CIBC Q1 2010 Earnings

Scotia Capital, 26 February 2010

• CM reported a decline in cash operating earnings of 1% to $1.65 per share above our estimate and consensus due to higher net interest margin and stronger-than-expected results from wholesale with trading revenue flat QOQ. ROE was 22.5% with RRWA of 2.21%.

Implications

• CIBC Retail Markets earnings declined 9% YOY to $529M due mainly to loan loss provisions increasing 31%, but increased 12% sequentially. CIBC World Markets earnings were surprisingly strong at $181M, increasing 23% from a year earlier and 37% from the previous quarter.

Recommendation

• We are increasing our 2010 and 2011 earnings estimates to $6.40 per share and $7.20 per share from $6.05 per share and $7.00 per share, respectively, due to the improvement in net interest margin and higher level of earnings from World Markets. We are increasing our 12-month share price target to $80 from $75 based on higher earnings.

• We are upgrading CM to a 2-Sector Perform from a 3-Sector Underperform due to stabilization of wholesale platform, continued run-off in the structured credit portfolio and slight improvement in revenue outlook in Retail Markets.

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Veritas Investment Research, 26 February 2010

Q1 results were a step in the right direction for CIBC, with the bank taking steps towards delivering on the operating and credit recovery that Veritas considers already priced into the stock at $70. Reported earnings were $652M [compared to $644M in Q4-F09], and adjusted earnings of $654M were down 1.7% against adjusted earnings a year ago though up 13.5% against Q4. One-time items this quarter netted to between $2M and $20M, but the gross one-time items were material and necessarily complex – gains on improvements in sub-prime valuations and monoline spreads, further complicated by steps taken by CIBC to unwind its nettlesome sub-prime and non sub-prime exposures. The case for caution on CIBC is nevertheless compelling. Veritas remains concerned about the potential performance of the structured credit run-off book in another downturn. Quarter-in, quarter-out through the recovery, the $13B CLO portfolio and its underlying components continue to migrate while the aftershocks of the credit crunch – such as potential litigation from the Lehman estate – and the aftershocks of Enron continue to reverberate at CIBC. Veritas concludes that CIBC’s first quarter was positive in the sense that it was the second positive loan loss quarter in a row, the retail business may have bottomed out, and CIBC World Markets continues to generate above expectation earnings. Investors must decide, however, whether CIBC’s P/E discount to peers compensates for the following risks: the structured credit overhang, potential for capital markets earnings normalization, credit risk on cards and a few high-risk, high yield loan portfolios, and a few sharp objects still in its path.

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National Bank Q1 2010 Earnings

Veritas Investment Research, 26 February 2010

On first glance and deeper inspection, it is hard to find too many noteworthy aspects of the National’s solid & steady first quarter. Earnings were in line with Veritas’ expectations, which were themselves slightly above the consensus view. The quarter unfolded pretty much according to script: trading revenues normalized but didn’t melt away, while credit losses increased, but didn’t blow out. The bank’s transition from using standardized credit risk calculations to advanced credit risk models for capital purposes, along with internally-generated capital, resulted in a 180bps increase in the Tier 1 capital ratio. Balance sheet and revenue growth was solid if unspectacular. Having missed expectations slightly last quarter, NA delivered just a bit more this quarter – a bit more than last quarter and a bit more than expectations. But, Veritas thinks the results show that the most likely range for NA’s earnings is in the low- to mid-$6/share range this year and mid- to high-$6/share range next year. The bank’s normalized ROE this quarter was 18%, the Tier 1 ratio is 12.5%, and the dividend payout ratio is 40%. Though lower growth deserves a lower multiple, Veritas continues to recommend shares of NA with a $65 intrinsic value.

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Financial Post, 26 February 2010

National Bank of Canada was upgraded from Sector Perform to Outperform by CI Capital Markets analyst Brad Smith after the bank reported better-than-expected first quarter results.

Adjusted cash earnings per share of $1.55 were well ahead of his $1.36 estimate and consensus at $1.45. A 4% revenue shortfall, primarily due to lower trading revenues, was more than offset by an 8% lower-than-anticipated expense run after the $75-million penalty from the bank’s ABCP involvement was excluded.

The bank changed the way it measures risk-weighted assets during the quarter, which meant its Tier 1 capital ratio climbed to 12.5% from 10.7% at the end of the fourth quarter of 2009. Management confirmed that if recently proposed new capital rules are enacted as set out, the preliminary estimate of the impact on Tier 1 would be a reduction of 300 to 400 basis points.

Despite beating his quarterly estimates by a healthy margin, Mr. Smith left his 2010 and 2011 full-year estimates unchanged. He told clients this is due to lingering uncertainty relating to the sustainability of National’s reduced provisioning and expense efficiency levels.

Nonetheless, the upside the analyst sees in the stock justified to upgrade. Mr. Smith’s price target on National Bank shares is $65.

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Preview of Banks' Q1 2010 Earnings

Scotia Capital, 18 February 2010

Banks Begin Reporting February 25

• Banks begin reporting first quarter earnings with Canadian Imperial Bank of Commerce (CM) and National Bank (NA) on February 25, followed by Bank of Montreal (BMO) on March 2, Royal Bank (RY) and Laurentian Bank (LB) on March 3, Canadian Western (CWB) and Toronto Dominion (TD) on March 4, and Bank of Nova Scotia (BNS) closing out reporting on March 9. Scotia Capital’s earnings estimates are highlighted in Exhibit 1, consensus earnings estimates in Exhibit 3, and conference call information in Exhibit 4.

First Quarter Earnings to Decline 5% YOY

• We expect first quarter operating earnings to decline 5% year over year (YOY) and to decline 1% quarter over quarter (QOQ). Bank operating results are expected to be stable and solid with a 16.3% return on equity and very impressive RRWA of 2.05% while absorbing what we believe are peak LLPs in the 80 bp range.

• We have trimmed our first quarter and fiscal 2010 earnings estimates (Exhibit 2) based on expected weaker trading revenue given the decline in volume and tighter asset spreads.

• Reported earnings are expected to closely parallel operating earnings with mark-to-market losses negligible following the trend in 2009 that saw mark-to-market losses decline throughout the year, reaching a nominal amount in Q4/09. Thus, banks are expected to continue to build capital via acceleration of internally-generated capital and aggressive management of risk-weighted assets, especially market at risk.

• In terms of operating earnings this quarter, we assume stable LLPs in the $2.5 billion range and weaker wholesale earnings partially offset by net interest margin improvement. The two most important factors this quarter are the impact of lower trading volumes and equity underwriting (although fixed income is extremely strong), and the net earnings impact on wholesale earnings and the magnitude of the potentially offsetting improvement in NIM.

• Bank earnings have beaten street expectations for most of fiscal 2009 with a substantial beat in Q4/09. Interestingly, bank share prices did not respond particularly well to the heavy Q4/09 beat.

• Wholesale banking earnings resilience will be tested this quarter especially in light of weak trading revenue from U.S. banks. However, it is important to note that the time period is different, with January being a very strong month versus October, especially from a fixed income underwriting perspective. Therefore, we would expect Canadian banks’ trading revenue/wholesale earnings to perform better in Q1/10 (ended January 31) than the U.S. banks’ in Q4/09 (ended December 31), although we expect lower trading revenue versus much of fiscal 2009. Wealth management earnings recovery is expected to continue to be driven by higher asset levels and positive operating leverage. Retail banking results are expected to remain solid, buoyed by stable-to-improving net interest margin.

• Banks’ earnings this quarter are being supported by continued loan repricing (mainly wholesale), stable interest rates, a steep yield curve, relatively high wholesale interest rate spreads, expected improvement in retail spreads, slight narrowing of bond spreads, higher LCDX Index, and significantly lower net security losses (perhaps security gains).

• The drag this quarter is expected to be the continued high level of loan losses, although they are relatively stable (flat QOQ, up 12% YOY), higher gross impaired loans (although gross impaired formations are expected to decline modestly), and the 2% QOQ, 16% YOY, appreciation in the Canadian dollar to the U.S. dollar (average), which will negatively impact foreign currency earnings. Lower securitization gains (narrower mortgage treasury spread), although not much of a factor in Q3/09 and Q4/09, and of course expected lower trading revenue, are expected to be a drag on earnings as well.

• Trading revenue reached record levels in both Q1/09 and Q3/09 at $3.4 billion, with a Q2/09 figure of $2.8 billion and Q4/09 at $2.9 billion. In terms of trading revenue, we continue to believe that there is both a cyclical and structural component to the high level of trading revenue, with the split very difficult to ascertain with any degree of accuracy. However, trading revenue is expected to decline this quarter (cyclical) due to lower volumes and tighter asset spreads.

• Loan loss provisions in Q1/10 are forecast at $2,475 million or 0.80% of loans, essentially unchanged from the past three quarters. Quarterly loan loss provisions are expected to be flat again this quarter down from a peak quarterly growth rate of 45% in Q1/09. We continue to believe that the bank group loan losses are at or very near peak levels for this cycle, in the $10 billion per annum range or 80 to 85 bp, in line with expectations from our report “The Credit Cycle”.

• Our forecast is for a 6% increase in operating earnings in fiscal 2010 and a 15% increase in 2011. Return on equity is expected to bottom in fiscal 2010 at 17.4%, increasing to 18.2% in 2011 as the banks move into a more favorable stage in the credit cycle and economic growth improves.

• The Canadian banks’ caution on the timing of dividend increases was very evident with the release of Q4/09 results. The uncertainty about bank dividend increases has increased with the release of the Basel consultative documents (see our report published January 27, 2010 entitled “Canada’s Dividend Culture – Caught in the Crossfire – Dividend Reset”).

• We expect Canadian banks will be able to meet any new capital requirements with very little disruption to their operating platforms, but dividend increases are likely on hold in the near term pending clarity from regulators.

• Bank fundamentals, we believe, are strong and are expected to improve over the next several years. We view Canadian banks as having low balance sheet risk, being well capitalized and highly profitable, and expect them to continue to generate superior shareholder returns.

• Long-term outperformance is expected, but in the near term we believe the bank group is in a consolidation phase pending some regulatory certainty. We need regulatory clarity, especially on capital and dividend policy, before bank valuations can expand further, in our opinion, thus our market weight recommendation (downgraded December 11, 2009). We expect dividend increases that are currently on hold will be the catalyst for substantially higher P/E multiples in the future.

• In terms of stock selection, we continue to believe RY to be a standout, given the strong reinvestment, competitive positioning in all its major business lines, the resulting industry high profitability and capital, and absence of a premium valuation. We have 1-Sector Outperform ratings on RY and BMO, with 2-Sector Perform ratings on BNS, LB, CWB, NA, and TD, and a 3-Sector Underperform rating on CM. Our order of preference is RY, BMO, NA, CWB, LB, TD, BNS, and CM.

ABCP Settlements – BNS, CM, NA, and LB

• On December 22, 2009, the Ontario Securities Commission (OSC), the Autorité des marchés financiers (AMF), and the Investment Industry Regulatory Organization of Canada (IIROC) announced that settlements had been reached in connection with investigations into the Canadian ABCP market resulting in $138.8 million in administrative penalties and investigation costs. The settlements are as follows: National Bank Financial (NA), $75 million; Scotia Capital Inc. (BNS), $29.3 million; CIBC World Markets (CM), $22 million; HSBC Bank Canada, $6 million; Laurentian Bank Securities Inc. (LB), $3.2 million; Canaccord Financial Ltd., $3.1 million; and Credential Securities Inc., $0.2 million. ABCP settlement costs are non tax-deductible and will be items of note in first quarter 2010 earnings.

TD – TD Ameritrade Earnings Below Consensus

• On January 19, 2010, TD Ameritrade reported a decline in first quarter earnings of 26% YOY to US$0.23 per share, below consensus of US$0.26 per share. Earnings were negatively impacted YOY by higher expenses, particularly higher employee compensation and benefits and higher advertising spend. TD Bank estimates TD Ameritrade’s contribution from this quarter to be C$43 million or C$0.05 per TD share versus C$0.07 per share in the previous quarter and C$0.09 per share a year earlier.

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Financial Post, 17 February 2010

Toronto Dominion Bank’s US operation is facing a jump in “past due” loans in the fourth quarter that could herald a rise in defaults in future quarters, says Brad Smith, an analyst at CI Capital Markets.

Of the major domestic banks, TD has the biggest operation south of the border.

Citing U.S. regulatory filings, Mr. Smith said in a note to clients that TD’s U.S. banking group had a US$326-million or 48% increase in loans that were 30 to 90 days in arrears compared to the previous quarter. Of particular concern, he said, was a 134% hike in past due loans secured by non-residential properties.

The bottom line is that if the trend continues, it will likely translate into “upward pressure on future provisioning levels,” Mr. Smith said.

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