30 August 2011

Scotiabank Q3 2011 Earnings

BMO Nesbitt Burns, 30 August 2011

Bank sector earnings rose by 16% year over year in the quarter ended July, about 2% more than consensus expectations. We have added to our sector weight with a percentage point in the Bank of Nova Scotia. Despite a challenging environment and higher-than-expected expense growth, BNS continues to meet, or exceed, financial targets. Operating EPS should grow at 13% in 2011, higher than the targeted range of 7–12%. Operating EPS are projected to be $4.50 in 2011, which excludes $0.28 in gains in H1/11. Credit trends are stable and cash ROE in the latest quarter was healthy, at 18%.

29 August 2011

RBC Q3 2011 Earnings

Scotia Capital, 29 August 2011

• RY cash operating EPS increased 13% YOY to $1.06, slightly below expectations of $1.08. Reported cash EPS was a loss of $0.09/share.

• Operating ROE: 17.0%, RRWA: 2.37%, CET1: 7.7%(E).


• Wholesale earnings declined 32% QOQ due to a larger-than-expected decline in trading revenue to $302M from $708M in Q2/11. Fixed income trading revenue collapsed to $71M from $396M in Q2/11.

• The disappointing Wholesale earnings were partially offset by strong earnings from Canadian Banking increasing 12% YOY to $855M (compares to BMO 2%, NA 6%). Wealth Management earnings were up 24% YOY on an adjusted basis.


• Our 2011E EPS is unchanged at $4.50; however, the estimates have been moved to a continuing operations basis. Thus, on a net basis, Q4/11E EPS would have been reduced $0.07 to reflect the difficult market environment in August and weakness generally expected in Q4. We are also reducing our 2012E EPS to $5.00 from $5.15. One-year share price target is unchanged at $70. Maintain 1-Sector Outperform.

28 August 2011

Manulife's Financial Outlook Still Too Uncertain

Citigroup Global Securities, 28 August 2011

Risk of Earnings Shortfalls Rising as Weak Macro-Economic Climate Exacerbating Pricing Mistakes at John Hancock

• Maintain Sell but target lowered — We reiterate our Sell (3H) rating on MFC’s shares but have lowered our target price to C$12/US$12 and downwardly revised our 2011E-13E to C$0.65, C$1.60 and C$1.75. As one of the largest writers in the U.S. of VAs offering living benefits, secondary guarantee universal life (SGUL), individual long-term care (LTC) and VAs in Japan, MFC possesses well above average sensitivity to both equity markets and long-term interest rates. Our target and estimate changes incorporate the decline each has seen and our expectation current levels will persist for the foreseeable future. Quarter-to-quarter results will likely remain volatile and largely outside of management’s control including a $0.50/share loss we now project for 3Q11.

• Balance sheet quality issues persist — The recent drop in U.S. interest rates and equity markets coupled with pricing mistakes made at John Hancock on VAs, LTC and SGUL will depress MFC’s earnings and ROE for years, if not decades to come. Exacerbating this was weaker, relative to peers, risk management practices. While we have been encouraged by the steady increase MFC’s use of hedging activities, the announcement of a $700M or $0.39/share charge in 3Q11 for adverse mortality at John Hancock raises a new area of concern. It relates primarily to deteriorating experience on Hancock’s old permanent life insurance block. MFC is the only insurer we are aware of to have this issue and leads us to question overall reserve adequacy and other deficiencies that have yet to come to light.

• 2Q11 better than forecast but core trends mixed — On a nominal basis, operating earnings of C$490M compared favorably to a loss of C$(2.4)B a year earlier. While the U.S. Insurance and Wealth Management, and Reinsurance segments performed better than our forecast, Canada was weaker than projected and Asia was in-line. ROE of 8.2% compared to 17.4% in 1Q11. Targeted insurance and wealth management sales were up 28% to C$575M and C$275M to C$8.4B, respectively; while non-targeted sales fell 68% and 30%, respectively. Targeted premiums & deposits grew 3.7% to C$16.9B, where targeted products represent 90% of in-force vs. 85% in 2Q10.

• Pace of improvement will be slow — We are encouraged by the steps management has taken to help to stabilize MFC’s financial position, but it will still take many years to fully resolve the problems at John Hancock. The risk of earnings shortfalls vs. market expectations remains tangible. Despite the high growth potential of a very strong Asian franchise and the stable and high ROE of its Canadian business, from a risk vs. reward perspective this is more than offset by the uncertainty posed by John Hancock.

26 August 2011

National Bank Q3 2011 Earnings

Scotia Capital, 26 August 2011

• NA cash operating EPS increased 10% YOY to $1.72 in line with expectations. Earnings were supported by extremely low PCLs of 15 bp (40+ bp for bank group) and security gains of $0.11/share or 6% of earnings. Retail earnings were up 6% YOY, with Wealth up 28% YOY and Wholesale up 13% YOY.

• ROE: 17.5%, RRWA: 2.29%, CET1: 8.0%.


• Reported EPS was $1.84 including $0.07/share reversal of ACLs, $0.13/share tax recovery, $0.03/share charge in severance pay (Wellington West), and $0.05/share charge for litigation provisions.


• Slightly increasing our 2011E EPS to $6.95 due to the slight beat this quarter. 2012E EPS unchanged at $7.60. One-year share price target unchanged at $90. NA, we believe, is fully valued and is currently trading at 9.3x or 93% relative to the bank group (85% historical mean since 1984) on our 2012E EPS. The higher relative P/E is reflective of the bank's improved operating performance versus the bank group. However, based on profitability and business mix, we feel that the relative P/E multiple is capped at 90%-95%, thus fully valued. Maintain 3-Sector Underperform.

24 August 2011

BMO Q3 2011 Earnings

Scotia Capital, 24 August 2011

• BMO cash operating EPS increased 19% to $1.36 per share, beating our expectation of $1.30 per share and IBES consensus of $1.31 per share, aided by tax recovery, partially offset by weaker insurance revenue.


• BMO Capital Markets earnings were stronger than expected due to tax recovery, as well as trading revenue held up better than U.S. Bank results, improving to $269 million from $250 million the previous quarter. Equities trading revenue was particularly strong at $103 million (including a couple of small items of note) versus $66 million in Q2/11.

• P&C Canada earnings growth slowed to 2%, with Private Client earnings (ex Insurance) strong increasing 43% and P&C U.S. earnings increasing 39%, excluding M&I.

• Operating ROE: 15.6%, RRWA: 1.79%, CET1: 6.6%.


• Increasing slightly our 2011E EPS to $5.36 from $5.30 due to the beat this quarter. Our 2012E EPS is unchanged at $5.85 per share.

• Maintain 2-Sector Perform as relative valuation remains high versus low RRWA and low CET1.

15 August 2011

How TD Bank Is Invading the US Market

The Wall Street Journal, Caroline Van Hasselt, 15 August 2011

Toronto-Dominion Bank has quietly launched an assault south of the border, hungry for growth opportunities that have dried up in its home country.

Canada's second-largest bank by assets now has 1,285 retail branches in the U.S., compared with 1,131 in Canada. TD's retail-banking unit is the 10th-largest in the U.S., bulking up with four takeovers last year that deepened its reach in Florida and pushed TD into North Carolina and South Carolina.

Some analysts expect TD Ameritrade Holding Corp., the online brokerage firm that is 43%-owned by TD, to bid for E*Trade Financial Corp. That could deliver yet another boost to the Canadian bank. TD declined to comment on the possibility of a takeover bid.

On Monday, TD announced an agreement to buy Bank of America Corp.'s MBNA Canada, the fourth-largest credit-card issuer in Canada, for C$7.5 billion (US$7.64 billion) in cash, or a 1% premium above the portfolio's book value.

As part of the deal, TD will assume C$1.1 billion in liabilities. The purchase, expected to be completed later this year, will more than double the bank's outstanding credit-card balances to C$16.7 billion, or about US$16.9 billion.

Given the U.S. economy's struggles, TD's expansion is risky. Still, the U.S. is a tempting growth market for Canadian banks, since their home country has a saturated retail-banking market with no opportunities to consolidate because of government restrictions on big bank mergers.

The pressure of slowing economic growth has intensified recently, with low Canadian interest rates triggering a borrowing binge. Canadian household-debt levels are now above those in the U.S. That has many economists and analysts warning Canadians may be tapped out, threatening to slow retail-banking growth opportunities.

TD moved cautiously into the U.S., acquiring in 2004 a 51% stake in Banknorth, based in Portland, Maine. TD bought the entire company three years later. In 2008, TD paid $8.5 billion to acquire Commerce Bancorp, of Cherry Hill, N.J. In April, TD completed a $6.3 billion acquisition of U.S. auto lender Chrysler Financial Corp.

TD's acquisition of Commerce was initially jeered as poorly timed. But the deal now is an example of how the bank hopes to tap the U.S. market and wring more profit out of its recent purchases there.

Commerce was a convenience-oriented lender, bent on getting customers in and out quickly with ample branch hours. That resembles the "8-to-8, six days straight" service model of Canada Trust, which TD acquired in 2000 and renamed TD Canada Trust.

Ed Clark, TD's chief executive, said an 18-month integration effort at Commerce puts TD in position to win more market share along the East Coast. "If we did nothing more than what we've done now and just exploited the organic, in-place opportunities, I'd be a very happy camper," he said.

TD's branches in the U.S. still aren't nearly as profitable as those in Canada, but executives hope to narrow the gap by boosting sales of everything from checking accounts to mortgages. The growth potential eases the pressure for more acquisitions, Mr. Clark said.

Greater New York City, for instance, boasts a deposit base just shy of $1 trillion, about two-thirds the size of the whole of Canada. TD Bank is now fifth by deposits in that retail-banking market, with a 3.6% share. Mr. Clark wants to be No. 3 in four or five years, without new acquisitions.

His strategy is rooted in U.S. community banking, including extending banking hours and opening branches on Saturday and, in some states, on Sunday. But the Toronto-based bank is also pushing its U.S. branches to rev up so-called cross-selling—for instance, marketing mortgages or other financial services to plain-vanilla checking account holders. TD is tying a portion of compensation to those new product sales.

By targeting mortgage lending, Mr. Clark said he can capture new customers neglected by U.S. banks still shell-shocked from the American housing bust. "In the U.S. today, people with great credit scores and sitting on houses that are not going to depreciate dramatically cannot get mortgages," he said.

Branch employees now spend 30% more of their time selling products compared to last year, said TD Bank's Fred Graziano, head of regional commercial banking. In the first six months of the year, insurance referrals have more than doubled from the year-earlier period, and store employees sent more than 17,000 referrals to TD Ameritrade, he said.

But TD Bank has ceded some ground in terms of customer satisfaction. Last year, it lost Commerce's coveted top ranking by J.D. Powers and Associates for customer satisfaction in the Mid-Atlantic market, dropping to No. 5. TD has moved back up in this year's survey, now ranking No. 3.

"They have challenges that typically come with acquisitions," said Lubo Li, J.D. Powers' senior director of financial services.

TD says it doesn't think its efforts at selling more products will detract from the customer experience. "As much as we love the service end of the business and want to own that space, we actually want to own the sales and service space" as well, Mr. Graziano said. "And, that's being driven from Canada."

09 August 2011

Bank Shares Retrace Under High Systemic Risk

Scotia Capital, 9 August 2011

Banks and Systemic Risk/U.S. Downgrade in a Fragile Market – Revisit Capital Markets Impact to Canada/Bank Downgrades in 1992

• S&P downgraded U.S. credit rating from AAA to AA+ on Friday August 5, 2011, placing additional stress on global markets and increasing overall systemic risk. Bank stocks in general do not do well with heightened systemic risk: however. banks with low balance sheet risk can hold up surprisingly well on a relative basis, although share price declines in the short term on an absolute basis are usually inevitable.

• As per our Daily Edge note published on July 29th titled "Bank Shares Retrace Under High Systemic Risk/Soft Earnings; U.S. Treasuries Exposure Very Manageable", we estimate Canadian banks' U.S. Treasuries exposure at $61 billion, or 2.1% of assets, with relatively modest duration estimated at 3.8 years. If we assume that U.S. Treasuries yield increases 50 basis points along the entire yield curve and there is no hedging or matching, earnings would be reduced by 3.0% on our 2012 earnings estimates. We also estimate the capital impact to be negligible (see note for details). Canadian banks' balance sheet risk, we believe, is very low with negligible exposure to PIIGS, very manageable exposure to U.S. Treasuries and OECD debt, and no U.S. legacy mortgage problems. Canadian banks also operate in a relatively stable industry environment with a non-hostile regulator/government in a country with a relatively sound fiscal position (Exhibit 2).

• The market's reaction to the S&P downgrade of the U.S. is certainly magnified as one would expect versus the reaction from the credit rating downgrade of Canada in the early 1990s, especially given the level of systemic risk that currently persists.

• Canadian bank stocks have now declined by 17% since they reached new all-time highs in April of this year due, we believe, mainly to systemic risk although soft earnings and weak economic growth also contributed to the share price retrace. The bank share price decline from their highs equates to a decline in market capitalization of $54 billion, which almost equals their entire $61 billion in estimated U.S. Treasuries exposure. However, bank share prices are expected to remain under pressure until systemic risk moderates, as high systemic risk typically outweighs fundamentals in the short term. In the medium to long term, heightened systemic risk should create buying opportunities for fundamentally sound banks. However, the difficulty is always gauging the market's reaction time and the magnitude of the response to systemic risk.

• Canadian bank stocks' performance has been weak in 2011 with the Bank Index down 7% year-to-date, partially offset by a dividend yield of approximately 4%. However, on a relative basis, bank stocks are outperforming the TSX, which is down 13% YTD and substantially outperforming global banks with the MSCI World Commercial Bank Index down 25%. Global banks are having a rough year, with the five large US banks down 32%, Swiss banks down 32%, UK banks down 24% and even the Australian banks down 15%.

• It is an interesting dilemma for global investors that have played the bank beta trade on the deep discount banks (market to tangible book not P/E) hoping for a return to a "normal" environment post Financial Crisis I versus the steadier low-risk banks (Canadian). Canadian bank stocks thus far are holding up relatively well in Financial Crisis II, not dissimilar to their performance in Financial Crisis I.

• To accurately predict how long Financial Crisis II will last and how low valuations will dip is not feasible. However, with Canadian banks' dividend yield now 4.3% with earnings yield 2.3x corporate AA bond yields, we are seeing glimpses of Financial Crisis I type discounting. The banks' P/E multiple is 11.5x trailing and 9.4x 2012 earnings estimate.

• On a long-term macro basis, if the next couple of decades have lower economic growth from government deleveraging and the equity markets have modest returns, dividends will likely represent a much larger portion of total market returns. According to Research Affiliates LLC, dividends have represented 25% of total market returns from 1989 to 2009 versus dividends representing 53% of total market returns on a longer-term basis from 1871 to 2009 (Exhibit 19). Thus, if we expect a shift towards the higher contribution from dividends, Canadian bank stocks that have increased their dividends at nearly 10% CAGR over the past 40 plus years fit this profile very well. Remain Overweight the bank group.

Revisit Capital Markets Impact of S&P Downgrade of Canada from AAA in 1992

• If we look at the S&P downgrade of Canada's credit rating in 1992 from AAA to AA+, we see a relatively modest response post the announcement (Exhibit 5). It appears the market discounted the downgrade one month prior as the TSX declined 8%, slightly less than the 9% decline for the Bank Index. The S&P 500 declined approximately 4% one month prior with TSX underperforming by 4%. The bond market also was very active one month prior with 10-year Canada bond yields spiking 66 bps and 47 bps relative to US 10-year Treasuries. Canada bond yields regained 42 bps of the spread one month post the downgrade.

• Canadian bank stocks did underperform the market by 7% one year post the downgrade but we believe this was impacted by the banks' large concentrated commercial real estate exposure to companies such as O&Y and projects such as Canary Wharf and low level of earnings (Exhibit 9).

• So it seems the market impact under a split rating was moderate and it was almost fully discounted by the time of the announcement. However, when Moody's downgraded Canada in June of 1994, the bond market reacted quite sharply in the three months prior to the downgrade, with 10-year bond yields spiking 163 bps and the spread with U.S. bonds widening 83 bps. Interesting that the peak Canada-U.S. bond spread was actually 269 bps in October 1990, two years before the first rating downgrade by S&P (Exhibits 12, 13)

• The banks declined 10% in a three-month period prior to Moody's downgrade versus the TSX declining 2% with the banks underperforming by 8%. Again, we believe that the bank underperformance was heavily influenced by earnings declines driven by the large loan losses it was booking on its commercial real estate portfolios.

Canadian Bank Credit Ratings – Downgrades/Upgrades

• S&P downgraded (Exhibit 7) two major Canadian banks in 1992: TD and RY. S&P downgraded TD from AA+ to AA on March 9, 1992, seven months before it downgraded Canada on October 14, 1992. RY's credit rating was downgraded from AA to AA- on October 26, 1992, less than two weeks after Canada was downgraded. The RY downgrade brought RY to AA-, in line with BMO's, BNS's, and CM's credit ratings, which were unchanged. NA's rating was unchanged at A.

• Further Canadian bank credit rating downgrades began in 1999 with both TD and BNS being downgraded, followed in 2002 by a downgrade (telco & cable exposure) for CM and a further TD downgrade. The TD and CM downgrades were despite Canada's upgrade back to AAA from AA+ on July 29, 2002.

• S&P did however upgrade BNS in 2004 to AA- and TD in 2007 to AA-. The last Canadian bank to be downgraded was BMO in 2007 to A+ from AA-.

• RY's share price relative to the bank group underperformed 13% in the year prior to its downgrade but outperformed for the most part after. TD's share price underperformed 16% in the year prior to the downgrade but outperformed after the announcement.

U.S. Banks Vulnerable – BAC, C

• The Canadian banks' credit rating are currently high relative to global peers as highlighted in Exhibit 4, and we would expect Canadian banks to fare relatively well on the rating front through Financial Crisis II. The five major U.S. banks are listed, with Bank of America and Citibank particularly vulnerable to the U.S. downgrade, both rated A with negative outlook. The market certainly appears to be discounting a downgrade and or at least some major concerns about balance sheet risk. BAC share price is down 51% year-to-date with Citibank down 41%.