TD Bank Leads H1 2007 Equity Underwriting

The Globe and Mail, Boyd Erman, 7 August 2007

TD Securities Inc. has retained its grip on top spot in the rankings for selling stock on behalf of companies in the first half of the year.

In the second quarter, when equity issuance slowed down after a big first quarter, TD played a lead part in big deals for companies such as Provident Energy Trust and Saskatchewan Wheat Pool Inc. , bringing the firm's year-to-date tally for stock sales to $3.1-billion. TD also led after the first quarter with a total of $2-billion.

RBC Dominion Securities Inc., the country's biggest securities firm, moved into second place with a year-to-date result of $2.9-billion.

TD has made a big push in the equity capital markets business since Ed Clark, Toronto-Dominion Bank chief executive officer, said he wanted the securities arm of the bank to take a bigger share of business.

But with markets in turmoil, investment bankers at TD and elsewhere who handle stock sales said there's likely to be not much business to do in coming weeks. Companies are unlikely to issue stock when their shares have plunged.

“We're in for a quiet end of the summer, with all the volatility in the markets,” said Sante Corona, head of equity capital markets at TD.

“As long as things are bouncing around, with companies' share prices below where they expected to issue equity, we're probably going to see some deals that were planned put on hold.”

Things may pick up in September if markets settle down, as investors return to their desks and companies readjust their expectations about stock prices, Mr. Corona said.

Initial public offerings, which were very quiet in the first six months of the year, were just starting to pick up with a small flurry of filings in early July, but that market too is likely to go on hold for the time being, bankers said.

As of June 30, BMO Nesbitt Burns Inc. was leading the IPO business on the strength of two deals, one for OceanaGold Corp. and another for Northstar Healthcare Inc.

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The Globe and Mail, Boyd Erman, 7 August 2007

Sometimes, the league tables don't tell the whole story.

The only one of the securities dealers owned by Canada's Big Five banks not to appear among the top five in overall equity underwriting or initial public offerings so far this year, Scotia Capital Inc. is nonetheless consistently among the top money makers.

So what is it that Scotia's doing, out of the limelight of the league tables, that's bringing in all that money?

The firm has put a big focus on derivatives trading, is known for its corporate lending, and has focused on metals trading and services to hedge funds. And, the firm isn't averse to opportunistic plays that some other firms might view as a little oddball, such as a big investment in U.S. retail automotive asset-backed securities, better known as car loans.

"We do have certain things that we do uniquely well, that are kind of niche business," says Steve McDonald, one of the firm's two co-chief executive officers.

None of those businesses show up in the league tables, which track high-profile deals such as IPOs and mergers and acquisitions, and are a big focus for many investment bankers, who use the tables when pitching for deal assignments and bigger bonuses.

"Everything that goes to making money safely and well is what we're interested in," says John Schumacher, the other half of the CEO tandem. "Tables don't really convey that."

For example, one of Scotia's highest return businesses is in derivatives, where the firm has specialties in interest rate and equity derivatives, Mr. Schumacher says. The business is a relatively small operation that is "very material" to the firm's results, he says, declining to elaborate on profit numbers.

The league tables, while a useful measure of one slice of the business and an indicator of which banks are winning relationships, have numerous doubters. One of the main criticisms is that securities dealers can buy business and market share by discounting fees, undercutting one of the reasons behind league tables - trying to figure out which firm is making the most money.

The tables are also governed by rules that exclude certain types of offerings. In Scotia's case, the bank has a leading business in issuing preferred shares, which aren't counted in some equity rankings, including those prepared by Thomson Financial and published in The Globe and Mail.

But whether they count or not, preferred share issues bring in fees, helping Scotia Capital report a profit of $616-million in the first six months of the year, second only to RBC Dominion Securities Inc.'s $746-million among the big Canadian dealers. Revenue was just over half of RBC's $2.4-billion, though comparisons can be muddied because different banks lump different businesses into their capital markets segments when reporting profits.

"We are very bottom-line oriented," Mr. Schumacher said. "A lot of people focus too much on the revenue line."

The bank's ability to hold down expenses, generating wide margins and lots of profit per dollar of sales, makes it a favourite of analyst Brad Smith at Blackmont Capital.

"That culture of efficiency at Scotia is ingrained for generations," Mr. Smith said. He does cite a concern about the bank's slower growth profile, but he's not fussed about Scotia Capital's no-show at the top of the league tables.

"I'm not sure I care too much about that. I don't want them to be less selective in the business they do."

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The Globe and Mail, Boyd Erman, 7 August 2007

Five years ago, as CIBC World Markets Inc. scaled back from a foray into the United States, the firm's name started to ring hollow.

But with a big focus on China, and a large presence in Israel, a tiny country with a disproportionate impact in the technology business, CIBC World Markets is returning to an international strategy, albeit with limited aims.

"We're working on the 'world' part of CIBC World Markets," says Brian Shaw, head of the firm, which is owned by Canadian Imperial Bank of Commerce. "I view us as a strong North American franchise and outside of North America we compete in select markets: London, Asia and Israel."

While almost every bank in the world has some presence in London, the emerging market of China, where many of even the biggest foreign banks are starting from scratch, and the niche market of technology-rich Israel provide opportunities for a Canadian bank that might not have the heft to compete globally on every stage. In China and Israel, CIBC is one of the busiest banks for equity deals.

The increases in business abroad is one way the bank can offset the loss of income trust underwriting, one of its key focuses in Canada in recent years before the government clamped down on the structure last fall. CIBC, a fixture at the top of equity capital markets league tables in Canada for years, so far this year ranks fifth in overall stock sales.

CIBC has 37 people in Tel Aviv, serving a country that despite its tiny size exports the largest number of companies to the Nasdaq Stock Market. Israel has 69 companies listed on Nasdaq, topping even Canada and Britain.

In 2006, CIBC snagged a role in more than half the equity offerings coming out of Israel, and acted as lead manager most of the time when involved.

For its press on China, where regulatory hurdles often make it difficult for banks to establish offices that can do wide-ranging business, CIBC has teamed up with Balloch Group. This Beijing-based boutique investment bank was founded in 2001 by Howard Balloch, who served five years as Canada's ambassador to China. CIBC bought a one-fifth stake in Balloch Group, in essence adding the 40 deal makers at the firm to its deal-finding network, which revolves around Hong Kong, where CIBC has been located for almost four decades.

CIBC's strategy is based on bringing Chinese companies to North American stock markets, and the firm calculates that it's been involved in more deals than any other investment bank in the past four years when it comes to issuing stock for Chinese companies listed on U.S. exchanges.

The pace is picking up: The bank only recently graduated to leading its first transaction, a $259-million (U.S.) deal for solar-cell maker JA Solar Holdings. The company went public on Nasdaq in February at $15 a share and the stock has more than doubled since.

The Chinese operations are profitable and revenues have grown at least sixfold in the past year, says Chetan Bhatia, head of greater China investment banking for CIBC, adding there are more deals to come.

"There's a huge amount of pipeline for us in 2007 and 2008," Mr. Bhatia said.

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NatWest Trio Say RBC Hindering Defence

The Globe and Mail, Tara Perkins, 7 August 2007

Lawyers for the three British bankers known as the NatWest Three allege Royal Bank of Canada is stonewalling their attempts to question RBC employees who might be able to help clear their clients' names.

The NatWest Three – Gary Mulgrew, Giles Darby and David Bermingham – were extradited to the United States last year after the U.S. government accused them of defrauding their former employer, National Westminster Bank PLC, of $7.3-million (U.S.) in a deal related to Enron.

The three men deny the allegations and are now awaiting a January trial in a Houston court.

The criminal allegations date back a number of years to a time when the NatWest Three worked for Greenwich NatWest, which has since been bought by Royal Bank of Scotland.

RBC hired the three British bankers in 2000, as it sought to build up a structured finance group in London, and they spent a period of time working for the Canadian bank.

Now, lawyers for the three want to question a number of people who are working for RBC in London, including John Burbidge, the chief operating officer of RBC's investment banking operations in Europe and Asia.

An RBC spokeswoman in Toronto said Monday that “RBC and its counsel have fully complied with all their legal responsibilities and have acted appropriately at all times throughout this matter.”

RBC has not been accused of any wrongdoing in the criminal case.

In court documents filed in Houston last week, the NatWest Three's lawyers allege that the Royal Bank of Scotland (RBS) and Royal Bank of Canada have taken steps to prevent them from obtaining testimony from former colleagues.

“Outside counsel for RBS and RBC have informed [the] Defendants that they represent dozens of their former colleagues (including numerous individuals that no longer work for either company), and that nearly all of the individuals represented by RBS's and RBC's corporate counsel are unwilling to meet with counsel for the defense, let alone travel to the United States to testify at trial,” the court documents allege.

They go on to allege that many of those individuals have said that they didn't know they were being represented by lawyers, and that they never authorized lawyers for RBS and RBC to represent them.

The NatWest Three's ability to mount a vigorous defence is being “severely compromised, if not eviscerated,” they state.

Foreigners who live and work outside of the U.S. are not subject to the Houston court's subpoena power, and therefore cannot be compelled to testify at the trial, the documents say.

The NatWest Three's defence team is hoping to invoke a treaty between the U.S. and Britain that would result in British authorities compelling the potential witnesses to give video depositions.

“We've made RBC's lawyers aware of many people that we would like to talk to,” Matt Hennessy, a lawyer for Mr. Darby, said yesterday. “The people that we want to speak to all have knowledge of the facts relevant to our case, and we believe that many of them possess exculpatory knowledge. They possess knowledge of facts which show that our clients are innocent,” he said.

“Many of the people who currently work at RBC formerly worked at NatWest at the same time as the defendants,” he added.

For instance, Mr. Hennessy and the other lawyers for the NatWest Three want to question Dai Clement, who is now the head of one of RBC's infrastructure investment banking groups in Europe. Mr. Clement used to be an associate director at Greenwich NatWest, and the court documents say he personally analyzed a transaction that is central to the criminal charges, and drafted a memo recommending it.

Mr. Clement has not been, and is not being, accused of wrongdoing. The NatWest Three's lawyers hope he can demonstrate that their clients did not act with the intent to defraud NatWest.

The fraud charges against the NatWest Three allege that they devised a scheme to defraud the National Westminster Bank and Greenwich NatWest in connection with the bank's sale of its interest in a Cayman Islands company, working in cahoots with former Enron chief financial officer Andrew Fastow.

Mr. Clement has his own attorney, and is not being represented by RBC's lawyers. His lawyer has said he is not willing to assist the defendants in any way, their court documents allege.

Mr. Hennessy would not name all of the RBC employees who the defence team wants to speak to, “for the sake of their privacy.”

“But RBC's counsel are well aware of who we want to speak to,” he said.

In addition to Mr. Clement, the NatWest Three's court documents are asking the Houston court and the British government for help in obtaining video depositions from four other London bankers, including RBC's Mr. Burbidge, who has been with the Canadian bank for about two decades. He was named vice-president of RBC's treasury operations for Europe and Asia in 1994, and a managing director of RBC Dominion Securities two years later.

The documents state the “defendants desire to ask Mr. Burbidge about RBC's investigation of [the] defendants' involvement in the transactions at issue in the [criminal charges] and [the] defendants' activities in connection with that investigation.”

Two of the other bankers whose video depositions are being formally requested now work for Royal Bank of Scotland. The final banker was a director at Greenwich NatWest.

A date has not yet been set for the Houston court to consider the defendants' request, Mr. Hennessy said.

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Life Insurance Cos' Exposure to Subprime

The Globe and Mail, Tara Perkins, 6 August 2007

At 3 p.m. last Wednesday, Great-West Lifeco Inc. chief executive officer Raymond McFeetors welcomed analysts to the insurer's conference call on second-quarter financial results from "hot and steamy Winnipeg," and proceeded to tell them that it was "one of the best quarters ever for Great-West Lifeco."

About half an hour into the call, an analyst asked whether the company could outline its exposure to the U.S. subprime mortgage market.

Executives were prepared to answer. Great-West has about $1.2-billion of subprime through various pools its purchases, and the vast majority of that - 99.2 per cent - is rated triple-A, the safest rating.

The details came fast and furious. One of the company's U.S. executives said Great-West's subprime exposure is "about 5 per cent of our total assets."

In trading on the Toronto Stock Exchange, Great-West's stock was whacked.

It appears there might have been a misunderstanding, said Genuity Capital Markets analyst Mario Mendonca, who follows the company. He said the $1.2-billion exposure actually represents less than 1 per cent of Great-West's total assets.

Apparently, the executive had meant that the exposure is 5 per cent of the insurer's U.S. assets. That might not have been clear to some investors.

Too late.

At a time when the market is waiting for the next subprime-related shoe to drop, investors are shooting first and asking questions later.

Great-West stock, which closed Tuesday at $35.05, had fallen 5 cents to $35 shortly after 1:30 p.m. Wednesday, prior to the conference call. By about 3:45, the stock had dropped 85 cents. It closed down 88 cents, or 2.5 per cent, at $34.17.

That came on a rocky day for the broader market, which was also reeling from subprime concerns. Great-West is controlled by Montreal's Desmarais family.

"We believe the market completely ignored [Great-West's] stronger-than-expected earnings, 15-per-cent dividend increase, and strong P&D [premiums and deposits] and instead focused on the word 'subprime' in taking the stock down almost 3 per cent near the close," Mr. Mendonca of Genuity wrote in a note to clients the day after the earnings call.

Investors and analysts are scouring financial firms' earnings statements and tuning into conference calls, on the alert for any mention of subprime mortgage exposure.

Numerous major Canadian financial players, including all of the major banks, have not yet reported quarterly earnings since the subprime situation degenerated dramatically.

Toronto-based Manulife Financial Corp., the country's biggest insurer, will report Wednesday.

Canada's third-biggest insurer, Sun Life Financial Inc., also of Toronto, was the first to report last Tuesday, and kicked off the disclosure of subprime mortgage exposure. Sun Life's total exposure is about $400-million, chief financial officer Rick McKenney told analysts during a conference call.

"Total U.S. residential mortgage exposure is less than 4 per cent of invested assets. And of that, residential mortgage-backed and asset-backed securities with subprime exposure represents less than half of 1 per cent of total invested assets," Mr. McKenney said.

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Citi Analyst's Comments on Banks

The Globe and Mail, Angela Barnes, 2 August 2007

Financial stocks on both sides of the border were bounced around yesterday in the face of mounting credit worries and turmoil in the debt markets arising out of subprime mortgage market woes.

But in a contrarian stance, Citi Global Markets Inc. suggested the selloff in recent days is creating compelling buying opportunities in the sector.

Three Canadian banks, Canadian Imperial Bank of Commerce, Bank of Nova Scotia, and Bank of Montreal, appear on the list of financial stocks that the Citi team considers oversold in the wake of the subprime worries.

Citi's "buy on weakness" recommendations were made, it should be noted, before yesterday's trading.

The Citi team came up with a list of North American financial stocks that it believes have little or no subprime risk. Buying them should produce returns of between 17 and 44 per cent, Citi said.

In trading on the Toronto Stock Exchange yesterday, shares of CIBC fell 2.2 per cent, Scotia slid 1.3 per cent and BMO lost 2.2 per cent. The S&P/TSX financial sector fell 1.1 per cent.

In the United States, the S&P 500's financials index fell sharply during the day, but recovered in the last half-hour of trading to finish in positive territory.

Still, shares of Bear Stearns Cos. Inc., which saw two of its hedge funds collapse last month and is now stopping withdrawals from a third, dropped $2.92 (U.S.) to close at $118.30, and Lehman Bros. Holdings Inc. shares lost $1.18 to $60.82. Both trade on the New York Stock Exchange. E*Trade Financial Corp. shares slid $1.02 to $17.50 on the Nasdaq Stock Market.

For most of yesterday, the market was listening to negative views from analysts such as Andre-Philippe Hardy of RBC Dominion Securities Inc., who lowered his stock-price targets for BMO, CIBC, Scotia, Toronto-Dominion Bank and National Bank of Canada.

He cut his earnings estimates for the banks' wholesale and wealth management divisions based on the risk of continued weakness in the capital markets, and reduced the multiples on profit from those areas to reflect the rising uncertainty.

The analyst cut his 12-month stock price target for BMO to $69 from $71; CIBC to $108 from $114; National to $64 from $65; TD to $81 from $82 and Scotiabank to $54 from $57.

Tobias Levkovich, Citi's chief U.S. equity strategist, acknowledged in the Citi report that investors are worried about the possible evaporation of financial institutions' deal fees, declines in trading commissions, the status of lending facilities to hedge funds and acquirers, and even proprietary trading desk positions.

But he said, "we suspect the almost singular focus on financial sponsors and their ability to tap the credit market misses the point that U.S. equities are still very attractively priced," unlike the situation in 2000. Profits remain solid, he added.

U.S. financial stocks on Citi's recommended list included Merrill Lynch & Co. Inc., American Express Co. and NYSE Group Inc.

Shannon Cowherd, who covers the Canadian banks for Citi, recommends investors buy Scotiabank, CIBC and BMO on the expected pullback after the third-quarter results are reported, beginning Aug. 22. She said the fundamentals for the banks remain intact and that the banks' asset bases are large enough to absorb the losses expected on loans and writedowns on securities holdings "with minimal long-term impact." She also noted that the Canadian credit and housing fundamentals remain robust.

The Canadian banks do not have direct exposure to the U.S. subprime market, though they are active in some secondary markets and will be "affected by the spillover contagion impacting various structured products," she added. She has 12-month price targets of $64 (Canadian) for Scotiabank, $121 for CIBC and $85 for BMO.

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TD Waterhouse Within Rights to Meet Margin Calls: Judge

Financial Post, Jonathan Chevreau, 2 August 2007

The hazards of using discount brokers to buy stocks on margin are well illustrated in a "landmark" court ruling involving TD Waterhouse.

The Ontario Superior Court of Justice has ruled TD was in its rights when it sold out a client's positions in some blue-chip U.S. stocks during the 2002 bear market. The judgement was released July 24 and flagged online in yesterday's FP Trading Desk.

Retired investor Bruce Paciorka, 55, alleged the sell-outs were premature and excessive. He claimed TD Waterhouse breached its statutory duty and fiduciary obligations to him as an investor.

This was all rejected by Justice Mary Jo Nolan. She ruled "the very nature of a discount brokerage business implies a lower standard of care and does not create any fidiciary obligation between the client and the discount brokerage."

TD's lawyer, Gavin Tighe, a partner with Gardiner-Roberts LLP, says the ruling "erases the debate over whether reasonable notice is needed for margin calls." It also underscores a client's "responsibility to mitigate losses from margin calls," he added.

In an interview, Tighe said "you get what you pay for" in brokerage services. He says Paciorka's margin was 70/30: that is, he put up $30 and borrowed $70 for each $100 of stock in the account.

According to the judgement, Paciorka had invested in stocks since 1981, initially with full-service RBC Dominion Securities. He had margin accounts there and with other firms.

Paciorka opened a margin account in 1992 with what was then Green Line Investor Services. He considered himself a "sophisticated" investor. He experienced credit sell-outs in 1993, 1995 and 2001 when he failed to cover margin calls.

Windsor-based Paciorka retired in May, 2000, and invested in solid blue chips for long-term growth and income.

On margin, he bought hundreds of thousands of dollars worth of Home Depot, Office Depot and Ford Motor Co. His statement of claim says he was in a financial position to cover any margin calls because he had a line of credit for that purpose. As of June, 2002, his U.S. portfolio was worth $1.58-million, with margin debt of $1.03-million.

From July to October, 2002, TD sold out some positions when the stocks began to fall. Paciorka complained the sales were made before deadlines he was given in letters demanding he correct the deficiencies.

Paciorka was upset when those stocks soon recovered in value. TD's position is they had to mitigate any further losses and that if he was so sure the stocks would recover, he could have repurchased them on the open market.

Stan Buell, president of the Small Investor Protection Assocation (SIPA), does not recommend small investors use leverage, especially if they're near retirement.

But he says the financial industry encourages leverage to increase assets and generate commissions. He agrees discount brokers have no fiduciary duty to clients, but full-service brokers, mutual fund dealers and other "advisors" selling financial products do have such a duty.

B.C.-based certified financial planner Fred Kirby says discount brokers are in the transaction rather than relationship business. They serve sophisticated investors who do not need advice.

"This is far different from an advisor/client relationship which ideally should be fiduciary in nature where the client's interests are placed first."

Kirby says it's fair for brokerage firms to take action to protect their interests. "Margin calls are not made arbitrarily." Funds provided by brokers are based on strictly regulated and enforced formulae.

Investors need margin accounts to sell stocks short or trade options. But Kirby warns trouble can ensue if they use margin to leverage positions they can ill afford to take.

Adrian Mastracci, of Vancouver's KCM Wealth Management Inc., says there are better ways to borrow to buy stocks and still retain control.

"I'd counsel clients not to borrow from brokers. When you relinquish control, someone else can pull the trigger.".

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The Globe and Mail, Tara Perkins, 2 August 2007

It's buyer beware when it comes to trading with borrowed money in online discount brokerage accounts, a new court ruling suggests.

TD Waterhouse Group Inc. was within its rights when, three separate times, it sold off hundreds of thousands of dollars worth of stocks held by 55-year-old Bruce Paciorka, a retired employee of Chrysler Corp. That was true even when the selloffs occurred before the deadline the brokerage had given him in a margin call, and even though his account still had more value than his loans, an Ontario Superior Court judge has ruled.

It's an issue that's becoming more important for brokerages and investors as the amount of trading Canadians are doing with borrowed money - or on margin - hits record highs, while the stock markets are jittery.

The court ruling means online discount brokerages can "pull the switch" and liquidate a client's position before the client has nothing but debt, even without the client's permission, said Gavin Tighe, the lawyer who represented TD Waterhouse.

Canadian investors are borrowing more money from brokerage firms these days to place bets on securities. Margin accounts allow investors to trade with borrowed funds as long as they maintain a certain amount of money in the account. If the stocks or securities fall, the brokerage can issue a margin call requiring the investor to put more money in the account. If that doesn't happen promptly, the brokerage will often sell off some of the stocks.

Canadians had $14.06-billion worth of margin debt at the end of May. That's up from $12.4-billion one year earlier, and $9.8-billion in May, 2005, according to the Investment Dealers Association of Canada.

The court case involving TD Waterhouse was launched by Mr. Paciorka in 2005. The Windsor, Ont., resident believes he could have made more money by holding on to the shares of companies such as Home Depot.

In his lawsuit, he argued that TD Waterhouse should have honoured the dates it gave him when it issued margin calls. For instance, on July 15, 2002, the brokerage issued a margin call to Mr. Paciorka saying he had 10 days to make a deposit of $231,998. But that same day, it sold off 14,400 of his shares for $405,120.44.

Justice Mary Jo Nolan pointed out in the ruling that the brokerage's letters state that it might be obliged to cover the margin call without notification if the stocks fall further.

In addition, the agreement clients sign with TD Waterhouse for margin accounts says sellouts are allowed without any attempt to notify the client. Every discount brokerage uses that boilerplate clause in their agreements, Mr. Tighe said.

Mr. Paciorka's lawyer, Arthur Barat, could not be reached for comment yesterday.

He had argued that TD Waterhouse had a fiduciary duty to act in Mr. Paciorka's best interest. But Justice Nolan said that's not the case, noting the discount brokerage did not provide investment advice to Mr. Paciorka and was not in a position of trust.

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Banks' Losses from US Subprime Expected to be Manageable: DBRS

Reuters, 2 August 2007

U.S. and Canadian banks face limited exposure to subprime mortgage losses and future rating downgrades, bond rating company DBRS said on Thursday.

The U.S. mortgage market has been hit by rising delinquencies and defaults on subprime loans made to risky borrowers, setting off a wave of rating downgrades of related securities in July. Healthy earnings should insulate financial institutions, DBRS analysts said on a conference call.

"There has been a lot of over-reaction in the market," said Alan Reid, a DBRS managing director of U.S. financial institutions in New York. "We do not expect wholesale downgrades of banks with exposure to subprime."

The rating company has re-evaluated its views on some mortgage companies. DBRS on Thursday changed its view on IndyMac Bancorp Inc. , one of the largest independent U.S. mortgage providers, to stable from its previous positive rating trend.

DBRS also revised CIT Group Inc. , the commercial and consumer lender, to stable from positive on July 20. CIT said last month that it is exiting the mortgage business.

U.S. banks, including Citigroup Inc. , Wachovia Corp. and Bank of America Corp. , reported higher-than-expected quarterly earnings last month as their banking activity helped offset a decline in credit quality and concern about bad loans.

"The banks face some risks from subprime but the strength of their earnings will help them to ride that out," said Roger Lister, chief credit officer for U.S. financial institutions at DBRS. "The fundamentals are fairly strong."

Brenda Lum, who covers Canadian banks for DBRS, reiterated remarks made in a report on Wednesday that said Canada's five largest banks also face limited losses from their exposure to U.S. subprime loans.

"There are no credit rating implications for the five largest Canadian banks," Lum said. "There is minimal impact."

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Financial Post, Grant Surridge, 1 August 2007

Canadian banks have limited exposure to the U.S. sub-prime mortgage market, according to a report released Wednesday by the Dominion Bond Rating Service.

“Though the big five banks do have exposure to the sector, their exposures do not affect their credit risk profiles sufficiently to impact credit ratings,” said report author Brenda Lum.

The report did not provide details of each bank’s exposure, or of the total exposure of the “big five” banks: Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and Toronto-Dominion Bank.

Canadian banks are exposed through their market making activities, securitization businesses and the financing of players in the U.S. subprime market.

While DBRS expects banks to make some writedowns, it said the magnitudes should be manageable relative to earnings and capital.

The deteriorating sub-prime mortgage market has dominated headlines, with some commentators estimating losses could total $100-billion.

“We felt it was necessary to have a comment out with respect to this particular subject,” said Ms. Lum

Some observers have suggested that even AAA-rated sub-prime debt instruments could see their ratings downgraded. Ms. Lum declined to comment on the implication for Canadian banks.

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Investment Executive, James Langton, 1 August 2007

The big five Canadian banks have limited exposure to the subprime mortgage market, and are well positioned to weather the credit quality storm, says DBRS.

The rating agency says that while the subprime market in the United States has come under increasing pressure of late, it has concluded that there are no credit rating implications for the five largest Canadian banks. “Though the Big Five do have exposure to this sector, their exposures do not affect their credit risk profile sufficiently to impact current ratings,” it says.

As participants in the U.S. capital markets, some of the Canadian banks are exposed through their market making activities, securitization businesses and the financing of participants in the U.S. subprime market, DBRS says. As such, DBRS expects some losses, but they are expected to be manageable.

The outlook for the credit risk profile of the Canadian banking industry remains strong, DBRS adds. It anticipates the magnitude of losses and write-downs to be manageable relative to earnings and capital.

DBRS says it expects the Canadian banking industry to absorb the losses and maintain its current credit ratings, as a result of: strong pre-tax earnings, which is the first line of defence to absorb higher losses; and, being well capitalized. Regulatory capital levels are at historically high levels, and earnings are reasonably diversified at all the Big Five banks, it notes.

These factors give DBRS comfort that a significant cushion of earnings and capital are available to support further write-downs, barring any unforeseen negative economic events (i.e., a U.S. recession).

DBRS’s review of information provided by each of the banks indicates that the largest exposures to U.S. subprime mortgages are primarily in the Big Five’s capital markets businesses. “Their exposure, if any, is mainly in their securities books, either in inventory held for trading or investments and in providing liquidity lines to securitization vehicles which may have some exposure to U.S. subprime mortgage lending,” it explains. “There are also modest amounts of exposure in some banking books, such as lending to subprime borrowers or to U.S. subprime mortgage lenders.”

With the deterioration of the ratings of many U.S. subprime RMBS programs, DBRS expects that some of the Big Five may need to write down a portion of the carrying value of RMBS and CDO securities that are exposed to U.S. subprime mortgages. Market conditions are expected to deteriorate further in the near term, resulting in additional losses, it points out.

DBRS expects minimal impact on the Canadian banks from higher default rates in the Canadian subprime mortgage market. The Big Five are not active direct lenders in the subprime market, given their conservative underwriting, the small size of the Canadian market and high administration requirements, as these mortgages are more labour-intensive than prime mortgage loans, it says.

The Canadian subprime market is growing, DBRS allows, but there are fundamental differences between the Canadian and U.S. Markets, it finds. “Given the lack of data on the Canadian subprime market, the only comparable default rates were 2.35% (over 90 days in arrears) in Canadian subprime as of October 31, 2006, compared with U.S. subprime adjustable rate mortgage loans past due, which were 14.03%, and subprime fixed rate mortgage loans past due, which were 9.96% for the month of October 2006,” it suggests.

According to more recent data from the U.S. Mortgage Bankers Association (March 2007), U.S. subprime adjustable rate mortgage loans past due were 16.22% and subprime fixed rate mortgage loans past due were 10.21%.

The better performance of the market in Canada is likely due to: the slow adoption of subprime mortgage products in Canada; more conservative application review; limited underwriting of low quality subprime products within the market; and, a lack of mortgage-interest deductibility, DBRS says. “At the same time, the role of mortgage brokers in the U.S. capital markets combined with low interest rates and house price increases appear to have been the key drivers for rapid growth in the U.S. subprime market,” it adds.

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Bloomberg, 1 August 2007

Bank of Montreal and Canadian Imperial Bank of Commerce led Canadian bank stocks lower, adding to their biggest two-month decline in five years, on concern that turmoil in the credit markets will erode earnings.

The Standard & Poor's/TSX Banks Index fell 1.2 percent, the seventh decline in eight days. The index of nine Canadian lenders plunged 7.6 percent in June and July, the steepest drop since the summer of 2002.

Reduced demand for corporate credit may cut underwriting fees for lenders such as Royal Bank of Canada, analysts and investors said. The banks may also be forced to write down the value of their mortgage-backed securities in the U.S. as defaults among subprime borrowers reach a 10-year high.

``This subprime thing has got everybody really nervous,'' said John Kinsey, who helps manage $900 million at Caldwell Securities Ltd. in Toronto, including bank stocks. ``People are saying `what if?', but so far the banks haven't made any disclosures, and nobody's warned about the earnings.''

RBC Capital Markets analyst Andre Philippe-Hardy today lowered his price targets and 2008 earnings estimates for five of the six largest banks, citing concerns about capital markets fees. The Canadian banks are scheduled to report fiscal third- quarter results at the end of this month.

Hardy said investment banking earnings will fall 3 percent on average next year because of slower revenue growth and rising loan losses. That compares with a 15 percent increase in 2006 and an estimated 10 percent gain this year.

``Fixed-income trading, debt and equity underwriting, M&A, bridge financing and asset management could all suffer,'' Hardy wrote in a note to investors today.

Shares of Bank of Montreal, the fourth-biggest lender, fell C$1.45, or 2.2 percent, to C$65.14 at 4:10 p.m. in trading on the Toronto Stock Exchange. Bank of Nova Scotia, the No. 2 bank by assets, fell 65 cents, or 1.3 percent, to C$48.80. Canadian Imperial Bank of Commerce fell 2.2 percent to C$90.47, and has dropped 12 percent since May 31.

Analysts and investors are concerned about the banks' holdings of U.S. subprime loans, which are souring at the fastest pace since 2002, according to the U.S. Mortgage Bankers Association.

Canadian banks have ``limited'' ties to the U.S. housing market by holding mortgage-backed securities, which could lead to writedowns or losses, according to Dominion Bond Rating Service. Among Canadian lenders, Royal Bank, Canadian Imperial, and Bank of Montreal have the largest capital markets businesses in the U.S.

CIBC, the fifth-largest bank, may record a writedown of as much as C$100 million ($94.2 million) in the third quarter to reflect the reduced value of its investments tied to subprime housing, Hardy wrote last month.

``We believe the markdown at CIBC could exceed our previously estimated range given the continued rapid deterioration,'' in asset prices, he wrote today.

The Toronto-based bank has investments in mortgage-backed securities including collateralized debt obligations, which package mortgage bonds into new securities. New York-based newsletter Grant's Interest Rate Observer reported in June that CIBC may have as much as $2.6 billion in such investments.

CIBC said in a July 10 statement its ``unhedged exposure'' is well below that amount. CIBC spokesman Rob McLeod declined to comment today.

Royal Bank said on May 25 it had a ``small net trading loss'' in the second quarter related to weakness in the U.S. subprime market.

The Canadian subprime market, while growing, has a lower default rate than in the U.S., Dominion Bond Rating Service said in a note today. Canada has been slower to adopt subprime mortgages, and borrowers can't deduct mortgage interest payments from their taxes, the ratings agency said.

Another concern among investors is that companies such as CanWest Global Communications Corp. have scrapped high-yield bond sales, forcing banks to take more risk in leveraged buyouts. U.S. banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc. failed to sell $20 billion of loans last week to finance the buyouts of Alliance Boots Plc and Chrysler by Kohlberg Kravis Roberts & Co. and Cerberus Capital Management.

Toronto-Dominion Bank said it will provide C$3.8 billion in financing for the proposed C$34.2 billion takeover of BCE Inc., Canada's largest phone company. Toronto-Dominion plans to distribute the debt and equity to other lenders and investors.

Toronto-Dominion spokesman Simon Townsend declined to elaborate on the bank's financing for BCE.

``People in general are skeptical towards all the banks,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages about $4.2 billion, including bank stocks. ``They're a little uncertain exactly how this whole credit spread widening is going to affect any one of them."

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Great-West Lifeco Q2 2007 Earnings

BMO Capital Markets, 2 August 2007

Impact

Slightly positive.

Forecasts

No changes to our 2007E and 2008E EPS of $2.40 and $2.75, respectively.

Valuation

The $40 target price is unchanged, representing 14.5x 2008E EPS.

Recommendation

Overall, results in the quarter were good, with particular strength in Europe and Canada. New business growth remains attractive across all major segments: Canada, US Financial Services and Europe. The Putnam acquisition is expected to close shortly and the company has left open the option of issuing some equity to help finance the transaction; however, GWO is analyzing alternatives to minimize any equity issuance. Of note, GWO did disclose that it has US$1.2 billion in exposure to US subprime residential mortgages, representing 1.1% of general fund assets. It is important to note that 99.2% is AAA rated, all fixed rate, 78% loan-to-value, 70% of the exposure came prior to 2006 and we estimate that GWO has been active in these types of securities since at least the mid 1990s. Despite these assurances, we suspect that GWO’s exposure to subprime mortgages could weigh on the shares, at least in the short term. We are maintaining the Outperform rating, based on attractive new business growth over the last few years to drive earnings, cost management and the benefits from the Putnam acquisition.

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RBC Capital Markets, 2 August 2007

Fully diluted EPS of $0.61 for Q2/07 were up 18% versus Q2/06 and were ahead of our $0.57 estimate and the street estimate of $0.59. Expected earnings from the in-force business were up a very strong 26%, and experience gains remained high, accounting for 21% of pre-tax earnings. The quarterly dividend per share was raised from $0.255 to $0.275. We were looking for an increase to $0.26.

We maintain our Outperform rating and 12-month price target of $40. We believe that Great-West is one of the better stocks to own in our universe in turbulent times given the conservative nature of the company. We believe that the company has less exposure to potentially weaker equity markets and deteriorating credit quality, notwithstanding exposure to U.S. sub-prime mortgages. We believe that earnings upside could come from the integration of announced acquisitions, including Putnam, and potential improvements in U.S. healthcare results.

We believe that Great-West's share price is temporarily held back by the potential for a share issue to help finance the Putnam transaction. Management indicated at the time of the transaction announcement that it may issue up to C$1.2 billion in equity to finance the transaction, which is a short-term risk to the stock price. This risk is mitigated by our belief that Power Financial will likely subscribe for a large portion of the offer, and we believe that management will favour other types of financing options, if available, and issue less equity than the $1.2 billion figure, particularly since the appreciation in the Canadian dollar against the U.S. dollar reduces the ultimate purchase price.

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RBC CM Cuts EPS Estimates & Target Prices for Banks

RBC Capital Markets, 1 August 2007

• Lowering target prices based on capital markets weakness. We have lowered our EPS estimates for wholesale and wealth management based on the risk of continued weakness in capital markets by 5%. Our new estimates reflect our view that capital markets earnings will not be as strong as previously anticipated; we may need to review them as the revenue outlook is unclear. We also lowered our multiples on wholesale earnings to 8-10x to reflect rising uncertainty. Our target prices for Scotiabank and CIBC are most negatively impacted (5%), although for different reasons, while TD is least impacted (-1%).

• Target multiples below 5-year average. Our new target valuations aggregate to 11.7x forward EPS (5-year average is 12.2x). We believe this is justified by the likelihood of less buoyant capital and credit markets, and a likely slowdown in wealth management revenue growth.

• Banks with a retail focus should outperform wholesale banks. TD appears best positioned with a dominant retail franchise and an earnings mix that is more weighted to retail (20% wholesale in the last 12 months versus a 30% group median). RY also has a dominant retail franchise, and its wholesale mix is in line with group median.

• Continued weakness could lead to buying opportunities. If banks trade toward the 5-year trough (10.5x in 2002), we believe it would be worth looking through short-term volatility and buying the Canadian banks aggressively.

• Increasing price of risk has negative implications for many businesses. Fixed income trading, debt and equity underwriting, M&A, bridge financing and asset management could all suffer. Partially offsetting those negatives, trading volumes spiked in many asset classes and volatility increased in recent weeks. Also, large sudden moves can lead to large gains.

• CIBC is most exposed to U.S. sub-prime real estate. CIBC and RY acknowledged exposure to securities backed by U.S. sub-prime real estate when releasing Q2/07 results. The cushion that banks have in higher-rated CDO tranches is getting thinner as delinquencies in underlying assets are rising, and weakness in CDO prices is likely to force both to mark down the value of their assets when Q3/07 results are released. We believe the mark-down at CIBC could exceed our previously estimated range ($50-100 million) given the continued rapid deterioration in asset prices backed by U.S. sub-prime real estate.

• 12 Month Target Price
.............Old........New
BMO.. $ 71.00 $ 69.00
BNS... $ 57.00 $ 54.00
CM .. $114.00 $108.00
NA.... $ 65.00 $ 64.00
RY.... $ 64.00 $ 63.00
TD.... $ 82.00 $ 81.00

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Sun Life Q2 2007 Earnings

RBC Capital Markets, 1 August 2007

Investment Opinion

• Core EPS of $0.96 were ahead of our $0.94 estimate and in line with the street view ($0.96). Reported EPS were higher, but we exclude a $42 million ($0.07 per share) gain on an internal reinsurance transaction in Canada. Core EPS were up 20% over the weak Q2/06 results and in line with Q1/07.

• The quarterly dividend was increased $0.02 to $0.34 per share, a touch below our $0.03 expected increase.

• Quality of earnings was excellent this quarter with management actions and changes in assumptions of approximately ($43 million) on a core basis versus a gain of $60 million (i.e. a reserve release) in Q2/06.

• Value of new business growth of 10% on a trailing 12 month basis is positive on an absolute basis, but it is likely to trail the peer group's growth (IAG reported +22% growth).

• A major near term positive catalyst for earnings is the probable re-capture of strain related to Q4/06 and Q1/07 universal life sales in the U.S. We estimate the strain recapture will be between $80-$120 million (pre-tax), some time in H2/07. Near term risks to the Q2/07 earnings run-rate include: (i) currency translation in H2/07 if the Canadian dollar remains at current levels compared to U.S. dollar and British pound and (ii) likely unsustainable experience gains primarily related to equity markets and morbidity.

Investment Thesis

Sun Life is currently trading at 12.1x NTM earnings compared to its 5-year average of 12.0x and the current lifeco median of 12.9. Sun Life is highly capitalized, has exposure to large asset management businesses and has a well-positioned domestic group platform. Also, the company would benefit more than banks from rising interest rates, while it would be less impacted by deteriorating credit quality. The discount to Manulife and Great-West is justified, in our view. Sun Life's international platforms are less well established than Manulife's, while earnings quality and medium-term embedded value growth has been weaker. Compared to Great-West, Sun Life is more exposed to deteriorating credit quality and has less upside potential from recent acquisitions. Our 12-month price target remains $57, representing 16% potential upside including the dividend.

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TD Securities, 1 August 2007

Impact – Positive

Headline operating EPS was $1.03, vs. our and consensus estimates of $0.97. However, if we back out a $42m (after-tax) reinsurance gain, operating EPS was $0.96, a penny shy of expectations. Other than the one-time reinsurance gain, we'd classify Q2/07 as a relatively clean quarter, with most of the themes playing out as we expected, and we go through the details below. We have raised our EPS estimates (see side bar); our price target goes to $59 (from $58); and, we maintain our BUY rating.

Details

• Improved U.S. Life Insurance GAAP Earnings. SLF’s U.S. life insurance division’s GAAP earnings had suffered due to the lack of a proper funding structure (resulted in higher new business strain), an issue that is being rectified, and we saw improvements flow through in Q2/07. Earnings increased to $41m, vs. a loss of $4m in Q2/06. Also contributing to the yr/yr improvement was lower sales ($60m vs. $109m) - not a trend we’d like to see continue longer-term – and higher interest rates. Management has guided to slower U.S. life insurance sales in the coming quarters as producers’ transition to new product offerings.

• MFS had a Good Quarter. Earnings increased 28% (32% on a US$ basis); net margin was 34%, up from 27%; net outflows improved to US$121m, from US$341m; and, assets under management at quarter end were up 20% (to US$202b) – all on a yr/yr basis.

• U.S. Variable Annuity (VA) Sales showed Momentum. Gross U.S. VA sales were US$805m (and net inflows US$82m) vs. US$411m (outflows of US$277m) in Q2/06. This is the first quarter of net VA inflows in some time. The launch of its Income ON Demand VA contract, and ongoing initiatives (i.e., management changes and wholesaler expansion), are having a positive impact. We continue to believe that a more sustainable level of net inflows is still a year off as an old book of (single manager) business runs off, and competitors move into the “Income ON Demand” feature space.

• Canadian Earnings Increased 6%. Actually, earnings fell at this division by 3% if we exclude unusual items from both quarters. This is in line with our slower growth theme for Canada.

• Value of New Business Growth Tailed Off. Over the LTM, SLF’s VNB increased 10.1% over the prior year’s comparable period, a decent showing, but down from 13.2% growth at the end of Q1/07. While quarterly figures are not disclosed, we suspect VNB was down in Q2/07 vs. last year. Lower U.S. life insurance sales contributed to this softness; and, given management guided to slower U.S. life insurance sales over the next few quarters, we expect a similar showing in the second half of 2007.

• SLF repurchased 3m shares for $152m, and increased its dividend to $0.34 (from $0.32).

Justification of Target Price

Our $59 target price (up from $58) equates to 14.5x our four-quarter forward EPS estimate. We believe SLF offers the following positive attributes: (1) improving fundamentals in several key divisions; (2) strong recent performance / increase in the value of MFS; and (3) long-term growth prospects of its Asian operations.

Key Risks to Target Price

(1) Spikes in sales strain; (2) US$ weakness; (3) integration problems with the Genworth U.S. group business; (4) sudden spikes in interest rates; (5) significant downturns in equity markets; (6) poor mortality or morbidity claims experience; (7) regulatory investigations into industry sales practices; and (8) declining interest rates.

Investment Conclusion

We believe SLF’s shares have come under pressure over the past 6-months due to concerns regarding increased strain at its U.S. life insurance division, a result of new product launches, and the lack of a proper funding structure, which skewed results under Canadian GAAP (no impact on the economics of the product). As well, general noise in SLF’s results has caused investors to question the quality of its earnings. A few items provide us confidence with our BUY rating:

• A proper funding structure should alleviate new business strain at its U.S. life insurance operation.
• Accretion benefits from recent acquisitions in Asia / U.S.
• An innovative U.S. VA product has resulted in strong sales (and we expect earnings improvements).
• MFS is starting to gain momentum.
• Attractive relative valuation.

While there will always be noise in life insurance results, the magnitude of this noise could dissipate or be overshadowed by positive events over the coming few quarters. That said, if the C$ continues to strengthen (against the US$ and GBP), and equity markets decline (by our estimate, just over 50% of SLF’s earnings are derived from wealth management), we will have to revisit our EPS estimates, with a downward bias.

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Bloomberg, Sean B. Pasternak, 31 July 2007

Sun Life Financial Inc., the first Canadian insurer to report quarterly earnings, said profit rose 15 percent to a record, topping analysts' estimates, as higher stock prices lifted asset-management fees. The stock had its biggest one-day jump in almost a year.

Second-quarter net income climbed to C$590 million ($557 million) or C$1.02 a share, from C$512 million, or 88 cents, a year earlier, the Toronto-based insurer said today in a statement.

Canada's third-largest insurer benefited from higher fund sales as the benchmark Standard & Poor's/TSX Composite Index climbed 5.6 percent during the quarter. Sun Life owns 36.5 percent of CI Financial Income Fund, the country's second- biggest mutual fund company, and has a stake in asset manager McLean Budden.

``Equity markets have been strong,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages about $4.2 billion, including Sun Life shares. ``When the markets go up, people usually put money into their mutual funds.''

Excluding one-time costs related to scrapping the Clarica brand in Canada and buying the U.S. group benefits unit of Genworth Financial Inc., profit was C$1.03 a share. That compares with the 96-cent-a-share median estimate of 10 analysts polled by Bloomberg.

Shares of Sun Life climbed C$1.34, or 2.7 percent, to C$50.39 at 4:18 p.m. in trading on the Toronto Stock Exchange, the biggest gain since Aug. 15, 2006.

Revenue dropped 28 percent to C$4.5 billion on lower returns from investment income. That was mostly because of changes in international accounting rules that reduced the value of the fixed-income portfolio, Chief Executive Officer Donald Stewart said.

``It's no longer what most people would regard as a solid indicator of the revenue received during the quarter,'' Stewart said today in a telephone interview.

Profit from Canadian insurance and asset management climbed 6 percent to C$280 million, boosted by sales of individual insurance and investment products. Mutual fund sales in Canada rose to an 11-year high in May, according to the Investment Funds Institute of Canada.

Earnings from MFS Investment Management, the company's Boston-based fund business, climbed 28 percent to C$68 million.

U.S. insurance earnings surged 73 percent to C$156 million on higher sales of annuities and individual life insurance. Sun Life reported last month that gross sales of variable annuities in the U.S. were at least $1 billion in the first five months of 2007, a 66 percent increase from the year-earlier period.

U.S. insurance results were ``well ahead of our expectations and one of the strongest quarters ever,'' UBS Canada analyst Jason Bilodeau wrote in a note to investors today.

Sun Life raised its quarterly dividend 6.3 percent to 34 cents a share, the fourth increase in two years.

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Scotiabank Mexico Q2 2007 Earnings

Financial Post, Jonathan Ratner, 31 July 2007

Solid second quarter results from Bank of Nova Scotia’s Mexican banking business showed net earnings rose 15% on a quarterly basis to $994-million pesos.

Blackmont Capital analyst Brad Smith thinks this should more than offset the 5% quarterly gain for the Canadian dollar as reflected in Scotiabank’s third quarter results.

He continues to rate BNS a “buy” with a $61 price target, representing upside of more than 20%.

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Dow Jones Newswires, Ken Parks, 31 July 2007

The Mexican banking arm of Canada's Bank of Nova Scotia said Tuesday its 2nd quarter net profit fell 36.3% mainly as a result of a one-time tax gain the previous year.

Net profit was 993.8 million pesos ($90.5 million), down from MXN1.56 billion in the year-ago quarter, Grupo Scotiabank said in a press release.

Net interest income for the quarter rose 16.7% to MXN2.20 billion thanks to strong growth in retail loans and an improving cost of funding, while non- interest income fell 31.5% to MXN1.11 billion.

Scotiabank reported an extraordinary gain of MXN528.9 million, principally from a tax refund, in the second quarter of 2006.

Administrative expenses increased 2.5% to MXN1.78 billion, while loan loss provisions soared to MXN502.9 million in the quarter from MXN44.6 million a year ago.

The bank's assets rose 5.3% to MXN136.67 billion at the end of June, while retail deposits grew 5.5% to MXN104.02 billion.

The bank's performing loans rose 4.5% to MXN90.01 billion, with strong growth in mortgages offsetting a drop in commercial and government lending.

Asset quality slipped during the quarter, with the bank's non-performing loan ratio rising to 2.5%, from 2.4% in the first quarter and 2.0% a year ago.

Scotiabank Mexico opened 15 branches during the quarter, ending June with just over 520 branches. The bank said its on track with plans to open 85 new branches in 2007.

Scotiabank Mexico ranks as the country's sixth-largest bank.

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Banks May See Decline in Trading Revenue

The Globe and Mail, Tara Perkins, 31 July 2007

Today is the last day of the fiscal third quarter for Canada's big banks, meaning what the markets do today will affect the profits they report.

While those profit announcements are still weeks away, Desjardins Securities analyst Michael Goldberg says he's going to be watching for possible profit warnings after today.

The banks need today's closing prices to determine the value of their trading books for the quarter. The prices will be used to figure out what the paper gains or losses are on securities the banks are holding.

The past week has seen concern intensify about the impact of credit related to U.S. subprime mortgages, as well as debt financing for leveraged buyouts. Mr. Goldberg said he now believes there is the chance of a systemic decline in banks' trading revenues for the first time since 1998.

Banks' trading revenues generally fluctuate from quarter to quarter, with the direction at each bank moving independently. The exception was the fourth quarter of 1998, when four of the big banks all suffered sharp declines in their trading revenue, driven by a downturn that followed billions of dollars in losses at the hedge fund Long-Term Capital Management.

Spreads on collateralized mortgage-backed securities have widened dramatically very recently, and that "could be the catalyst for another systemic downturn in trading revenue," Mr. Goldberg wrote in a report yesterday. The wider spreads may have serious negative repercussions for debt investors, he said.

"We believe that this increased risk explains the pullback that has taken place in many financial services stocks."

The situation might have an impact on investors far beyond just those that hold deeply subordinated exposure to collateralized mortgage-backed securities, he said. And he is not going to guess which banks may or may not be affected.

"It's very hard to tell where the actual exposures are going to turn up, because it's gone beyond just kind of junior exposures and it's widened out in the debt capital markets," Mr. Goldberg said in an interview yesterday. There is a lot of leverage that is related to the subprime mortgage-backed securities, and that adds to the complexity of figuring out where banks might be exposed, he said. "It may be in places that nobody has even thought of."

Increasing credit spreads, U.S. banks turning off the subprime lending tap, and the spectre of failed leveraged buyouts sent markets tumbling last week. And this time, the Canadian financial players saw their stocks fall along with the U.S. names, Genuity Capital Markets analyst Mario Mendonca pointed out in a note to clients yesterday. The bank stocks were down about 5 per cent on average.

"Like the U.S. financials, Canada's large-cap banks and insurers are trailing the composite by levels not seen in years," he wrote.

Shares of Toronto-Dominion Bank fell because the $3.3-billion in debt and $500-million equity bridge it had contributed to the buyout of BCE Inc. attracted renewed attention as other high-yield debt offerings had troubles, Mr. Mendonca said. With credit spreads widening, he said he would not rule out TD taking "at least a modest charge" as it tries to syndicate its exposure to BCE.

The market is not going to ignore the number of looming financial risks facing the banks in the near term. But that means that bank stocks are now heading toward attractive - i.e. reasonably priced - territory, Mr. Mendonca said.

There are numerous risks of bad headlines ahead, he said. Credit rating agencies are likely to downgrade some securities related to the subprime sector. There could be a leveraged buyout problem. A hedge fund could get into trouble, and "all of our banks have done some kind of lending to hedge funds." And, widening credit spreads are an indication that "this long period of the credit environment being perfect looks like it could be coming to some kind of end, or at least deteriorating."

While the potential headaches are numerous, and investors will react, Mr. Mendonca does not believe any bank will be crushed by any of these issues.

"So, I would say in the near term you're going to find opportunities to buy these banks cheaper."

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Financial Post, Grant Surridge, 30 July 2007

More word today regarding the imploding subprime mortgage situation south of the border. In a note to clients this morning, Desjardins Securities analyst Michael Goldberg says Canadian banks and lifecos could see reduced trading revenues as a result of exposure to such debt.

He refers to a Web site (www.markit.com) that measures the spreads for collateralized mortgage-backed securities (CMBS). Recently the spreads for even the AAA-rated tranches of CMBS have risen steeply, which could affect investors beyond those exposed only to the subordinated debt.

The implication, writes Mr. Goldberg, is that banks and lifecos could see significant declines in their trading revenues. He sees this possibility as being behind the recent pullback in financial sector stocks, and advises investors to watch for possible profit warnings after the banks’ July 31 quarter end.

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BMO Renews Buyback Plan for 25 Million Shares

Dow Jones Newswires, 25 July 2007

There could be more than meets the eye in Bank of Montreal's renewed normal course issuer bid for 25 million shares, says Genuity Capital Markets. The proposed Normal Course Issuer Bid is much larger than the bank's 4 year average, and if completed, means BMO will have returned more than 100% of earnings in dividends and buybacks. Analyst suggests BMO's move means "the bank is modeling for a substantial reduction in capital requirements under Basel II" by building "sufficient capital flexibility to manage under the new requirements." This, Genuity says, "does alert us to the potential for a material increase in buyback activity heading into 2008."

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Bloomberg, Doug Alexander, 24 July 2007

Bank of Montreal, Canada's fourth-largest lender, plans to buy back as much as 5 percent of its stock, extending its share repurchase program for another year.

Bank of Montreal will buy up to 25 million shares over 12 months starting Sept. 6, the Toronto-based bank said today in a statement. The bank had bought back about 5.33 million shares for an average price of C$69.72 as of the end of June under its current program, which ends Sept. 5.

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RBC CM Lowers CIBC's Q3 2007 EPS Estimate

The Globe and Mail, Tara Perkins, 24 July 2007

Canadian Imperial Bank of Commerce could be forced to take a hit of about $100-million this quarter because of its exposure to securities related to the U.S. subprime mortgage market, analysts say.

"The continued weakness in securities related to U.S. subprime housing will likely force CIBC to mark down its exposure to the space, as most of its securities are held in its mark-to-market trading book," RBC Dominion Securities Inc. analyst André-Philippe Hardy wrote in a note to clients yesterday.

"We believe that a $50-million to $100-million markdown is possible."

BMO Nesbitt Burns Inc. analyst Ian de Verteuil recently estimated CIBC could take a charge of $100-million to $150-million this quarter.

It is still in the midst of its fiscal third quarter, which runs to the end of this month. Financial results are scheduled to be released Aug. 30.

"Given that CIBC should earn $675-million after tax in the third quarter, such a charge could amount to about 10 to 15 per cent of quarterly earnings," Mr. de Verteuil wrote in a note to clients.

He is assuming the bank's total exposure, or holdings, of this type of securities could be about $1.2-billion. The bank has not disclosed how much exposure it has and CIBC declined to comment on the analysts' reports yesterday.

Any markdown or loss would almost certainly be partly offset by lower taxes and lower employee bonuses, Mr. Hardy said.

He revised his per share earnings estimate down from $2.01 to $1.90. Analysts' consensus is $1.95.

"The bank has not issued a press release on its quarterly results, which is somewhat comforting as the current quarter is only seven days from being over," Mr. Hardy wrote. "In our view, this suggests that the bank's exposure to U.S. subprime housing securities will not cause a material shortfall to earnings estimates."

At this point, CIBC's losses are probably paper losses rather than realized cash losses, Mr. Hardy said.

The paper value of these investments on the bank's books can be volatile, Mr. de Verteuil explained.

The holdings must be valued, or marked, regularly. A weak mark at quarter's end can cause a large mark-to-market - or paper - loss, only to have the position reverse the next quarter, he said.

"Given the poor market currently, this could easily be a problem in CIBC's third quarter, even though holding the positions to maturity may produce no economic [or actual cash] loss," he wrote.

But the idea that any losses would only be on paper is scant comfort, he added.

"The reality is that CIBC purchased a security [or the derivative of a security] that is worth less than when it was originally acquired. In the cold light of hindsight, there must be some negative consequences for the income statement."

Taking a charge this quarter "would be a disappointment for CIBC," which has "done a tremendous amount to de-risk the bank," Mr. de Verteuil added.

CIBC chief executive Gerry McCaughey has made reducing risk a major priority since the bank took a $2.4-billion (U.S.) charge in 2005 to settle a lawsuit related to Enron.

The bank now earns a larger proportion of its profit from bread-and-butter Canadian consumer banking than any of its peers, Mr. de Verteuil said. And, disregarding this situation with the subprime-related securities, it seems to be on track for a strong operating year, he added.

Mr. de Verteuil said he takes comfort from the fact that Bank of Montreal took a "very surprising" $680-million charge earlier this year from its commodity trading operations, and has still performed roughly in line with its peers since.

Blackmont Capital analyst Brad Smith pointed out in a note to clients yesterday that CIBC was the only Canadian bank to make the list of "Top 20 Counterparties by Trade Count" released in Fitch Ratings Ltd.'s recent credit derivative survey. CIBC crept onto the list at No. 20. It did not rank in the top 20 counterparties by notional amount. Morgan Stanley topped both lists.

Fitch's report notes that valuations of credit derivatives are being largely driven by assumptions that may not always reflect market prices, and so "institutions may be understating losses or overstating gains." That "leaves little doubt in our view as to the potential for broad-based mark-to-market losses over coming quarters," Mr. Smith wrote in yesterday's note on the banks and structured finance.

Eleven U.S. banks, investment banks and brokers reported financial results last week, and on average they beat analysts' consensus estimates by 5 per cent. But their stocks ended the week down 4 per cent, as investors focused far more on risks than near-term earnings, Genuity Capital Markets analyst Mario Mendonca said in a note to clients yesterday.

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RBC Capital Markets, 23 July 2007

Investment Opinion

• The continued weakness in securities related to U.S. sub-prime housing will likely force CIBC to mark down its exposures to the space, as most of its securities are held in its mark-to-market trading book.

• We believe that a $50-100 million mark down is possible, based on our belief that the April quarter mark down was in the $25 million range. A mark down would almost certainly be partially offset by lower income taxes and incentive compensation.

• Our prior core cash earnings estimate was $685 million, so the net income hit we expect represents 5% of Q3/07E earnings. We expect the bank to earn a ROE of 23.0%.

• The bank has not issued a press-release on its quarterly results, which is somewhat comforting as the current quarter is only 7 days from being over. In our view, this suggests that the bank's exposure to U.S. sub prime housing securities will not cause a material shortfall to earnings estimates. Our core cash EPS estimate is revised from $2.01 to $1.90, compared to the consensus estimate of $1.95.

• Management has stated that the majority of its exposures to the U.S. subprime real estate mortgage market are in securities that are AAA-rated. AAA-rated securities have seen price weakness, with drops in some ABX indices of 5%, certainly a large decline for AAA-rated securities (and a disastrous drop for holders that employ leverage), but not as drastic as the 50%+ declines in some lower-rated indices.

• CIBC has stated that its unhedged exposure to this sector is well below the US$2.6 billion exposure that media reports have estimated. If CIBC's exposure was indeed that large, we believe that the mark-to-market would have been larger than $25 million in Q2/07.

• We believe that CIBC's losses so far have been limited to mark to market adjustments, rather than real losses. Since CIBC probably holds these securities in trading books, we do not mean to imply that the losses would not be incurred if CIBC sold its positions today but rather point out that loss rates in underlying assets need to rise higher than they are today before holders of AAA tranches begin to lose real money.

Maintain Outperform rating

CIBC trades at 12.0x our estimated 2007E earnings versus a peer average of 12.6 times. We believe that the relative multiple makes CIBC's stock attractive, in spite of a lower revenue growth profile and greater exposure to U.S. sub-prime real estate, hence our Outperform rating. The following points summarize our investment thesis on CIBC shares:

• Potential for upward earnings revisions. We expect the consolidation of FirstCaribbean's results and improving retail revenue growth, combined with flat expenses in Canada, will drive earnings growth that exceeds expectations in 2008. We also believe that Q2/07 retail loan losses could prove to have been abnormally high in the near term.

• 17% increase in the dividend expected in Q3/07. The current dividend rate of $3.08 implies a payout ratio of 38% based on our 2007E EPS, well below the bank's official target range of 40%-50%.

• The bank's multiple should benefit from having the second-lowest exposure to wholesale income. The retail mix should also increase given the acquisition of FirstCaribbean, improving revenue growth in retail businesses and a likely reduction in merchant banking gains.

• Less exposure to potentially rising business loan losses, the area that most concerns us from a credit quality standpoint. Business loan losses for the Canadian banks are currently non-existent, compared to a 17-year average of 80 basis points. CIBC's loan book has the least exposure to business and government loans and the bank holds $10.4 billion in credit default swaps - a large amount relative to its $34.0 billion business and government loan book.

• CIBC's stock is likely to trade on news in the near term. However, the bank's exposure to sub-prime real estate does not prove costlier than we estimate, we believe that those willing to handle short-term volatility will benefit. The disclosure of Q3/07 results on August 30 is likely to shed some light on the issue.

Valuation

Our 12-month price target of $114 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 13.0x 2008E cash EPS, compared to the 5-year average forward multiple of 12.0x. Our target multiple is high versus the historical multiple because we believe there is upside to earnings estimates. Our relatively high price to book target multiple of 3.0x reflects the bank's industry-leading ROE and low credit risk. Our sum of the parts target P/E of 12.3x is in line with our target average for the banks, as lower exposure to low-multiple wholesale businesses is offset by slower than average revenue growth.

Price Target Impediment

Risks to our price target include the health of the overall economy, sustained deterioration in the capital markets environment, loss of domestic market share, a decline in underwriting activity and U.S. subprime CDO markets, and weakening retail credit quality.

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BMO Capital Markets, 13 July 2007

Establishing Limits

Concerns on CIBC’s exposure to sub-prime have clearly weighed on the stock. With the bank having made little disclosure as to the potential hit to earnings (other than to say that the “un-hedged” exposure is less than US$2.6 billion), it is scarcely surprising that the market is suspecting the worst. What is interesting is that the market seems to be discounting the stock far worse than a worst case scenario. Clearly, the Enron fiasco still weighs heavily on the market’s perception of how the bank is run.

Before we get into our understanding of the details, it is worth noting that the vast majority of CIBC’s business is domestic, retail-oriented. Indeed, in the first half of 2007, CIBC got a larger proportion of its earnings from retail banking in Canada than any of its peers (see table below). Outside of the CDO situation, CIBC seems to be on track for a strong operating year. We believe that the market has overcorrected and we are reiterating our Outperform recommendation on CM shares.

Our continued preference for CIBC shares is not to say that we are confident that CIBC won’t at some time in the next few quarters take a “mark-to-market” loss on its CDO positions. Indeed, a charge of $150 million (pretax) seems likely in the third quarter if, at quarter end, the market remains as hostile as it currently is. What gives us comfort however is this: Bank of Montreal took a very surprising $680 million charge on commodity options, despite its reputation as a conservative institution. Since that charge, the bank has performed roughly in line with its peers. We are relatively confident that CIBC charge will be less than $680 million, yet its stock has already underperformed its peers by roughly 7% since this “kerfuffle” began.

A Look at Tricadia

CIBC was relatively late to re-enter the game of underwriting Collateralized Debt Obligations (CDOs) - and its timing was atrocious. The underwriting of Tricadia 2007-8 coincided with a sharp sell-off in residential mortgage backed securities (RMBS) - the collateral that often backs these CDO structures. This isn’t to say that CIBC was totally ignorant of the CDO market. It is clear from notes to the financial statements that the bank had ongoing involvement in “warehousing” these securities on behalf of various underwriters or managers. It does, however, seem as though the bank picked the wrong time to become more aggressive in this business.

In April 2007, with the Tricadia deal in the late stages of underwriting and with the well-publicized weakness in the residential mortgage market, demand for high-rated CDO paper declined (from what we can determine, the demand has typically been relatively good for the lower quality, higher yielding parts of these CDOs). As such, CIBC as underwriter was left holding most, if not all, of the US$330 million senior-secured tranche of the deal.

We have not been able to see what collateral/securities are in Tricadia, but from analysis of various deals done by this manager, we can assume that the underlying collateral was RMBS and that some proportion was investment-grade. Given the rating of the tranche held by CIBC (US$330 million out of an entire deal size of US$507 million), we assume that the majority of the collateral was investment-grade at the time of origination. This probably means default rates on the mortgages that back the structure need to be well over 10% before the AAA tranche takes a haircut. Above this level however, there would be fundamental impairment on these securities. As we show in the chart on page 4, which shows the ABX-AAA Index, and despite material concern within the market, indicative bids for AAA rates RMBS securities remain in the high 90s.

Fundamentals are Only Part of the Story

Whatever the fundamentals, CIBC holds its Tricadia and other CDO exposures in its mark-to-market, or trading book. A quick note on the accounting for these positions: Given the lack of transparent markets for some positions, banks occasionally have to mark-to-“model” rather than mark-to-“market”. The CDO market requires this, given the unique nature of each structure. Having said that, indicative prices and/or prices for various indices provide important ingredients in establishing the carrying value of these positions.

As we have said above, these CDO positions are maintained in CIBC’s trading book. This is both good news and bad news. On the good news front, accounting regulations force management to “fess up” quickly to problems. The bad news is that the quarter-end “marks” are important in establishing the P&L, which can result in increased volatility—a weak mark at quarter-end can cause a large mark-to-market loss, only to have the position reverse the next quarter.

Given the poor market currently, this could easily be a problem in CIBC’s third quarter, even though holding the positions to maturity may produce no economic loss. This is however scant comfort to us. First, the maturity date of the Tricadia senior secured note is 2052 (about my retirement date), and second, the reality is that CIBC purchased a security (or the derivative of a security) that is worth less than when it was originally acquired. In the cold light of hindsight, there must be some negative consequence for the income statement.

How Can We Estimate the Quarterly Pain?

To date, CIBC has indicated that its 'unhedged' exposure to CDO’s is less than US$2.6 billion, but given its comments on Tricadia, one can assume that it is greater than the US$330 million that made up the original senior secured notes. A wild guess would be to simply use the mid point of these numbers, about US$1.5 billion. Note that management continues to state that the “majority of the positions are AAA”.

Another yardstick is to consider the exposure as disclosed in the bank’s annual report as of October 2006. The bank states that at that time, the maximum loss on its exposure to CDOs was $729 million. If we assume that the current level includes both the Tricadia deal and incremental growth in the business, the number could be in the $1.0-1.2 billion range.

A third way to approach the bank’s exposure is to consider the impact of the weak market for CDO pricing at the end of April on CIBC’s second quarter earnings. Management indicated on the conference call that the weak trading revenues were a result of problems in structured product (read CDO’s) and credit markets. From the trend in the “other” segment of trading revenues, it appears as if revenues were $50 million below normal. Some of this would be due to the weakness in overall credit markets, and some to the CDO problem, but in the most punative situation, the entire figure could be due to the CDO’s. Using the ABX levels across various tranches (assuming a 50:50 split AAA to non-AAA) and using some rudimentary arithmetic, we can reverse engineer the current size of the book to be $750 million.

Conclusion

In conclusion, we believe that an estimate of $1.2 billion of CDO exposure for CIBC sounds reasonable. Assuming this, a 50:50 mix of AAA and non-AAA, and using yesterday’s closing prices (see graph below to see indicative pricing on AAA, A and BBB exposures), we estimate that the loss in the third quarter could be $100-150 million. Given that CIBC should earn $675 million after tax in the third quarter, such a charge could amount to about 10-15% of quarterly earnings. Of course, mark-to-market pricing is just that, so that inter-quarter volatility doesn’t require the bank to disclose any issues until the quarter end. Needless to say, early August will be an interesting time for CIBC investors.

From our perspective, such a charge would be a disappointment for CIBC. It has done a tremendous amount to de-risk the bank – despite the numerous detractors that have focused on items such as single elements of trading and derivatives. This situation again raises the spectre that the bank is accident-prone. However, we continue to believe that investors in CIBC shares, which are trading at roughly a multiple point lower than their peer group, are adequately compensated for the risks.

Another situation that provides us with comfort is the events surrounding BMO’s recent $680 million trading loss. From the day prior to the BMO announcement of its initial estimate of the loss until today, BMO shares have roughly traded in line with the bank group. It is therefore interesting that since the start of the sub-prime debacles, CIBC stock has lagged by 7% even though we believe that the loss will be less than half that experienced by BMO. The one difference is that BMO was relatively clear that it believes it has its “hands around” the problem. We believe that if CIBC was able to actually quantify a charge in the third quarter in the order of $100-150 million, the stock would actually perform well.

One material risk to our analysis is that CDO structures are opaque. We have heard second hand reports that even prospective buyers have been denied details on the collateral backing these structures. If the CIBC’s CDOs are in fact “mezzanine” structures or CLO-squareds, it is possible that their entire holdings could be worthless. We are assuming that they aren’t, and are also assuming that when management says the majority of the securities are AAA-rated they, as holders of (and in some cases underwriters of) the CDO are comfortable that there won’t be complete loss unless there is a widespread melt-down in the U.S. housing market. If we are wrong, the entire $1.2 billion position may be at risk. This would certainly hurt, but given CIBC’s ROE and capital position, we note that it would be handled without material risk to solvency.

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TD Ameritrade Q3 2007 Earnings

The Globe and Mail, Tara Perkins, 20 July 2007

Nearly two months after hedge funds began pressuring TD Ameritrade Holding Corp. to merge with a rival, the online brokerage firm shows no signs of acquiescing. And the hedge funds show no sign of backing down.

As TD Ameritrade reported record profit yesterday, its chief executive officer, Joe Moglia, told investors that the company has "an absolute focus on organic growth."

And a spokesman for Jana Partners LLC - one of the two hedge funds putting heat on TD Ameritrade to pursue a merger - said its financial results continue to show the need to pursue a strategic combination, given the challenges in growing organically.

"They just want to run their business for six or nine months and see if they can actually start generating some organic growth in client assets, better growth in client accounts, and see if they can actually take the tools that they combined from the two entities and add some value for their customers," BMO Nesbitt Burns Inc. analyst Michael Vinciquerra said yesterday.

While a merger with a rival could add value for shareholders, the company does not want to do anything in the near term, he added.

TD Ameritrade has just finished moving the customers it obtained from last year's acquisition of TD Waterhouse USA over to its own online trading platform. Causing more disruption for customers at this point could prompt some of them to leave, Mr. Vinciquerra said.

The company's profit was $159-million (U.S.), up from $140-million a year ago. But that didn't come from new revenue, with the top line remaining virtually flat.

A lower tax rate helped a bit, as did lower expenses.

"A mediocre earnings report increases pressure on management to find a merger partner," said Patrick O'Shaughnessy, an analyst at Morningstar who gives TD Ameritrade one star, the lowest rating on a scale of five. "At least they can put the merger with TD Waterhouse behind them, and they have done a pretty good job of managing their expenses."

TD Ameritrade had total client assets of $298.2-billion at the end of the quarter, up 5.7 per cent from three months earlier, Mr. Vinciquerra pointed out in a note to clients. It had 6.321 million total accounts, having gained 152,000 new customers but losing 61,000 during the quarter. Average client trades per day fell 3.5 per cent to 244,800.

Despite Ameritrade's higher profit, Toronto-Dominion Bank is expected to see a lower contribution from its 40-per-cent stake in the brokerage because of the stronger Canadian dollar, said Blackmont Capital analyst Brad Smith. While TD Ameritrade's profit was up 13 per cent from a year ago, the portion that hits TD's bottom line will actually fall 13 per cent to $59-million (Canadian). TD Bank is scheduled to release its earnings on Aug. 23.

The hedge funds have accused TD Bank of using its seats on Ameritrade's board of directors to block any possible mergers.

Mr. Moglia reiterated yesterday that the online brokerage industry is delving further into the business of asset gathering, and so the types of takeovers or mergers it might look to do now would be different from a year ago.

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Financial Post, Jonathan Ratner, 19 July 2007

Among the news out with online brokerage TD Ameritrade Holding Corp.’s third quarter earnings, which showed net income rose to US$159-million – its best quarter ever, was Toronto-Dominion Bank’s piece of the action.

TD said it expects the earnings will contribute $59-million to its own third quarter net income.

This was up from $55-million a year earlier, but down from $63-million in the second quarter, Desjardins Securities analyst Michael Goldberg said in a note.

He says TD’s internal allocation of more debt against its Ameritrade investment and a weaker U.S. dollar are to blame. As a result, he thinks Ameritrade’s overall performance was positive.

“AMTD now moves on to the third leg of benefits from its acquisition and integration of Waterhouse, development of the longer term investor business,” Mr. Goldberg said.

He has a “top pick” rating and $79 price target on TD, which reports third quarter results on Aug. 23.

Brad Smith at Blackmont Capital maintained his $73 price target and "hold" rating on TD, while agreeing that the results were solid.

However, he considers news that more investment spending will likely be required to retain Ameritrade's existing client asset base a signal that margin pressures remain a concern.

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Bloomberg, Bradley Keoun, 19 July 2007

TD Ameritrade Holding Corp., the online broker facing shareholder pressure to merge with a rival, boosted profit 14 percent last quarter by reducing costs as customers traded less.

Net income rose to $158.7 million, or 26 cents a share, in the quarter ended June 30, from $139.8 million, or 23 cents, a year earlier, TD Ameritrade said today in a statement. The Omaha, Nebraska-based company was expected to earn 25 cents, the average of 13 analyst estimates compiled by Bloomberg. Revenue climbed less than 1 percent, the slowest in more than two years.

Jana Partners LLC and SAC Capital Advisors LLC, hedge funds with an 8 percent stake in TD Ameritrade, have called for the company to merge with Charles Schwab Corp. or E*Trade Financial Corp. TD Ameritrade Chief Executive Officer Joseph Moglia, who slashed more than $300 million in costs following the company's 2006 purchase of TD Waterhouse USA, has vowed to spend $100 million in the next 15 months to spur growth.

``A mediocre earnings report increases pressure on management to find a merger partner,'' said Patrick O'Shaughnessy, an analyst at Morningstar who gives TD Ameritrade one star, the lowest rating on a scale of five. ``At least they can put the merger with TD Waterhouse behind them, and they have done a pretty good job of managing their expenses.''

Until yesterday, the shares climbed 22 percent this year, the second-best performer in the 12-member Amex Securities Broker-Dealer Index after A.G. Edwards Inc., which is up 34 percent. St. Louis-based A.G. Edwards agreed in May to sell itself to Wachovia Corp.

Revenue growth flagged in part because the 25 percent rise in the Standard & Poor's 500 Index in the past year failed to spark a surge in trading by the company's clients. Commissions and other transaction fees are the company's biggest source of income, followed by interest on loans to customers.

Trading revenue in the quarter fell by 7.2 percent to $197.8 million, TD Ameritrade said. Net interest revenue fell by 30 percent to $138.9 million, while fees on money-market bank accounts almost doubled to $134.6 million.

Clients averaged about 245,000 trades per day, compared with 254,000 last quarter and 253,000 in the third quarter of last year.

Moglia, 58, said today on a conference call with analysts that retail investors ``are not wildly bullish'' in part because they're concerned about rising costs for heating, gasoline and groceries. ``That does have a psychological impact.''

At the end of June, TD Ameritrade held about $297.2 billion of client assets, up 16 percent from a year earlier.

Schwab, the biggest online broker, said earlier this week that second-quarter profit increased 16 percent as $52 million of advertising helped drive the fastest customer-account growth in five years. The San Francisco-based company also said customers traded less, leading to a 6 percent drop in transaction fees. Schwab, which has a mutual-fund arm and bank, relies on trading commissions less than TD Ameritrade does.

Moglia offset slowing revenue by shaving expenses. He shifted TD Waterhouse's 2.2 million customers to TD Ameritrade's trade-processing system in May, completing a step he promised when the merger was announced in mid-2005. TD Ameritrade had been routing TD Waterhouse trades through a clearing system maintained by Automatic Data Processing Inc., under a legacy contract inherited in the merger.

The ``clearing conversion'' aimed to eliminate about $200 million in annual costs, the company said in April.

The $1.6 billion purchase of TD Waterhouse fueled four straight quarters of 60 percent-plus revenue growth for TD Ameritrade. In June, the company said it received a letter from Jana and SAC urging another merger, with Schwab or New York- based E*Trade, the No. 4 broker.

The funds said in the letter that a merger with either of the rivals may lead to as much as $800 million in new revenue and cost savings.

Today's results ``continue to show the need to pursue a strategic combination, given the challenges in growing organically,'' Charles Penner, a New York-based spokesman for Jana, said today in an interview.

Jana and SAC have accused TD Ameritrade of letting its largest shareholder, Toronto-Dominion Bank, wield too much influence over merger discussions. Toronto-Dominion, Canada's third-biggest lender, controls five of TD Ameritrade's 12 board seats. Jana and SAC say a merger might interfere with the Toronto-based bank's U.S. expansion plans.

In July, TD Ameritrade responded to the criticisms by removing Toronto-Dominion's representatives from a committee established to review merger prospects.

Toronto-Dominion has said its representatives on the TD Ameritrade board are acting in the best interest of all shareholders.

On the conference call, Moglia said the company made $8 million of the $100 million new investment in the last quarter, and has budgeted $20 million for the current quarter and each of the following three quarters. Uses include providing training for call-center staffers, who are being asked to promote a broader range of products and services.

``The management team has come to me with individual requests'' for uses of the $100 million, and ``I've allocated probably 85 or 90 percent of that so far,'' Moglia said. ``Frankly the sooner we implement that spend, we think the sooner we're going to get results.''

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TD Banknorth U$4 Million Lawsuit Settlement Thrown Out by Judge

Bloomberg, Sophia Pearson, 19 July 2007

TD Banknorth Inc.'s $4 million settlement of a shareholder suit over a buyout by its parent, Toronto-Dominion Bank, was thrown out by a judge who said the amount should be higher.

The accord is ``insufficient,'' Judge Stephen Lamb wrote in a decision issued today in Delaware Chancery Court in Wilmington. Six investors sued after TD Banknorth said in November that Toronto-Dominion would buy the 41 percent of TD it didn't own for $3.2 billion. Plaintiffs agreed to settle for about $3 million, roughly 3 cents a share, and more than $1 million in legal fees.

``The class members appear to have received insufficient consideration in the form of a token cash increase in merger price, a virtually meaningless change in the calculation of the vote and several proxy disclosures for which the plaintiffs cannot even wholly claim credit,'' Lamb wrote.

The judge's ruling opens the door for a trial. Toronto- Dominion is trying to revive earnings at its slumping U.S. consumer bank. Edmund Clark, chief executive officer of the Toronto-based company, said in November it would focus on making TD Banknorth competitive in three or four years.

Neither TD Banknorth spokesman Jeffrey Nathanson nor plaintiffs' attorney James Notis replied to phone messages seeking comment.

Several Banknorth shareholders objected to the settlement amount. Objectors said plaintiffs' lawyers failed to argue that Toronto-Dominion officials violated a shareholders agreement by initiating the buyout negotiations with Banknorth. Lamb agreed.

Lawyers for the shareholders ``unreasonably'' chose not to pursue viable claims based on the violation of the stockholders agreement in exchange for a meager settlement, Lamb said.

TD Banknorth, based in Portland, Maine, with $1.95 billion in 2006 revenue, has branches in Maine, Massachusetts, New Hampshire, Vermont, Connecticut, New York, New Jersey and Pennsylvania.

Shares of Toronto-Dominion Bank rose 12 cents to C$73.12 today in trading on the Toronto Stock Exchange. They have gained 4.9 percent this year.

The case is In Re: TD Banknorth Inc. Shareholders Litigation, Consolidated CA2557-VCL, Delaware Chancery Court (Wilmington).

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UBS Reiterates Its 'Buy' Rating on Scotiabank

UBS maintains its 'buy' rating on Bank of Nova Scotia, with a target price of $63.00, based on 13.5x forward earnings, a slight premium to the outlook for the banking group.

The research report noted that due to a broad range of moving parts, there is low visibility into the bank’s near-term international operations; Scotiabank is carrying on the integration of recent acquisitions, which is likely to bear fruit in the upcoming quarters. Scotiabank is focused on enhancing its international presence through acquisitions and has a healthy pipeline, UBS adds.

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Understanding CIBC's Subprime Mortgage Exposure

The Globe and Mail, Fabrice Taylor, 18 July 2007

CIBC is having trouble assuaging investors who fear yet another cock-up from the accident-prone bank.

This time it's over its dealings in the U.S. subprime market. Media reports, leaning heavily on hedge fund managers, suggest the bank is whistling its way to a massive haircut on some investments in collateralized debt obligations (CDOs).

Nonsense, says the bank, beyond which it fails to mount a convincing defence.

Truth is, not even the bank knows what's in store for its subprime deals. CDOs are extremely complex to value. The net result for investors, however, is that this might prove to be as much an opportunity as it is a risk.

CDOs are pools of debt, usually junky debt. The CDO issues notes against the debt pool, but the notes are not created equal. The top group, or tranche, has first dibs on the assets and gets paid first. So if the CDO owns subprime mortgages, and, say, 10 per cent of them default, investors in the top tranche are okay.

Those in the bottom tranche are typically wiped out, while those in the middle tranches get burned but keep some of their capital. The higher tranches are usually AAA rated, the lower ones, often called equity tranches, are not rated at all. The interest payments are commensurate with the respective ratings.

By dividing the collateral pie into slices, CDOs turned lousy credit into gold-plated (AAA) bonds. At least on the surface. They also encouraged the U.S. housing bubble by helping supply credit to extremely suspect customers. Like all great financial ideas, they can be, and are, abused - especially when they morph into more complicated versions.

A CDO squared, for example, invests not directly in pools of mortgages or other loans, but rather in certain tranches of other CDOs. For example, a CDO might own the middle tranches of a large number of other CDOs.

These tranches are typically rated A or thereabouts, but again, through the alchemy of risk restructuring, lead becomes gold (well, in this case silver becomes gold.)

The CDO squared can now issue AAA-rated securities on the back of collateral of distinctly lower quality, which in turn rests, ultimately, on the credit-worthiness of Bubba Jones or, failing that, on his Tallahassee home.

It's in such CDOs that CIBC acknowledges an investment. Specifically, in the highest tranche of a vehicle called Tricadia 2006-07 Ltd., though it says it has other subprime investments too. BMO Nesbitt Burns, for instance, says CIBC also invested in Tricadia 2007-2008 Ltd.

Tricadia 2006-2007 invested in other CDOs that ultimately own mortgages originated in 2006 - one of the worst vintages. The bank's investment, it should be noted, is synthetic: that is, it used derivatives to replicate the economic behaviour of such a security. The bank earns small payments - under a million a year by our math - but is on the hook for defaults beyond a certain percentage. The worst-case scenario for Tricadia 2006-2007 is $330-million (U.S.), according to stated records.

But CIBC's Tricadia investments are AAA rated so what's the worry right? Well, it's not that simple.

The first problem is that the tranche CIBC is exposed to may well have not been so safe. Ratings agencies have been downgrading or reassessing tranches of CDOs. Expect more downgrades to come.

According to Bear Stearns, Tricadia's odds of getting kicked down the rating ladder are high. A downgrade might force CIBC to take a charge even if the loan keeps performing (CIBC officials declined to comment on this column).

But of greater concern is a wave of homeowner defaults, which investors appear to be betting on judging from indexes that track the performance of CDO tranches (see the accompanying chart that tracks A-rated tranches of loans originated in 2006). The values have fallen by about quarter.

Ratings agencies and lenders are ratcheting up their predictions for more mortgage defaults. The latest estimates are that around 7 per cent of subprime mortgages will default.

That may not sound like much, but here is why it matters for CIBC.

The highest rated tranche of a CDO might have a 40 per cent cushion beneath it: that is, as long as no more than 4 of every 10 mortgages defaults, the top tranche is fine - and that's an unheard of default rate. But a CDO squared's collateral might have a cushion closer to 10 per cent (remember that its assets are the lower rated tranches of other CDOs).

If defaults hit 7 per cent, then 10 per cent isn't far away. So much for a AAA investment.

One saving grace for the bank is that it's the only investor in some of the CDO tranches, so there's probably no market for them. That means we're depending on CIBC's disclosure and we might not hear all that much about it.

If there are massive defaults though, they aren't likely to bring the bank down. Remember that the Enron settlement - more than $2.4 billion (U.S.) - ended up creating a great opportunity to buy CIBC shares. Look at the charts. That's another way to turn lead into gold.

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