a structural component and is not all cyclical, and that banks are arguably absorbing peak loan losses, weak wealth management earnings, and generally booking security losses in their available-for-sale securities portfolio, we conclude that earnings quality is only marginally lower. Also, we believe the actual income statement/net income impact of trading and securitization revenue (exhibits 15 and 16) is much lower than the market is generally factoring in. Thus, we conclude third quarter earnings were stellar with reasonable quality and that bank earnings are poised to rise.


• Bank stocks have increased 50% year-to-date 2009, substantially outperforming the TSX, which has increased 24%. Despite the share price performance, we believe valuations remain attractive on both a dividend yield and a P/E multiple basis.

• Dividend yields of 4.1% are compelling, especially with the prospects of dividend increases as early as the next several quarters and the particularly low yield on government bonds. The sustainability of bank dividends, scarcity of reliable yield, and the resumption of superior dividend growth are expected to be the catalysts for significantly higher bank share prices.

• Bank P/E multiples have rebounded to 12.3x trailing from the 6.0x low reached in late February. We estimate the valuation contagion overshoot was three to four multiple points. We believe fundamentals support higher valuation as the market refocuses on fundamentals and earnings power.

• We continue to expect bank P/E multiple expansion similar to that experienced post the 2002 cycle. We expect bank P/E multiples to expand to 14x trailing over the next 12 months and eventually reach 15x to 16x. Thus, with P/E multiple expansion and bank earnings bottoming, we believe this bodes well for continued strong share price gains over the next several years.

• In summary, we believe the positive earnings outlook that is unfolding and the continued high profitability will lead to dividend increases, complemented by low yields on treasuries, and will be supportive to continued expansion or recovery in bank P/E multiples. We do not expect meaningful share price resistance and consolidation until the bank P/E recovers to the 14x range, allowing for a further 28% ROR from the bank group.

• We continue to recommend an overweight position in bank stocks based on strong fundamentals and attractive valuation. In terms of stock selection, RY continues to be a standout given the strong reinvestment, competitive positioning in all its major business lines, and resulting industry-high profitability and capital.

• We have 1-Sector Outperform ratings on RY and BMO, with 2-Sector Perform ratings on BNS, CWB, LB, TD, and NA, and a 3-Sector Underperform rating on CM. Our order of preference is RY, BMO, BNS, CWB, LB, TD, NA, and CM.
Financial Post, David Pett, 11 September 2009

Investors anxious for Canadian banks to start raising their dividends should not hold their breath, says Desjardins Securities analyst Michael Goldberg.

"The impact on operating profit of unsustainably high trading revenue and sustained pressure on loan loss provisions, we do not believe that earnings quality or quantity are yet sufficient to support dividend increases," he said in a note to clients.

Mr. Goldberg added that future dividend increases are dependent on the direction of capital regulation.

"If we assume that OSFI maintains its current minimum standards of 7% Tier 1 and 10% total capital and that the banks will want to maintain a comfortable margin of safety above that level (because the consequences of falling below it are so draconian), then this is another reason for banks not to increase their dividends and it may not even justify issuiing more common equity to strengthen that margin of safety," he wrote.
TD Securities, 8 September 2009

• Q3/09 well through expectation. Exceptional trading results helped drive bottom-line numbers that were 21% better than expected on average. We are most encouraged by the credit trends which were broadly better than feared. Domestic P&C banking segments were also solid.

• Hard to see outsized returns. Outsized returns come on the back of outsized earnings growth or upward revaluation. We see limited prospects for either from current levels with the group seemingly already pricing in what we expect will be a relatively shallow earnings trough in 1H10.

• Introducing 2011 estimates. Our visibility is pretty limited that far out, particularly given what we view as heightened uncertainty around the macro outlook. Nonetheless, we are comfortable that credit costs will decline materially and that offers potentially significant bottom-line leverage for the group.

• Credit largely on pace. In most cases, the pace of deterioration appears to be easing and the outlooks are generally steady. We still expect conditions to deteriorate further (particularly on the commercial side), with losses ultimately peaking in 1H10. We still see credit topping out comfortably below the peaks of prior downturns.

• Staying with leverage to the recovery. We think Scotia and TD continue to offer the best leverage to a positive turn in economic growth. Both are trading at reasonable valuation in our view, but we see more potential for upward revaluation in TD (as ROE improves over time).

Executive Summary

Q3/09 results were largely better than expected, helped by exceptionally strong Trading/Wholesale results. These trends are likely to ease, but credit and core domestic P&C banking were also generally good. The stocks rebounded through results season, outperforming slightly. We are comfortable with how the fundamental story is unfolding. From here we still see valuation as the biggest constraint to outsized returns. We remain market weight.

Q3/09 results were largely better than expected with four out of the six Large-Cap Canadian Banks beating consensus estimate by an average of more than 21%. Through earnings week, the stocks were up roughly 4%, slightly outperforming the local index.

We made relatively minor changes on the quarter with no rating changes. We raised our estimates and Target Prices across Royal, National Bank and TD Bank. We reduced our estimates slightly at CIBC (target unchanged). Consensus estimates continue to rebound.

The composition of the results was still a bit questionable again this quarter, with strong trading results accounting for a large portion of the out-performance. Most management teams referred to the pace of trading results as unsustainable, noting that they are already seeing some softening.

Credit was also very encouraging. Most names reported inline or better than expected PCLs and most were still running below our assumed run rate for 2010 (we only increased our PCL estimates meaningfully in the case of CIBC). Furthermore, the underlying trends were generally encouraging with the pace of deterioration starting to slow. We also note that most banks appear to be well reserved.

We were also encouraged by the solid momentum evident in most P&C banking platforms, with particularly good volume growth which suggests good revenue momentum heading into 2010.

Overall we are comfortable with how the core fundamental story is unfolding. Domestic banking is enjoying a bit more momentum than we had expected, but we suspect some of the volume growth reflects the effect of lower rates and pent-up demand driving a bit of bounce in the housing/mortgage market. We expect trends to moderate in the coming quarters. Credit should also continue to deteriorate (particularly in commercial portfolios). However, the situation seems well in hand based on the underlying trends and management outlook. We expect credit costs to peak in 1H10, slightly above current run rates, and comfortably below prior peaks.

With this report we are rolling out our first look at 2011 estimates. It is still a ways off, but we have focused on what we expect will be the biggest single driver of what we believe will be an earnings recovery, and that is declining credit costs. As a result, we see 2011 EPS up in the order of 25-30% across the group. We remain market weight on the group. The biggest constraint to outsized returns in our view is valuations. The group is currently trading at 2.1x book value which is above the 15-year average of 1.8x book. In our view, a move toward peak valuations would require a more favorable environment than we currently expect (i.e. stronger economic growth and fewer risks). We see average returns on the order of 5-20%, including an average dividend yield of 4.4%.

In terms of stocks, our stance remains the same. We want to remain positioned with the best operating leverage to a recovering global economy. In our view Scotia and TD are the best ideas in this approach. Scotia suffered from some credit disappointment on the quarter with an uptick in GILs in the International commercial loan book. However, the issues appear to be quite concentrated (the rest of the book actually improved) and the related costs are likely manageable (the Q3/09 PCL run rate was still below our standing assumptions for 2010). Ultimately we believe Scotia will manage the credit downturn (likely better than feared) and will be well served by its favorable International positioning and corporate/commercial lending business.

TD saw a strong quarter with positive trading results helping to offset higher credit costs (but came in below expectations) and we see good upside in a recovery scenario. Credit trends remain well controlled and although we believe the bank will face greater pressure in the coming quarters, they will likely remain manageable in the context of the banks largely stable and sizeable Domestic Retail earnings base. In our view, the bank’s U.S. strategy will be key to the outlook of the stock and the integration of the U.S. platform is nearly complete. We believe TD will be able to generate greater value from its U.S. Retail franchise and offer potentially higher ROEs (and valuation multiple) in a recovery scenario.

CIBC remains the most interesting name to watch in our view. The quarter offered a new source of disappointment with surprising credit losses coming out of its leveraged loan book and deterioration in its U.S. commercial real estate business. However, the bank is exceptionally well capitalized with potential sizeable recoveries over the coming years with a large retail platform, although it is underperforming expectations under very tight risk management.