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.