29 May 2009

Scotiabank Q2 2009 Earnings

• BMO Capital Markets raises target price from $35 to $37
• Desjardins Securities cuts target price from $45.50 to $41.50
• National Bank Financial raised target price from $34 to $38
RBC Capital Markets has a target price of $53
• TD Securities has a target price of $46
• UBS Securities raises target price from $40 to $42
TD Securities, 29 May 2009

Q2/09: Weathering Downturn; Well Poised for Growth

Yesterday, the bank reported core cash FD-EPS of C$0.96 vs. TD Newcrest C$0.75 and consensus C$0.80.


Neutral. Helped by strong trading, the quarter was well through expectations on an adjusted basis. We are seeing clearer signs of credit deterioration (now including the wholesale book), but evidence suggests the bank continues to be pro-active in managing risk and building reserves. We remain comfortable that the platform will weather the downturn and it should emerge well poised for growth.


Actually one of the best Domestic results. Potentially lost in the mix of yesterday's results, Scotia again turned in one of the best Domestic results of the group (see Exhibit 1). While suffering from the industry wide slowdown, we continue to view Scotia's domestic positioning as materially improved over the past year and becoming a strength going forward.

Keeping ahead of the credit curve. The much anticipated deterioration in the corporate/commercial books has now materialized in the reported numbers as Scotia Capital recorded its first significant PCL in recent memory. Overall, we continue to expect significant PCL growth through year-end. However, we continue to believe the team has been proactive in anticipating and managing its exposure and related reserves. Case in point, with the cover of strong capital markets results, the bank added to generals and established a sectoral related specifically to its auto exposure.

Weathering the downturn and well positioned for recovery. The current downturn hurts the bank's corporate credit exposure and International business. However, we believe management has been proactive in preparing for the cycle. We expect the bank to weather the current conditions and emerge well poised to capitalize on a recovery scenario benefiting from its strong wholesale lending presence and well positioned International platform.

Conference Call Highlights

• Cautious tone on acquisitions. Management downplayed interest in immediate term acquisitions, suggesting continued discipline in reviewing the ample potential targets, primarily in the International portfolio.

• Tax rate to ease. The quarter actually saw a slightly higher than expected tax rate of around 31%. Going forward it is expected to run closer to 21-24%

• Acceptable capital levels. While lower on an absolute basis versus peers, management feels the bank is comfortably capitalized relative to its risk and ongoing earnings/ROE prospects.

Results Highlights (year-on-year growth unless stated)

• Domestic. A relative bright spot again this quarter. The segment was flat year-on-year, with decent revenue growth (+5%) and good operating leverage offset by PCL growth (including general and sectoral reserve build). As we have seen elsewhere, Wealth Management had a difficult quarter.

• International. Decent revenue growth at +13%, but expansion/investment driven growth and higher credit costs crimped bottom-line which was roughly flat.

• Capital Markets. A strong quarter that was on par with the strength of Q1 helped by trading revenues, offsetting an uptick in credit costs as the segment saw its first meaningful PCL expense in recent memory at C$109 million in specifics (plus sectoral for a total of C$159 million) reflecting the impairment of a handful of credits largely related to U.S. real estate.

• Other/Corporate. Continues to reflect higher funding costs driving elevated losses and the reported write-down on AFS securities, but pressure eased over Q1/09.

Operating Outlook. Despite the beat on the quarter we are leaving our outlook unchanged. Specifically, we expect trading income to be less robust in back half of the year, loan volume growth to moderate and credit costs to remain elevated.

Segment Outlook. Lower trading revenues and continued PCL growth is likely to reduce Capital Markets income through 2H09. PCLs will also keep pressure on Domestic, where growth rates should weaken materially as the bank cycles 2H08 strength. International remains difficult to forecast (currency, PCLs, NIE etc, etc), but on balance we expect the contribution to ease through 2H09.

Credit Outlook. Based on Q2 developments, we expect to see credit to continue to deteriorate through the year and sustain significant PCLs. In particular, we are expecting further impaired development in the corporate portfolio. We maintain that overall, credit should be manageable in the context of the bank given decent reserves and ongoing earnings.

Capital Outlook. With ratios slightly below its peers, we expect Scotia to continue to manage capital judiciously. However, we believe management is not uncomfortable with where current levels stand and concerns of an equity raise now seem quite remote.

Justification of Target Price

Our Target Price reflects a discount to our estimate of equity fair value 12 months forward (based on our views regarding sustainable ROE, growth and cost of equity), implying a P/BV on the order of 2.25x.

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 remain comfortable that the platform will weather the downturn and it should emerge well poised for growth.
Bloomberg, Sean B. Pasternak, 28 May 2009

Bank of Nova Scotia, the Canadian bank that’s expanded in about 50 countries, probably won’t make additional acquisitions amid the recession as it sets aside more money for bad loans.

“We have to be prudent in how we grow the bank,” Chief Financial Officer Luc Vanneste said today in an interview in Toronto. “In this environment, I think you’ll see more on the organic side than you will via acquisition.”

Scotiabank, which has spent about $4.2 billion on acquisitions in the last two years to expand in Peru, Chile and Thailand, will still look at deals, though “we have an onus to our shareholders to appropriately deploy the capital that we have,” Vanneste said.

The bank reported earlier today that second-quarter profit fell 11 percent after loan-loss provisions more than tripled. Net income in the period ended April 30 fell to C$872 million ($783 million), or 81 cents a share.

Vanneste said loan-loss reserves will probably rise until at least early next year.

“We see the world improving, but I think that we will still have several quarters of what I’ll call elevated provisions for credit losses,” he said.