30 May 2012

Scotiabank Q2 2012 Earnings

TD Securities, 30 May 2012

Yesterday, before the open, the bank reported Core Cash (f.d.) EPS of $1.18 versus TD Securities at $1.15 and consensus of $1.15.


Neutral. It was a reasonable quarter, in our view, with some gives/takes in the underlying composition. Domestic P&C was strong and Wealth was steady while Wholesale was a bit outsized. International was a bit light, but it continues to post strong growth. Credit was also very well behaved. We trimmed our estimates slightly mainly around the outlook for Wholesale, and our Target Price is down slightly. Against that, with the recent weakness in the stock, we see compelling returns from current levels. Concerns around the outlook for global growth are likely to offer some headwinds for the stock in the immediate term, but Scotiabank remains one of the best fundamental stories in the space, in our view. We reiterate our Action List Buy rating.


Continued work on delivering expense leverage. There was a fair amount of acquisition-related noise, but on a segment basis Domestic P&C saw good operating leverage, and management expects it to continue in H2/12. International is struggling to get there consistently, but management continues to suggest that investment spending has leveled off and has now indicated some specific cost cutting measures will hit in H2/12 to deliver positive operating leverage on the year. If successful, this could be an important lever supporting our constructive view on International growth and return prospects.

25 May 2012

TD Q2 2012 Earnings

Scotia Capital, 25 May 2012

• TD's cash operating EPS was $1.82, a modest beat. Earnings increased 12% YOY, driven by exceptionally strong results from TDCT, strong Wealth & Insurance performance, and high security gains.

• Operating ROE: 16.6%, RRWA: 2.78%, CET1: 7.4%.


• Canadian P&C (TDCT) earnings increased 14% YOY, leading the bank group, driven by strong loan growth of 10%, with margins declining a modest 2 bps sequentially. U.S. P&C earnings were solid, up 13% YOY, with Wholesale solid, increasing 5% YOY due to strong investment banking revenues and solid trading revenue. Wealth & Insurance earnings increased 16% YOY, with Insurance strong.

• We are increasing slightly our 2012E EPS by $0.05 per share to $7.35 per share, with 2013E EPS unchanged at $8.00 per share. Our one-year target price is unchanged at $100


• Maintain 1-Sector Outperform rating based on a very high capital generation rate (RRWA), low balance sheet risk, low earnings volatility, and a strong competitive positioning.

RBC Q2 2012 Earnings

Scotia Capital, 25 May 2012

• RY cash operating earnings from continuing operations were solid at $1.17 per share, in line with expectations.

• Cash operating earnings increased 5% YOY driven by strong wholesale banking, up 10% YOY, and resilient Canadian retail, up 7% excluding the prior year's gain related to the sale of Visa shares.

• Operating ROE: 19.0%, RRWA: 2.50%, CET1: 8.3% (IFRS phase in).


• Strong wholesale banking earnings were driven by solid investment banking and trading revenue. Fixed income trading revenue was solid with equity particularly strong.

• Canadian Banking earnings were resilient with loan growth of 7% YOY, while NIM declined 3 bps sequentially to 2.72%.


• Our 2012E and 2013E EPS estimates remain unchanged at $4.90 and $5.30 respectively. Our share price target remains unchanged at $68.

• We maintain our 1-Sector Outperform rating based on above industry group profitability and capital, as well as substantial earnings

24 May 2012

BMO Q2 2012 Earnings

Scotia Capital, 24 May 2012

• BMO cash operating earnings increased 15% YOY to $1.44 per share, above our expectations of $1.40 per share and IBES at $1.36 per share. The $1.44 includes $72 million after-tax or $0.11 per share related to recovery of provisions for credit losses on M&I purchased credit impaired loans versus $0.13 per share recovery in the previous quarter. Earnings in Q1/12 were $1.42 per share, which included the $0.13 per share recovery.


• Earnings growth was led by resilient P&C Canada, up 8% YOY, with Private Client Group earnings rebounding and BMO Capital Markets producing a relatively strong quarter driven by strong investment banking revenue and very solid trading revenue.

• Operating ROE: 15.4%, RRWA: 1.81%, CET1: 7.6%.


• Our 2012E EPS is unchanged at $5.75 per share; however, we are trimming our 2013E EPS to $6.20 per share from $6.30 per share. Our one-year target price is unchanged at $66 based on a target P/E multiple of 10.6x our 2013 earnings estimate.

• Maintain 3-Sector Underperform based on high relative P/E multiple given its low relative profitability.

18 May 2012

TD Bank Tripped by the Rothstein Scam

The Economist, 18 May 2012

One of the success stories in retail banking over the past decade has been the expansion of TD, Canada’s second-largest bank, along America’s eastern seaboard, fuelled by such basic ideas as longer opening hours and service that is better-than-halfway decent. But a fraud case in Florida threatens to sully the reputation of the firm known to millions as "America's Most Convenient Bank."

TD was the main depository bank for Scott Rothstein, a celebrity lawyer who sold dodgy investments linked to legal settlements. His $1.2 billion Ponzi scheme collapsed in 2009 and he was sentenced to 50 years in jail. Angry investors went after TD, accusing it of “pivotal participation” in the conspiracy. In a court filing plaintiffs alleged, among other things, that TD officers had met with investors to vouch for Mr Rothstein, even conducting “shows” for his structured products at TD branches and corporate offices; that they had misled Rothstein clients about the balances of, and restrictions on transfers from, accounts supposedly held for their benefit; and that the bank had, at Mr Rothstein’s request, moved $16m of investor funds to an account he held in Morocco.

TD has consistently denied engaging in wrongdoing. It settled with one group of investors for $170m. A case brought by another group went to trial, resulting in a $67m award in January, which TD is appealing. This set a worrying precedent for the financial sector as it was the first civil verdict against a bank for aiding and abetting fraud in a case brought by the victims (as opposed to the bankruptcy trustee). “It is a landmark case that will cause banks around the world to shudder,” says Charles Intriago, president of the Association of Certified Financial Crime Specialists.

There may be more trouble ahead for TD. One of the bank’s internal assessments of the money-laundering risks posed by Mr Rothstein had a red bar across the top with “High Risk” emblazoned on it. Those words were mysteriously missing in the version the bank presented to the court, a discrepancy only spotted when the correct version surfaced in another case in which TD is being sued. This matters because the document could be seen as having supported the bank’s defence that it did not consider the lawyer risky and thus did not conduct the enhanced investigations that might have detected the fraud. TD denies having tampered with evidence, blaming the blacked-out bar on a "copying error."

It stands accused of burying documents, too. In a filing on April 24th, TD recanted statements that it and its lawyers had made in court about an internal document called the “Standard Investigative Protocol”, which sets out the bank’s policies on the detection of dirty money. Having said several times that no such document existed, TD eventually produced it and announced that it had replaced its outside legal counsel, Greenberg Traurig, with another firm. One of the Greenberg lawyers representing TD has since left the firm.

Reportedly livid about these developments, the judge who oversaw the $67m award in January, Marcia Cooke, called a hearing to examine whether TD and its lawyers should be held in contempt. At its first session, on May 17th, lawyers for Mr Rothstein’s victims called for extra penalties against the bank and its lawyers—arguing that the award would have been higher had the jury known about the documents—and asked that TD’s pleadings be struck, which, if it were to happen, would cripple its appeal. Judge Cooke appeared to show little sympathy for the bank and Greenberg, reportedly saying: “It is hard for me to describe in words the difficulty throughout this trial related to documents and discovery…It was almost daily.”

This drama is good news for other investors lining up to sue TD. After weighing new evidence, a judge recently gave the go-ahead for another Rothstein-related case to proceed, this one a racketeering suit brought by New York-based Emess Capital. The law permits triple damages in such cases, and some think Emess could walk away with more than $100m. “The cases against TD are helping victims of frauds everywhere to compile a road map on how to recover their losses from deep-pocketed financial institutions,” says Mr Intriago.

On top of this, some expect TD’s regulator in the United States, the Office of the Comptroller of the Currency, to weigh in with enforcement actions and the Department of Justice to bring indictments. At least one of the individuals involved in the document debacle has hired a criminal-defence lawyer. The Rothstein scam may have been small compared with Bernard Madoff’s, but the implications of its collapse for banks and their legal advisers could be bigger.

16 May 2012

Preview of Banks' Q2 2012 Earnings

Scotia Capital, 16 May 2012

Banks Begin Reporting May 23

• Banks begin reporting second quarter earnings with Bank of Montreal (BMO) on May 23, followed by Royal Bank (RY) and Toronto-Dominion Bank (TD) on May 24, Bank of Nova Scotia (BNS) on May 29, Canadian Imperial Bank of Commerce (CM) and National Bank (NA) on May 31, Laurentian Bank (LB) on June 6, and Canadian Western Bank (CWB) closing out reporting on June 7.

• Scotiabank GBM’s earnings estimates are highlighted in Exhibit 2, consensus earnings estimates in Exhibit 3, and conference call information in Exhibit 4.

Second Quarter Earnings – 4% YOY Increase, Down 5% Sequentially

• We expect second quarter operating earnings to increase 4% year over year (YOY) but decline 5% sequentially from the strong first quarter.

• We expect Wholesale earnings to decline QOQ, Wealth Management to be up moderately, with Domestic/Retail Banking earnings resilient, although growth is slowing (see Exhibit 8). Domestic/Retail Banking earnings are dependent on net interest margin performance as volume growth slows. Overall, our second quarter earnings estimates are in line with consensus.

• We expect bank profitability to remain solid this quarter, although down from highs, with return on equity at 17.5% versus 18.8% in the previous quarter. Return on risk-weighted assets (RRWA) remains extremely high at 2.31% versus 2.41% in the previous quarter.

• The main earnings variables to focus on this quarter, in our view, are trading revenue and the retail net interest margin.

• Trading revenue will likely be negatively impacted by a deterioration in sentiment and increased uncertainty as European sovereign debt concerns resurfaced in March and April. We expect trading revenue to decline 21% QOQ and 7% YOY due to lower fixed income trading revenue (lower underwriting) and lower equity trading volume.

• The sequential trading decline is expected to be impacted by lower fixed income trading revenue, with 10-year Canadian and U.S. government bond yields increasing 15 bps and 12 bps, respectively, and fixed income underwriting activity declining. Canadian government bond and corporate bond underwritings declined by 25% and 20% QOQ, respectively, which is expected to translate into lower fixed income trading volumes. TSX average trading volumes (equity) were relatively soft, declining 3% quarter over quarter (QOQ) and 19% YOY, with block trading volumes down 6% sequentially. The S&P/TSX Composite Index declined 1% in the quarter; however, the majority of the decline in the index occurred in April, with the average value of the index in the quarter up 3% QOQ.

• We expect bank group underwriting and advisory revenue to increase 12% sequentially to $861 million, although down 10% YOY. Underwriting revenue is expected to be led by a 54% QOQ increase in equity issuance, although the lower margin fixed income underwriting is lower as previously noted. M&A activity was up 2% sequentially, although declining 5% YOY.

• We continue to forecast net interest margin compression of 2 basis points per quarter out to the end of 2013. Rational pricing is required to mitigate some of the margin pressure.

• Credit trends remain stable with loan loss provisions expected to be flat at $1.6 billion or 0.37% of loans.

Dividend Increases Unlikely – Timing Discretionary

• Dividend increases this quarter are unlikely with perhaps the exception being NA, as TD, RY, and BNS increased their dividends last quarter, and CWB, NA, and LB increased their dividends in the fourth quarter of 2011.

• The bank group’s dividend payout ratio is currently 45% of our 2012 earnings estimates versus the bank group target payout ratio range of 40% to 50%, so at the midpoint of the range.

• In our view, the strongest candidates for dividend increases in the remainder of fiscal 2012 based on target payout ranges (see Exhibit 5) are LB, NA, CWB, and BMO, followed by CM, TD, BNS, and RY. We expect dividend growth in 2012 to mirror earnings growth in the 6%-7% range. Timing continues to be extremely discretionary.

Bank Share Performance & Valuations - Canadian Housing Concerns

• Canadian bank share prices have outperformed the TSX by 6% in the quarter and 6% year-to-date as at May 14, 2012. As systemic risk from European sovereign debt fears eased in the first 3 months of 2012, the bank beta trade was on, with Bank of America, Citigroup, and JP Morgan up 79%, 42%, and 39%, respectively, versus 11% for Canadian banks. However, an uptick in systemic risk and uncertainty in Europe has resulted in a correction for bank stocks, with Bank of America, Citigroup, and JP Morgan down 26%, 25%, and 22%, respectively from the 2012 highs, versus an 8% correction for Canadian banks.

• We believe Canadian bank P/E multiple expansion has been delayed by increased headline risk and concerns over a Canadian housing correction and slower consumer loan growth, in addition to the uptick in uncertainty from Europe. We believe these concerns have been factored into bank valuations, with U.S. hedge funds potentially short selling Canadian bank shares to take advantage of the increased headline risk.

• We have analyzed the banks' exposure to a housing correction, concluding that price declines would be very manageable for the banking sector especially given the soundness of the Canadian banking system and Canada's relatively strong and stable fiscal position. The Canadian banks have roughly $900 billion in residential mortgage lending exposure (including helocs), with on average 64% insured and 36% uninsured. The insured/uninsured mix varies between the banks, with CM carrying the lowest proportion of uninsured mortgages at 21% and RY the highest at 64%. The average LTV on the uninsured books is 53%, ranging from 48% at CM to 59% at NA. The average LTV on the insured book is 66%, ranging from a low of 49% at CM to 86% at NA (see Exhibit 6).

• We stress tested bank earnings assuming that 10% of total uninsured mortgages were originated at peak house prices and at the maximum LTV of 80% with house prices declining 25%-35% (see Exhibit 7). The stress test also assumes mortgage holders will default when the value of their mortgage is greater than the value of their house. Under this severe stress test, the estimated direct bank earnings impact would be a decline of 5% to 16% with 2012E EPS as a base (see Exhibit 7). We note that the largest peak to trough house price correction in Canada occurred between February 1989 and May 1990, with house prices declining 14%.

• We estimate condos to represent approximately 10% of bank mortgage portfolios, with a guesstimate of 40% of the condo portfolio in Toronto and 20%-25% in Vancouver. If our stress test was applied to the condo exposure only, the direct earnings impact is estimated at approximately 1% to 2%.

• Additionally, historical data shows a strong correlation between house prices and employment levels, with current Canadian employment rate at a very strong 62%. It seems that a 10% house price correction is a reasonable assumption but anything significantly greater than 10%, we believe, would require a major drop in employment levels. A major factor in US house price declines was the collapse in the employment rate compounded by a collapse in underwriting standards which we don't believe we have seen in Canada. CMHC is no Fannie Mae.

• The market continues to chase high dividend yielding sectors, creating valuation premiums in Pipes & Utilities and REITs, while systemic risk has muted bank stock participation. The negative impact of systemic risk on valuations is evident when you compare bank dividend yields versus Pipes & Utilities (see Exhibit 19) and REITs (see Exhibit 20), where systemic risk is relatively low. As systemic risk eased in the first three months of the year, bank stocks began outperforming, with an apparent sector rotation out of Pipes & Utilities and into banks; however, the recent uptick in systemic risk has capped the outperformance. Bank dividend yields are now 1.0 standard deviations above the mean versus Pipes & Utilities and 2.7 against REITs.

• Bank earnings yield relative to Canadian corporate BBB bonds is at an all-time high, even higher than in Financial Crisis I (Lehman Brothers collapse), which is reflective of the level of systemic risk that still persists in bank valuation (see Exhibit 21).

• We believe the recent bank share price weakness offers an attractive entry point into bank stocks.

Maintain Overweight Recommendation

• Our share price targets remain unchanged. Our share price targets are based on 12.0x our 2013 earnings estimates and we believe are extremely conservative in the context of the interest rate environment, dividend levels, and capital generation rates.

• In fact, if Pipes & Utilities can trade at 20x to 22x earnings, we believe a banks stock can trade at 15x to 17x in a period of low systemic risk and perhaps a period where the market recognizes the decline in the risk premiums post the full implementation of Basel III and the global restructuring of the banking industry.

• We maintain 1-Sector Outperform ratings on TD, RY, and CM, 2-Sector Perform ratings on CWB, BNS, and LB, and 3-Sector Underperform ratings on BMO and NA. We believe CM is the most undervalued stock in the bank group by a wide margin.

14 May 2012

TD Bank's Ed Clark: Speculation Puts Banking System at Risk

May 14 (Bloomberg) -- Toronto-Dominion Bank Chief Executive Officer Edmund Clark talks about the Canadian firm's approach to banking and industry regulation. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack." (Source: Bloomberg);