CIBC Q3 2008 Earnings

RBC Capital Markets, 28 August 2008

CIBC's GAAP EPS of $0.11 were much better than our $(0.81) estimate, but core cash EPS of $1.65 was short of our estimate of $1.77.

• Writedowns of $885 million pre-tax on structured credit-related activities were less than our $1.5 billion estimate.

• The 9.8% Tier 1 capital ratio was in line with our estimate, as smaller than expected writedowns were offset by higher risk weighted assets to reflect credit risk in the bank's trading book.

• The 25% increase in provisions for credit losses versus Q3/07 was as expected.

• The shortfall in core earnings versus our estimate was from both retail and wholesale businesses.

We have revised our forward earnings estimates down to reflect the Q3/08 core EPS miss, lower expected profitability in CIBC World Markets to reflect lower risk appetite, and lower retail profitability. We lowered our core cash EPS estimates to $6.90 in 2008E and $7.15 in 2009E (down from $7.22 and $7.40, respectively). Our 12-month target price remains $62 per share. It is based on a P/BV multiple of 1.9x versus the 2.1x current multiple.

We maintain our Underperform rating

CIBC's stock is cheap relative to bank peers on a forward P/E basis (8.6x versus 10.0x) and we do not expect CIBC to need to raise capital or cut its dividend, but we do not believe that the stock will necessarily perform well against bank peers in the next 6 months.

• CIBC's exposures to structured finance assets and financial guarantors remain material, with little visibility on ultimate mark to market valuations. The exposure to financial guarantors, for example, remains $2.9 billion, in spite of over $800 million in incremental valuation adjustments taken during Q3/08.

• We expect retail banking growth to continue to lag the peer group, as was the case again in Q3/08. The 1% YoY revenue decline was worst of the banks that have reported so far, and net income was down 3%.

• Visibility on wholesale earnings is even cloudier than for peers given risk reduction initiatives, exposure to merchant banking assets (which likely need more buoyant equity markets to realize material gains) and U.S. commercial real estate finance, which would be facing a difficult revenue outlook.

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Scotia Capital, 28 August 2008

• CM reported a decline in underlying cash operating earnings of 33% to $1.65 per share, below our estimate of $1.72 per share. Year-over-year comparisons were extremely difficult versus record earnings of $2.45 per share a year earlier. Earnings were weaker than expected at CIBC Retail Markets and CIBC World Markets due to weaker revenue.

What It Means

• Reported earnings were $0.13 per share, due to net charges totalling $1.52 per share. Total charges included $885 million ($596 million after-tax or $1.56 per share) on structured credit run-off activities, in line with expectations, and additional net gains of $14 million after-tax or $0.04 per share.

• CIBC Retail Markets earnings declined 7% from a year earlier on a comparative basis (excluding Visa gain) with CIBC World Markets declining 67% from a record quarter a year earlier.

• Revenue declined 13.8% with expenses declining 10.4% from a year earlier for negative operating leverage of 3.4%.

• Maintain a 2-Sector Perform rating on shares of CM as the P/E discount is offset by expected lower near term and longer term growth prospects.

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Reuters, Lynne Olver, 28 August 2008

More charges lie ahead for Canadian Imperial Bank of Commerce even as it cuts exposure to risky U.S. securities and hedges that prompted multibillion-dollar writedowns in the past year, analysts say.

CIBC shares had rallied 5 percent on Wednesday after reporting less severe third-quarter charges than expected, and its stock gained a further 4.7 percent Thursday, closing at C$62.90 a share, after other Canadian banks reported strong quarterly profits.

CIBC, the No. 5 Canadian bank, posted a profit of C$71 million, the lowest among Canada's large banks.

It took a pre-tax hit of C$855 million on structured credit, mostly related to U.S. bond insurers, adding to a string of writedowns in previous quarters for the sliding value of sub-prime mortgage securities.

"We are reducing our estimates for the fourth quarter to include an assumption of another C$1 billion charge," BMO Capital Markets analyst Ian de Verteuil said in a research note on Thursday.

Mario Mendonca, analyst at Genuity Capital Markets, said he still sees downside risk in CIBC stock, if investors are pricing in belief that structured credit writedowns are over.

Settlements between U.S. bond insurers and their various counterparties "are likely to result in still further charges -- likely over C$1 billion," Mendonca said in a research note.

Gerry McCaughey, CIBC's president and chief executive, said on a conference call late Wednesday that recent settlements involving U.S. bond insurers -- also known as financial guarantors or monolines because they specialize in a single type of insurance -- were positive.

"Developments within the financial guarantor industry over the past few weeks have generally been encouraging and positive, with several corporations announcing results in terms of restructurings and/or tariffs," McCaughey said.

He also said rating agencies have generally been positive.

"We are actively managing our structured credit positions and continue to assess all opportunities to reduce contingent risk in this portfolio," McCaughey said.

In early August, CIBC and other institutions reached a deal with ACA Capital Holdings, parent of bond insurer ACA Financial Guaranty, to terminate contracts in exchange for cash.

ACA was the first bond insurer to run into trouble when its credit ratings were cut to junk status in December.

CIBC has contracts with other bond insurers as well.

"We expect further write-downs if credit markets remain under pressure ... but the bank remains well capitalized to handle further material hits," TD Securities analyst Jason Bilodeau said in a report.

Even if most of CIBC's writedowns are behind it, many analysts wonder where the bank's growth prospects will come from, particularly with Canadian economic growth slowing.

CIBC's per-share profit excluding its big charges fell short of market expectations for C$1.75.

The latest results "provided ample evidence of the continuing struggle facing management in their effort to manage down their legacy credit derivative exposures while defending their domestic retail market share," Blackmont Capital analyst Brad Smith said in a research note.

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Financial Post, John Greenwood, 28 August 2008

Bay Street breathed a sigh of relief after Canadian Imperial Bank of Commerce yesterday reported lower-than-expected writedowns on money-losing credit investments, fuelling expectations that the storm in credit markets is finally abating.

Compared with its Canadian peers, CIBC has taken the worst pummelling from exposure to risky derivative debt securities, announcing nearly $7-billion in charges over the past nine months. Analysts had predicted the country's fourth-largest bank would follow suit with further charges of up to $2-billion. Instead, the number was a comparatively modest $885-million.

And after two consecutive quarterly losses, CIBC moved into the black. For the three-month period ended July 31, it had net income of $71-million or 11¢ a share, a drop of 91% from the same period last year.

The earnings were slightly below consensus estimates "but clearly people think it could have been much worse, and the consensus view is that things are improving for CIBC," said John Stephenson, a portfolio manager at First Asset Funds Inc., which has about $1.5-billion under management. Mr. Stephenson doesn't own any CIBC stock.

"I think, generally speaking, for the Canadian banks [problems from subprime-related investments] are pretty much passed," he said.

Shares in the bank had their best day in nearly five months, surging $3.04 to $60.10 and sparked buying in the other big Canadian banking stocks.

Still, some analysts warned it may be far too soon to declare that the credit crunch is waning.

According to Genuity Capital Markets analyst Mario Mendonca, CIBC still has a distance to go before it resolves its problems with so-called structured credit derivatives.

"I don't think everyone appreciates they are not done with their settlements," said Mr. Mendonca, who anticipates a further $1-billion in writedowns in the next few quarters.

On the retail side, CIBC had a profit of $572-million, down 4% from last year, mainly because of lower treasury revenue allocations and higher loan losses.

On the wholesale and corporate banking side, CIBC World Markets reported a loss of $538-million, including a loss of $596-million associated with structured credit investments.

"While the current environment continues to be challenging, CIBC's franchise is solid," Gerald Mc-Caughey, the chief executive, said in a statement. "CIBC's capital position is strong and our core businesses are well-positioned for better performance and growth."

On a conference call with analysts, bank executives said several times that despite the ongoing difficulties with structured credit products, the bank's tier 1 capital ratio remains strong at 9.8%.

Like many of its U. S. and European competitors, CIBC is paying the price for bets on risky credit products that it made during the credit bubble. The bank attempted to hedge that exposure by taking out insurance with bond insurers called monolines, but in the wake of the credit crunch many of those monolines are struggling and expected to fail, leading many to question their ability to fulfill their contracts.

"There's certainly a lot more room for writedowns," said one analyst, adding that the question hinges mostly on what happens to the U. S. housing market.

In recent months CIBC has been cutting back its credit-derivatives operations and selling off assets underlying its structured investment trusts.

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The Globe and Mail, Tara Perkins, 27 August 2008

Canadian Imperial Bank of Commerce sparked a rally in its shares Wednesday by managing to eke out its first profit of the year, raising hopes the bank had finally put the bulk of its troubles with risky investments to bed.

The domestic bank most battered by the U.S. subprime mortgage crisis posted a $71-million third-quarter profit that missed analysts' expectations and were a 91-per-cent tumble from earnings of $835-million one year earlier. The results included an $885-million writedown on risky U.S. exposures.

But CIBC's stock popped because the writedown was less severe than many analysts had expected, increasing expectations CIBC is turning a corner and won't need to raise equity.

The stock closed up 5.33 per cent on the Toronto Stock Exchange, and traded as high as $61.19 during the day.

Gerald McCaughey, who stepped in as chief executive officer three years ago with a mandate to extract risk in the wake of CIBC's embarrassing Enron losses, said Wednesday that the quarter's results were hurt by the difficult environment and the bank's continuing efforts to exit risky areas in favour of concentrating on consumer banking.

“Our capital position is strong and prudent and will remain an area of focus during this period of uncertain market conditions,” he said, adding that the bank made progress in “getting back on track to deliver consistent and sustainable performance.”

CIBC has taken $6.8-billion in writedowns over the last three quarters.

Many analysts had been expecting a higher degree of pain for the bank this quarter. Dundee Securities Corp. analyst John Aiken upgraded his rating on CIBC's stock to “neutral” Wednesday, noting that he had expected a writedown of more than $1.5-billion.

Merrill Lynch analyst Sumit Malhotra said: “To the extent that this diminishes the probability of another equity raise, this will be seen as a positive.”

CIBC tapped the market for $2.9-billion earlier this year to shore up its balance sheet.

Only a tiny proportion of this quarter's writedown came from the obvious culprit, U.S. subprime mortgage exposure, the issue that's caused CIBC massive headaches in recent quarters and was expected to do so again this quarter.

Rather, more than 85 per cent of the $885-million hit came from collateralized loan obligations and corporate debt securities that are not directly tied to subprime, but are guaranteed by bond insurers.

That had a couple analysts fearing that some writedowns have been effectively delayed by market events but are still likely.

Near the close of the quarter, Security Capital Assurance Ltd. (SCA) – one of the bond insurers that guarantees a significant portion of CIBC's risky investments settled with another bank, Merrill Lynch in a deal that gave the bank about 20 cents on the dollar to cancel its contracts.

That gave bond insurers a lift by raising hopes they would be able to convince more banks to take steep discounts to settle their exposure.

CIBC is in discussions with some bond insurers, and when it strikes deals, “the subprime charges will be large, and we suspect that's next quarter,” Genuity Capital Markets analyst Mario Mendonca said.

Bond insurers still owe CIBC about $2.9-billion. The bank would only lose the full amount if all of the bond insurers it is exposed to fail and it receives nothing for its contracts.

Mr. McCaughey said developments with respect to bond insurers in recent weeks have generally been positive.

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Financial Post, John Sturgeon, 27 August 2008

Canadian Imperial Bank of Commerce reported its first profit in three quarters on Wednesday, but still took a massive charge from the bank's exposure to securities tied to the reeling U.S. subprime residential mortgage market.

CIBC said earnings fell 91% year-over-year to $71-million (11 cents a share), compared with $835-million ($2.31) in the same period of 2007.

Profit was squeezed by an $885-million before-tax loss from its structured credit business. "Problems originating in the U.S. subprime mortgage market last year continued to impact the conditions for credit and liquidity globally," the bank said.

But the pre-tax loss was much lower than expected, according to Dundee Capital Markets analyst John Aiken, who had called for writedowns to range between $1.5-billion and $1.9-billion.

The news lifted CIBC shares almost 5%, or $2.74 to $59.80 in early trading on the Toronto Stock Exchange on Wednesday.

"This should relieve much of the near-term concerns regarding its balance sheet and shift valuation more towards its earnings outlook," said Mr. Aikens in a morning note to clients. He raised his rating on CIBC shares from 'sell' to 'neutral.'

Mr. Aikens added a caution, however: "We have not waded all the way through [CIBC's] various counterparty and structured credit related disclosures yet, but note that the bank does remain exposed to additional potential writedowns."

Excluding the structured credit charge and other one-time items, diluted earnings came in at $1.63 per share, still below Dundee's estimate of $1.72. The consensus view among analysts was slightly higher, at $1.74 earnings per share.

"Our results this quarter were affected by the volatile, and generally difficult, environment that persisted over much of the third quarter, as well as by the impact of our ongoing run-off activities and the refocusing of our core businesses, particularly in CIBC World Markets," said Gerald McCaughey, CIBC's chief executive.

CIBC is by far the worst afflicted among Canada's big banks by the collapse of the U.S. subprime mortgage business in the past year, taking a total of $7.58-billion in writedowns related to the bank's exposure in the market. The bank took $2.48-billion in writedowns in the last quarter.

A $1.75-billion lawsuit filed by Canadian shareholders in late July asserts that the bank invested as much as $11-billion in hedged and unhedged investments in the market.

CIBC World Markets reported a net loss of $538-million tied to structured investments, the bank said.

On the plus side, CIBC said it further reduced notional exposure to deteriorating financial guarantors and bond insurers by about $3-billion "through a combination of the termination and amortization of credit derivative contracts."

Still, market and economic conditions relating to the financial guarantors may change in the future, "which could result in significant future losses," the bank said.

In a move to further de-leverage itself of U.S. exposure, CIBC has sold most of its American investment banking and trading businesses to Oppenheimer Inc. over the three quarters, it said, prompting an $80-million charge. Further asset sales located in the U.K. and Asia to Oppenheimer will close in the fourth quarter, CIBC said.

Difficult market conditions also hurt the bank's retail business, historically its strongest component. CIBC Retail Markets reported net income of $572-million, down 4% from a year ago. Retail loan losses totalling $196-million were partly to blame, CIBC said.

"Overall, CIBC's retail business remains well positioned. CIBC achieved strong volume growth and has maintained market share ... though CIBC is taking a measured approach to credit given the current environment," the bank said.

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Scotiabank Sets-up Fund Manager with Chinese Bank

Financial Post, Duncan Mavin, 28 August 2008

Bank of Nova Scotia is joining forces with a Chinese bank to launch a new fund manager, marking the Canadian bank's first foray into China's burgeoning wealth-management industry.

Scotiabank was named yesterday by Bank of Beijing as its partner in a planned joint venture in documents filed to the Shanghai Stock Exchange.

The Canadian bank has agreed to take a 33% stake, valued at about US$15-million, in a China-based joint venture that, pending regulatory approval, will be called Bank of Beijing Scotiabank Asset Management Co. Ltd. The firm will design and market a wide variety of mutual funds to retail and institutional customers through the Bank of Beijing's growing national branch network.

"This is an exciting opportunity for Scotiabank to grow our operations in China by partnering with one of China's leading banks," Rob Pitfield, executive vice-president, international banking, said in a statement.

China's fund-management industry is forecast to expand at an annual rate of 25% over the next few years, reaching US$1.4-trillion of assets under management by 2016, according to consultants McKinsey & Co.

Some local fund managers have been battered by steeply declining stock prices of late -- the Shanghai composite index has lost almost two-thirds of its value since peaking last October. That makes Scotiabank's timing pertinent, said Peter Alexander, head of Shanghai-based fund management consultancy Z-Ben Advisors.

"In China, when the timing looks a bit trying, that's the best time to get in," Mr. Alexander said. The Chinese fund-management industry will suffer fluctuating fortunes as it develops but in the long term China's demographics and rising wealth will support significant growth, he added.

Sino-foreign fund-management joint ventures were first authorized by China's regulators six years ago. They now account for half of the China's 60 fund-management firms, and include Fullgoal Fund Management Co. Ltd,, in which Scotiabank's domestic rival Bank of Montreal is a minority partner.

Almost all of the sino-foreign joint ventures are successful, said Mr. Alexander, even though they usually run into problems at some stage either because the shareholders fall out or because of operational difficulties. "It's the nature of the joint-venture beast," Mr. Alexander added.

Scotiabank, which has made no secret of its attempts to beef up its Canadian wealth-management capabilities, already has a small stake in China's financial-services industry, including an investment in a bank in Xi'an, in western China. The Canadian bank has also been trying for several years to negotiate a position in the Bank of Dalian in northeast China; so far Scotiabank has succeeded in signing a "strategic cooperation memorandum" with the Bank of Dalian, outlining the Canadian bank's intention to "explore a strategic partnership by way of a minority investment."

The bank's fund-management joint venture with Bank of Beijing could also face some challenging regulatory hurdles. It is too early to tell when the fund manager will be operational and when the first fund may be launched, said a source close to the negotiations between the two banks. The joint venture has yet to be given approval by regulators, the source added. Chinese rules do not explicitly permit banks from setting up fund-management joint ventures, though a handful of banks have been given special dispensation to do so.

Bank of Beijing is a city commercial bank -- one of the 114 smaller city-based banks in China's multi-layered banking industry -- operating mostly in the Chinese capital, as well as nearby Tianjin and also Shanghai. The bank, in which Dutch financial services giant ING Groep N. V. has a 16% stake, has total assets of about 363-billion yuan (US$53-billion) and is China's biggest city bank in terms of assets. Yan Zhubing, the chairman, said this week Bank of Beijing is planning to expand its branch network nationwide, according to Xinhua news.

Sources said executives of the Chinese bank have been casting around the idea of a fund-management joint venture for the past year.

In its statement to the Shanghai Stock Exchange, it said the bank's directors resolved to establish a fund-management company with registered capital of 300-million yuan (US$44-million). In addition to Scotiabank, there may be another as-yet-unnamed third partner in the joint venture, the Bank of Beijing's statement indicated.

By the Numbers:
• China's asset-management market
• 138 million investor accounts.
• $380-billion in assets under management.
• 230% compound annual growth rate over the past three years ending Dec. 31, 2007.
• 8.2 million Bank of Beijing customers hold co-branded mutual-fund products.
Source: Bank of Nova Scotia

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Scotiabank Q3 2008 Earnings

BMO Capital Markets, 27 August 2008

Scotiabank reported third-quarter cash earnings of $987 million, or $0.99 per share, compared to $966 million, or $0.97 per share, last quarter and $1.0 billion, or $1.03 per share, in the same quarter of last year. This was another clean quarter for Scotiabank. The bank earned over 20% ROE, side-stepped problems in structured credit markets and showed superior credit management skills. We are confident that it will outperform its peers over the course of this cycle.

One thing that does concern us is Scotiabank’s apparent lack of patience in building its domestic Wealth Management business. Over the past year, the bank has done two deals that in hindsight may indicate a degree of desperation: the decision to buy 20% of Dundee Wealth and the purchase of E*Trade Canada. The former resulted in an awkward period of uncertainty regarding a possible bid for Dundee overall, and the latter set the new high watermark on pricing of discount brokerage deals. Given management comments on the conference call, they appear to be prepared to give up control (or a clear path to control) of their mutual fund business for a non-controlling stake in a larger entity. We are not sure that short-term gain is sufficient pay-off for longer term complexity and cross ownership.

Domestic Banking earnings, which include wealth management, were $469 million, up a solid 10% from last quarter and 17% from the same quarter of last year. Year over year loan growth was a very strong 14%. Spreads remained stable versus the previous quarter. On the wealth side, fee revenues were strong and were only partially offset by the slowdown in new issuance and trading activity.

International Banking reported earnings of $337 million, flat with last quarter but up 22% over the same quarter of last year. This quarter’s results included a $40 million (pre-tax) gain on the IPO of the Mexican Stock Exchange, which was largely offset by a contingency liability and securities and trading losses in Latin America. Strong loan and deposit growth and higher contributions from recent acquisitions in South America account for the year-over-year growth.

Scotia Capital had a very strong quarter. Earnings of $298 million were up 16% from last quarter and 6% over the same quarter of last year due to a more attractive corporate lending environment and strong advisory and trading results. Trading revenues of $247 million were slightly above expectations due to strong derivative and fixed income activity. The segment posted a $4 million provision for credit losses this quarter. We expect earnings to trend lower into 2009. The Other segment reported a loss of $85 million, caused as much by transfer pricing as the widening spreads on bank funding. We assume that the loss will be more modest in 2009 as funding costs improve.

On the credit front, loan losses of $159 million came in lower than our expectations. Impaired loan formations continued to track up this quarter to $377 million. Net impaired loans (after general allowance) continued to decline but remained well in negative territory. Management indicated it expects provisions to move moderately higher in the medium term. We are assuming provisions of $1 billion next year.

Management provided further information about its GMAC auto lending program. Of the $7.1 billion exposure, 97% are auto loans and the remaining balance is leases. Credit enhancement is based on a discounted purchase price and is reset based on recent performance for each new pool purchased. Given the structure of the deal, management remains comfortable with this transaction.

Scotia’s capital position remained sound again this quarter. The bank’s Tier 1 ratio was 9.8%, up 20 bps from the second quarter as good internal capital generation and the issuance of $350 million of preferred shares more than offset growth in RWAs. Scotia was the only bank to participate in its share buyback program this quarter, indicating the confidence management has toward its balance sheet. Payout ratio is modest and the bank has the capacity to raise its dividend.

Projections and Valuation

We are leaving our 2008 and 2009 EPS estimates unchanged. Despite material headwinds, the bank has largely earned though the credit turmoil without significant “unusual” items. Scotiabank has a superior balance sheet and growth strategy, however the credit environment is deteriorating. We believe the next wave of problems will likely come from increased signs of pressure on Canadian loan books. Scotia is at least as well prepared as its peers to deal with this. We are maintaining our Outperform rating, and our target price of $52.50, which uses a 12.5x multiple on our forecast for 2009.

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RBC Capital Markets, 27 August 2008

Scotiabank's core cash EPS of $0.99 were short of our estimate of $1.04 and consensus of $1.03.

• Net income in the Canadian and wholesale businesses was ahead of our expectations, which was offset by lower than expected income in the international and "Other" segments. Loan losses of $159 million were in line with our expectations and the prior quarter, but up 73% versus Q3/07. Capital remains strong, with the Tier 1 ratio at 9.8%.

We have lowered our 2008 EPS estimates from $4.15 to $4.00 and our 2009E EPS from $4.25 to $4.15. Our 12-month target price per share remains $49.

We maintain our Sector Perform rating on Scotiabank shares. (We currently rate half our Canadian bank universe as Sector Perform and half as Underperform).

• Near term, we believe that Scotiabank's share price should benefit relative to peers from (1) stronger asset growth in domestic banking, international banking and corporate lending; (2) less exposure to U.S. lending than some of its peers (the area most impacted by deteriorating credit for now); (3) less exposure to structured finance and off balance-sheet conduits than most; and (4) greater exposure to a Canadian dollar that has weakened against the U.S. dollar.

• We believe that BNS will maintain its industry high valuation (forward P/E of 11.2x versus 8.9x for Canadian peers, P/B of 2.4x versus 1.8x) as long as credit problems remain centered on U.S. exposures and visibility on structured finance exposures/off balance sheet vehicles remains clouded.

• We believe that BNS' relative valuation will be more at risk in 2009 as concerns spread from the above-mentioned issues to the impact of a slowdown in economies on loan growth and credit losses.

• Our 12-month target price of $49 is based on a P/BV multiple of 2.25x, and it implies a P/E on NTM EPS of 11.7x.

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TD Securities, 27 August 2008

Event

Yesterday, Scotia reported Q3/08 core cash FD-EPS of C$1.01 vs TD Newcrest at C$1.05 and consensus at C$1.03.

Impact

Reiterate BUY. EPS came in a few pennies shy of expectations on the back of some heavier expenses along with some funding pressures in Corporate. However, again we note several encouraging trends 1) Domestic P&C/Wealth continues to make solid progress 2) Credit is trending as expected and Scotia remains well reserved and 3) International remains on track despite headwinds. All told, Scotia is weathering the current environment well, and holds one of the best medium-term operating outlooks in the group in our view.

Details

Credit worries manageable. Concerns have been building around potential credit risks in Scotia's corporate loan book, International segment and exposure to the auto sector. Management again expressed confidence in its management of credit risk, including these specific exposures, and we note that many of the bank's coverage ratios remain comfortably ahead of their peers. We do expect rising credit costs (reflected in our estimates), but the trends appear well managed at this point.

International prospects on track. International delivered 18% bottomline growth despite higher credit costs, higher operating spend and currency impacts. With strong volume growth, ongoing integration benefits and future acquisition prospects this segment continues to display strong potential to deliver superior medium-term growth in our view even with the headwinds of today's more challenging environment.

Domestic delivering. One of the most encouraging developments for Scotia over the past year in our view has been the acceleration of its Domestic business helped by concentrated efforts and some smart acquisitions. As a result, Scotia is evolving from a notable laggard, to posting some of the strongest operating trends in the group we expect to see this quarter.

Solid story deserving of premium. No bank is without issue in this environment, and Scotia is no exception. However, the bank is faring better than most and is exceptionally well positioned to capitalize on the eventual recovery with good operating momentum, strong capital position and competent management. We expect the stock to continue to trade at a premium valuation.

Q3/08 Conference Highlights

Credit exposure. A key focus on the call, management stressed that it is very comfortable in its overall credit exposure. Specifically it reiterated that its auto loan exposure is diversified and manageable. The GMAC program is performing inline with expectations and is well structured with credit enhancements to Scotia's benefit. Management expects moderate PCL growth over the coming year.

Mutual Fund deal. In our view, management clearly left the door open to a range of possible deal structures around its Mutual Fund business. Management remains focused on getting scale and growing the earnings contribution.

U.S. banking market. Conversely, in our view, management significantly downplayed any interest they would have in acquiring a U.S. P&C banking platform.

Domestic competition. The mortgage market is becoming very competitive, but Scotia is still gaining share. Deposits also remain hotly contested and Scotia has been able to gain market share (helped by Dundee Bank acquisition), but has not been 'buying' deposits with aggressive rates. Q3/08 Segment Highlights

Domestic. Another encouraging quarter in our view. Good volume growth in key products (mortgages +15%) and continued deposit growth (+13%). NIM improved +3bp quarter over quarter. Overall, revenue growth of 9% and NI growth of 17% should compare favorably with the best in the industry this quarter.

International. International continues to manage well despite some challenges. The group reported 25% revenue growth and 18% NI growth including the negative impact of FX (C$17M) and 20% NIX growth, reflecting recent acquisitions and strong organic growth. Credit costs are also on the rise reflecting largely portfolio growth and mix.

Capital Markets. The quarter was soft as expected with just 1% revenue growth, but good cost control (NIX - 5%) helped to deliver NI +6%.

Corporate. Typically volatile, corporate was a key source of the lower EPS on the quarter. The segment reported a NI loss of C$79 million compared to a gain of C$81 million in Q2/07. Higher liquidity, funding costs (run through Treasury) and hedging costs weighed materially on NII, while lower gains in non-trading securities hit Other Income. Ex corporate, NI was up 12%.

Outlook

We updated our 2008 estimate to reflect Q3/08 actual results and no change has been made to our 2009 estimate. We continue to see encouraging trends in Domestic, while International continues to progress as expected and credit costs remained in line.

Justification of Target Price

We expect Scotiabank to hold its premium valuation relative to the Big-Five Canadian banks, reflecting superior growth prospects, strong return on equity and healthy excess capital. We base our target price on 12.50x forward earnings, a premium to our outlook for the group.

Key Risks to Target Price

These include: 1) the continued weakening of the U.S. dollar, 2) country and political risk in its international markets such as Mexico, 3) integration challenges associated with its recent and future acquisitions and 4) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

Scotia’s Q3 results provided some encouraging core operating trends and good volume growth. We continue to view the bank as having one of the best medium term operating outlooks and reiterate Buy.

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Financial Post, John Greenwood, 27 August 2008

Given the ongoing economic turmoil and rising level of regulation, the United States is no place for a Canadian bank to be making acquisitions, Rick Waugh, Bank of Nova Scotia chief executive, said yesterday.

Speaking on a conference call with analysts, Mr. Waugh said that despite the collapse in share prices across the financial sector, banks there still face "a lot of issues" that could end up hurting potential buyers.

"We are aware of the significant change in valuations that we have seen over the past year," he said, adding that prices are still high.

"And the regulatory environment is getting worse rather than better. The U. S. has been through a major upheaval," he said.

In the wake of the collapse of former giants such as Bear Stearns Cos. Inc., regulators have launched a string of lawsuits, forcing players to pay out billions of dollars in fines and settlements.

"The legal system down there is reacting in many ways, creating problems for participants," Mr. Waugh said.

The bottom line for Mr. Waugh is that the United States is a hostile place for doing business and things will likely get worse. The bank, which has significant operations in the Caribbean, Mexico and Latin America, says it will continue to look elsewhere for acquisitions.

Contrast that with the view expressed by Bill Downe, Bank of Montreal chief executive, in a similar conference call. BMO yesterday surprised the Street with higher-than-expected loss provisions and a steep decline in third-quarter earnings, largely due to its substantial U. S. operations.

Analysts were particularly concerned by the bank's exposure to off-balance sheet investments that hold large amounts of credit derivatives linked to sinking U. S. real-estate loans such as the BMO-sponsored Parklands structured investment vehicle. But Mr. Downe dismissed such concerns.

"It is good news that U. S. housing starts are at the low level they are, [because] at some point people are going to come out of rental housing and move back into purchased housing," Mr. Downe said.

The major hurdle in the way of a recovery is the situation at mortgage giants Freddie Macand Fannie Mae, but they will be restructured, Mr. Downe predicted, and when that happens, "I think the U. S. housing market will become a much more orderly place."

Mr. Downe and Mr. Waugh may disagree about the state of the U. S. economy and the market for Canadian banks looking to expand there, but the fact that the rift is so big is illustrative of a general shift in perception in corporate Canada.

For years the United States was regarded as the place to be for business, especially banks, and only lofty valuations would keep them from expanding into world's most lucrative market.

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Financial Post, John Greenwood, 27 August 2008

While still quite strong, Bank of Nova Scotia reported a drop in profit for the third quarter in the face of higher credit provisions and languishing capital markets.

For the three months ended July 31, Scotia posted net earnings of $1.01-billion, or 98¢ a share, down 2% from last year.

"It looks like a good quarter," said Mario Mendonca, an analyst with Genuity Capital Markets. "It was pretty much in line with what we were expecting."

The numbers came in slightly below analysts' consensus estimate of $1.02 a share.

In the context of the bloodletting going on in the sector globally, Scotia's performance is regarded by many analysts as proof that prudence and strong management can enable a bank to avoid the credit turmoil that has claimed so many victims in the United States and Europe.

"Scotiabank's strategy of diversifying across business lines and geographies has enabled the bank to continue to perform well during a challenging period for the global financial services industry," said chief executive Rick Waugh.

One of the few ominous notes in the results was a warning by Mr. Waugh that the bank is "unlikely" to hit its earnings targets set at the end of last year. While Scotiabank's main businesses continued to make strides in the quarter, slow global growth is expected to weigh down future results, he said.

Nevertheless, Mr. Waugh stressed that the bank remains on the lookout for acquisitions, noting that its recent US$442-million purchase of E-Trade Canada will double Scotiabank's footprint in the online investing market.

The bank is also rumoured to be mulling over the potential acquisition of a large equity stake in fund manager CI Investments Inc.

Total revenue grew by 5% during the quarter over the period, while assets swelled by $54-billion, or 13%, thanks to healthy performance in domestic and international banking operations along with investment banking.

Despite signs of a slowing Canadian economy, Scotiabank's domestic banking revenue grew by 9% in the quarter, helped by increased mortgage activity and rising consumer deposits.

"Scotia Capital had a strong quarter, benefiting from its diversified portfolio of businesses," Mr Waugh said in a statement.

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Dow Jones Newswires, Monica Gutschi, 26 August 2008

Bank of Nova Scotia was expected to do reasonably well in the third quarter, and delivered.

Buffered by its international operations, the Toronto-based bank escaped any fallout from the U.S. subprime crisis. In contrast to Bank of Montreal, which also reported its third-quarter earnings Tuesday, its credit provisions rose by a less significant amount. And it missed analyst forecasts by only a few pennies.

Bank of Nova Scotia earned C$1.01 billion or 98 Canadian cents a share in the latest quarter versus C$1.03 billion or C$1.02 a year earlier. On a cash basis, earnings came in at 99 Canadian cents a share.

Bank analysts expected third-quarter cash earnings of C$1.03 a share.

"Things being what they are, holding your own is pretty good, I think," said David Baskin, principal at Baskin Financial Services, who counts Scotiabank as his favorite among Canadian banks.

Still, the bank's shares are being battered in afternoon trading in Toronto. Bank of Nova Scotia is down C$1.18 or 2.5% to C$46.45.

By contrast, Bank of Montreal is off 40 Canadian shares or 0.9% to C$43.66. And Canadian Imperial Bank of Commerce, which is widely expected to announce another huge writedown on its U.S. structured credit portfolio, is down only 36 Canadian cents or 0.6% to C$57.55.

Baskin said it was a "mystery" to him why the shares were under pressure, although he noted Scotiabank's stock has not fallen as far this year as many of the others.

John Aiken of Dundee Securities said the earnings were a "very positive comparison" to BMO, with manageable credit losses. Scotiabank's loan-loss provisions for the third quarter were C$159 million, above the C$92 million reported a year earlier and in line with analyst estimates. Bank of Montreal's provision for credit losses soared to C$484 million in the latest quarter from C$91 million a year earlier. Analysts had only expected an increase to C$195 million.

But Brad Smith at Blackmont Capital noted Scotiabank's loan portfolio had deteriorated over the quarter, while provisioning rose only slightly. That could imply, he said, that Scotiabank may fall behind in credit-loss provisions and have to make up for it later.

As well, he said, Scotiabank's earnings include a 3-Canadian cent gain from the initial public offering of Mexican Stock Exchange shares. Excluding that gain, he said, puts the bank 7 Canadian cents short of forecasts.

Blackmont has no investment-banking conflicts with Scotiabank nor does the analyst own the bank's shares. Dundee has an investment-banking relationship with Scotiabank and the analyst or a member of his household owns its shares.

There was more mixed news in Scotia's results. Return on equity, a measure of profitability, was 21.0%, down only marginally from 21.7% a year earlier.

Expenses rose 8% in the quarter, mainly on acquisitions and a big marketing push. Net income from its key international division rose 19% from a year earlier, but fell 2% from the second quarter, foreshadowing slower growth ahead.

"The bloom seems to be coming off the rose in the emerging marketplace," said Ian Nakamoto, market strategist at Macdougall, Macdougall and MacTier. He noted the recent strengthening in the U.S. dollar may indicate concerns that "cracks" are beginning to show in other regions of the world.

Analysts expected the Canadian banks as a group to report lower quarterly earnings, with UBS Securities predicting a 9% overall decline year-over-year, as they contend with the ongoing fallout from the credit crunch, weak capital markets and a slowing economy.

Bank of Montreal kicked off the third-quarter earnings season for the big six Canadian banks earlier Tuesday, posting a 20% drop in earnings on sharply higher credit provisions and another charge for valuation adjustments in its capital-markets division.

Analysts have said that Canadian banks' domestic retail business is increasingly important due to declines in capital-markets businesses and rising risk in U.S. platforms.

Nonetheless, Scotia Capital, Bank of Nova Scotia's capital-markets business, had a strong quarter, the bank said, benefiting from record revenue in Scotia Waterous and fixed income, continued strong contributions from ScotiaMocatta and foreign exchange operations and an increased contribution from its lending businesses.

The domestic-banking business, which includes wealth management, reported a record quarter, with mortgage growth recorded in all sales channels and a 12% increase in personal deposits.

Grupo Scotiabank, the bank's Mexican arm, contributed about C$104 million to earnings, including a C$40 million gain recognized in relation to the IPO of the Mexican Stock Exchange.

The second half of 2008 is showing improvement compared to the first two quarters of the fiscal year, the bank said, with continued asset growth in all three business lines and a rebound in capital markets activity. Nonetheless, the bank reiterated that it isn't likely to meet its fiscal 2008 earnings growth target set at the end of the last year.

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Dow Jones Newswires, Ben Dummett, 26 August 2008

Bank of Nova Scotia declined Tuesday to comment specifically on rumors it's in talks to sell its mutual fund business to CI Financial Income Fund in exchange for a significant equity holding in the big Toronto mutual fund company.

However, bank officials didn't rule out this type of transaction as a possible way of growing its relatively small mutual fund arm.

"One formula doesn't fit all," Rick Waugh, Bank of Nova Scotia's president and chief executive, said during the bank's fiscal third-quarter earnings conference call. Waugh made the comment in response to questions about the bank's strategy to grow its wealth management business.

Behind the question is market speculation that Bank of Nova Scotia is in talks to sell its mutual fund business to CI, a much bigger mutual fund operator, in exchange for a significant equity stake in CI. Late last week, CI confirmed it has held talks with a number of undisclosed parties about possible strategic combinations, but said there was no certainty a deal would be completed.

Bank of Nova Scotia has declined to comment on the rumors.

On the conference call Tuesday, Bank of Nova Scotia's Waugh reiterated the bank's strategy of growing its wealth management business. While the bank is pleased with the division's organic growth rate, Waugh also said the bank doesn't necessarily need to own 100% of the business to achieve this goal. It would consider owning a minority stake as long as the resulting transaction contributed to the bank's long-term strategic goal and made financial sense.

Waugh noted his firm initially expanded its banking operations in Mexico, Peru and Chile by taking minority stakes in the countries' local banks and then over time increasing these holdings to control positions.

If it sold its mutual fund business to CI under the rumored transaction, Bank of Nova Scotia would gain a meaningful equity stake in a larger mutual fund business that would further benefit by allowing CI to tap Bank of Nova Scotia's distibution network to grow sales.

Mutual fund companies seek scale in order to expand their sources of fee income while cutting costs.

In turn, Bank of Nova Scotia would be in a better position to acquire CI if and when it came for sale. The bank is already in a good position to acquire money-management firm DundeeWealth Inc. if its controlling shareholder, the Goodman family, ever puts the business up for sale, because of its existing 18% stake.

Still, Bank of Nova Scotia could face a bidding war for CI if CI's existing major shareholder Sun Life Financial Inc. has a similar plan.

Some observers suggest this prospect, in addition to the bank giving up the immediate control and brandname of its mutual fund business, are reasons why a deal with CI is unlikely.

However, others argue the bank doesn't have much of choice under current circumstances. The number of independent mutual operators in Canada is dwindling, and those with any significant size such as AGF Management Ltd. have controlling shareholders that don't want to sell.

Still, many industry watchers believe the consolidation trend of Canada's mutual fund sector will continue because of the importance of scale. By holding minority positions in mutual fund companies now, Bank of Nova Scotia could gain an edge over rival bidders when particular assets come up for sale. In the meantime, the bank potentially lowers its ultimate transaction costs for any deals, if the value of potential targets rise as they become increasingly scarce.

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The Globe and Mail, Tara Perkins, 22 August 2008s

CI Financial Inc. says it has been talking with a number of financial institutions about various strategic possibilities.

“Over the last several months, we have had discussions with a number of financial institutions about a number of combinations including CI and its subsidiaries,” chief executive Bill Holland said in an interview Friday as the company put out a similar statement.

There is no formal strategic process in the works, he said, adding “we're always talking to everybody. We have knocked on every single door in Canada. There's never been a door we haven't knocked on.”

Sources said Bank of Nova Scotia is among the companies CI has informally talked to, as a report said that CI was in talks to buy Scotiabank's mutual fund division in exchange for giving the bank an equity stake in CI.

CI said it would not comment further on speculation. Scotiabank spokesperson Frank Switzer declined to comment on the report.

Mr. Holland said that, over the last several months, the mutual fund giant has held discussions with several financial institutions about various different forms of combinations that might make sense. That is “very consistent with what we always do,” he added.

“Over the last eight years or something we've done 10 acquisitions, and for every acquisition [that] we do, we kind of lose five of them.”

Mr. Holland said there's no assurance that any of the informal talks that CI is holding with industry players will lead to a deal, but “we really believe it's important to take advantage of the scale that this business offers, and in a business that's dominated by a few big players you want to be big and bring down your costs.

“We believe that this is a bulge bracket game,” he said, and bulk will be key to success over the next decade.

CI's largest shareholder is Toronto-based insurer Sun Life Financial. A spokesman for the insurer, Michel Leduc, also declined comment on any talks. He did say “I can confirm that Sun Life is very committed to its strategic position in terms of its stake in CI.”

Sun Life holds roughly a 37 per cent stake in CI. One source familiar with the situation said the insurer would be actively involved in any major strategic process involving the fund company. Significant transactions often require approval from two-third's of a company's shareholders.

In a note to clients Friday, BMO Capital Markets analyst Ian de Verteuil said he believes the odds of Scotiabank selling its mutual fund operation in exchange for an equity stake in CI “are very low.”

“CI would certainly benefit from owning and managing Scotia's mutual fund business [which has about $19 billion in assets under management],” he wrote. “Improved access to a bank's distribution network would be desirable for any mutual fund company.”

But the potential deal would be far less attractive for Sun Life and Scotiabank, Mr. de Verteuil added. “Both are well capitalized, want to be bigger in wealth management and generally want to control their core businesses,” he wrote.

“Simply put, Canada's larger financial institutions typically don't share their ‘toys' well with others,” he wrote.

Last fall, CI attempted a run at DundeeWealth Inc., which sold an 18 per cent stake to Scotiabank, which has put a major emphasis on beefing up its wealth management capabilities. This summer, it announced a $444-million takeover of E*Trade Canada.

CI Financial Income Fund is the third largest investment fund company in Canada, and had fee-earning assets of $102.2-billion at June 30, down 5 per cent from $108-billion a year earlier.

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BMO Q3 2008 Earnings

RBC Capital Markets, 27 August 2008

Bank of Montreal's GAAP EPS of $0.98 were well below our $1.20 estimate on much higher than expected loan losses.

• Offsetting the higher loan losses were better than expected revenues in Canadian retail banking and the wholesale division.

• The Tier 1 of 9.9% was up from 9.4% in Q2/08, which is a strong capital position in our view.

Lowered EPS estimates; Maintain Underperform rating

We do not expect loan losses to be this high in Q4/08 and in 2009 but have nonetheless lowered our core cash EPS estimates to $4.70 in 2008E and $5.15 in 2009E (from $4.90 and $5.20, respectively) to reflect the Q3/08 shortfall versus our estimates and model tweaking.

Our 12-month target price of $44 is unchanged. It is based on a P/BV multiple of 1.35x, versus the current 1.5x multiple, and it implies a NTM P/E of 8.6x, whereas the stock currently trades at a NTM P/E of 8.8x.

We maintain our Underperform rating on Bank of Montreal's shares. We believe that BMO's share price is likely to lag its peers' given:

• Our outlook for greater deterioration in credit quality near term, based on the bank's U.S. exposures (although we do expect Q4/08 provisions for credit losses to be lower than in Q3/08);

• Domestic retail banking results that are likely to continue lagging those of the leading banks on a combination of revenue and bottom-line growth (Q3/08 revenue YoY growth was 3% and core earnings were flat);

• Greater concerns over the sustainability of wholesale earnings than most peers as the bank will likely reassess risk appetite; and

• Continued overhang from off-balance sheet exposures (Links, Parkland, Apex, Fairway).

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Scotia Capital, 27 August 2008

• BMO cash operating earnings were $1.06 per share versus $1.49 per share a year earlier. Operating earnings were well below our estimate of $1.23 per share and consensus of $1.21 per share due to a $247 million or $0.33 per share credit charge related to two real estate loans purchased from Fairway (BMO sponsored U.S. ABCP conduit) in Q2/08.

What It Means

• Underlying earnings adjusted for U.S. ABCP related LLPs, unusual items and higher trading revenue were strong in the $1.30 per share range. Earnings declined 29% YOY and even on an underlying earnings basis earnings were down 13% YOY. Operating leverage was a negative 1.2%.

• Private Client Group earnings increased 8% with P&C U.S. earnings improving 9% and P&C Canada earnings declining 4% year over year. BMO Capital Markets declined 7% excluding net charges.

• Operating ROE was 14.9% with underlying operating ROE of 17.8%.

• We maintain our 3-Sector Underperform rating on BMO based on lower earnings growth outlook, lower profitability, higher off balance sheet risk, higher dependence on wholesale (36%) and relatively weak operating platforms.

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Dow Jones Newswires, Monica Gutschi, 26 August 2008

Bank of Montreal's third-quarter earnings sank by more than 20% in the third quarter, as the lender sharply raised its credit provisions and posted yet another charge for valuation adjustments in its capital-markets division.

The Toronto-based Canadian chartered bank reported third-quarter net income of C$521 million or 98 Canadian cents a share, down from C$660 million or C$1.28 a share a year earlier.

The bank said its cash earnings (a non-GAAP measure) amounted to C$1.00 a share versus C$1.30 a year earlier.

Bank analysts on average had expected Bank of Montreal to earn C$1.21 a share in its latest third quarter.

The results, which were badly hurt by the battered U.S. housing market, bode poorly for the remaining Canadian banks that will report their third-quarter financials this week.

"This is not a very auspicous start to the third-quarter bank earnings," said Fred Ketchen, managing director of stock trading at Scotia Capital Markets. "It does not set things off on a pleasant footing for the rest."

Bank of Montreal is the first of the big six Canadian banks to report third-quarter earnings. It will be followed later Tuesday by Bank of Nova Scotia. Canadian Imperial Bank of Commerce reports Wednesday, and Royal Bank of Canada, Toronto Dominion Bank and National Bank of Canada will release results Thursday.

Shares of all banks were down in early trading in Toronto. Bank of Montreal, which lost 3% at the start, is now off 76 Canadian cents or 1.7% to C$43.30.

Dundee Securities slashed its outlook on Bank of Montreal to sell from neutral, noting the bank "no longer wears the crown of 'low provision bank.'"

Bank of Montreal said its provision for credit losses soared to C$484 million in the latest quarter from C$91 million a year earlier. Analysts had only expected an increase to C$195 million. The bank said C$247 million of those provisions were for two corporate accounts related to the U.S. housing market that were identified as impaired.

That will "obviously raise concerns" about credit provisions at Royal Bank and TD, the other Canadian banks with large U.S. retail operations, Dundee analyst John Aiken said in a note. While there are regional differences in the banks' various exposures, he said speculation would likely hit Royal's and TD's shares "despite the fact that each has reported meaningful increases in provisions over the past few quarters."

Bank of Montreal had also sharply increased its provisions in the first and second quarters and said in May that provisions for the balance of the year would be above the C$170 million recorded in the first quarter given the continued deterioration in the credit environment. It had initially set a target for the year for credit-related provisions of C$475 million; so far, provisions have totaled C$755 million.

The bank also fell short of its goal for return on equity of 18-20%. ROE, a key measure of bank profitability, was 13.5% in the third quarter, while cash ROE was 13.7%. Those results compared with ROE of 18% and cash ROE of 18.2% a year earlier.

Still, the news may not be all bad. Blackmont Capital noted that stripping away all charges and the credit-related provisions, the bank's core cash earnings came in at C$1.42 a share, mainly on strong trading results and better net interest margins.

Aiken at Dundee also noted the bad headline news overshadowed some key improvements in the bank's operations.

"What is truly disappointing is that the operations outside of capital markets and its U.S. real estate business appeared to have performed quite well, generating enough earnings to almost offset the substantial increase in provisions," Aiken said. "However, with little hope that credit issues will fade in the coming months, this positive is unlikely to provide much support as cracks continue to appear in BMO's loan portfolio."

Neither Blackmont nor Dundee have any investment-banking conflicts with Bank of Montreal, nor do the analysts own the bank's shares.

Bank of Montreal said P&C Canada, its Canadian personal and commercial banking unit, had one of its best quarters ever even though earnings of C$343 million were down C$13 million from a year earlier. After adjusting for a recovery of prior years' income taxes in 2007, it said net income in the division improved slightly from a year earlier and was up 3.4% from the second quarter.

Analysts have pointed out that, due to weakness in the capital-markets business and rising risk in the U.S. platforms, the importance of the Canadian banks' domestic retail operations has increased.

Bank of Montreal's U.S. personal and commercial banking operations showed improvement, with earnings up 12% from a year earlier on "solid" volume growth and early signs of spread stabilization in both loans and deposits.

The bank said its private client group delivered record net income in the quarter.

Meanwhile, BMO Capital Markets' results were up from a year earlier but continued to reflect current market conditions with low activity levels in some of its investment-banking businesses. The bank recorded a charge of C$134 million, (C$96 million or 19 Canadian cents a share after tax) in the latest quarter related to the capital-markets environment.

Citing the challenging economic environment, the bank reiterated that it doesn't expect to achieve its annual earnings target, which was for earnings-per-share growth of 10-15% in fiscal 2008.

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Preview of Banks' Q3 2008 Earnings

BMO Capital Markets, 12 August 2008

We are expecting a better earnings performance than we have seen so far this year when Canadian banks start reporting their third-quarter results at the end of this month. Earnings, inclusive of several large identifiable items, will be down about 20% from year-ago levels but the degree of decline should be far more modest than in the last two quarters (Chart 1).

This quarter, we expect the identifiable charges to include hits at CIBC ($750 million), Royal Bank ($300 million) and TD ($96 million, which was preannounced). The good news is that the bad news isn’t getting worse, and some will argue, is diminishing. Trading revenues, which we believe will include these charges, will be only modestly negative this quarter.

We also have a mixed bag on the “operating front”, but still down about 5%. Domestic Banking should continue to underpin the results with volume growth remaining strong. Spreads are forecast to be stable and expenses will remain well-controlled. On the other hand, Canada’s banks are facing two robust headwinds: loan losses are continuing their inevitable march upward and the low activity levels in Capital Markets have continued for another quarter. We are relatively sure that the loan loss situation will deteriorate and are uncertain on the medium term outlook in Capital Markets. One wonders whether the 2006 and 2007 periods are valid bases for forecasting either of these two variables.

We are maintaining a Market Perform rating on the Canadian bank sector. They have had a nice rebound and now only trail the market by 200 basis points year to date. Were it not for the big move in various individual issues (Potash and RIM), they could be declared winners. We still believe the earnings revisions will be to the downside over the coming year as the Canadian economy slows, operating leverage moderates and loan losses rise. We continue to recommend Scotiabank and National Bank (both rated Outperform) at current levels among the big six Canadian banks.

Loan Losses Should Continue Their Steady Climb Higher

Not surprisingly, we expect to see loan losses continue their concerted upward move in the third quarter. The average bank will see provisions that are 70% higher than a year ago, and three will have doubled. Factors include higher formations, as well as fewer recoveries. As is clear from Chart 2, loan losses are certainly higher than in the past five years but are still meaningfully below 2002 levels. This is despite the fact that the loan book is now 50% bigger than it was then – and with a larger bias to the U.S.

We also expect this quarter to exhibit a more broad-based deterioration in loan losses. To date, BMO, TD and Royal have been the culprits producing two-thirds of system-wide losses on a combined basis. This quarter, we expect Scotia, NA, and possibly CIBC, to show some acceleration in their specific loan losses. We show individual bank loan loss estimates in Table 1, which combine to system-wide provisions of $1.2 billion. Given recent U.S. regulatory filings, there is a real risk that BMO’s losses are higher than we have forecast in this report.

In recent memory, this quarter’s loan loss experience will include the first problem name of real size that runs across several banks, Semgroup Energy Partners, whose primary business is apparently running an oil pipeline. As we have detailed in several comments over the past few weeks, this has the potential to cause a blip in both formations and provisions for BMO, RY and BNS. Whatever the specific outcome regarding this credit, it is hard to believe that the worst of our loan loss problems over the next few quarters will be a pipeline company.

It is always enticing to try to link macro economic performance with loan loss forecasts. Unfortunately, the former is possibly more difficult to predict than the latter. Clearly, Canada in aggregate is slowing down. In addition, we are keenly aware that Canada is becoming (or has always been) a country with significant regional differences. While Alberta continues to do well, central Canada is clearly a concern. We remind investors that banks really want all their clients to “do okay” – if there are some regions doing very well but other areas experiencing a meaningful slowdown, loan losses can still mount. As the old saying goes, it is possible to drown in a river that is on-average, two feet deep.

Net Interest Income Should Continue to Be Robust

If there is one element of the Canadian bank income statement that still remains robust it is Net Interest Income (NII), which makes up close to 50% of total revenue. Several cross currents have affected NII over the past few years. In many ways, the simplest to discuss is loan growth.

Canadian banks have been blessed with outstanding loan growth for several years. Fundamental to this has been consumer demand for loans, which has run in excess of 10% since October 2003 (Chart 3). As if that were not enough, business credit demand accelerated in 2006 (in our opinion largely due to a strengthening Canadian dollar). The last boost to loan growth came from the credit problems in mid 2007 (read ABCP problems), which forced many issuers back onto bank balance sheets.

The recent results are far less impressive. Consumer demand remains good, but business loan growth seems to be slowing quite markedly (as one would expect). All in, we believe that the days of double-digit loan growth are largely behind us. This quarter’s results will probably “book-end” a wonderful period for Canadian Retail Banking.

The benefit of strong loan growth has been diluted by two factors. First, much of the consumer growth has been in residential mortgages, which are being extensively securitized. Effectively, securitization mitigates the growth in mortgage balances given the small NII contribution when the mortgage is not funded on the bank’s balance sheet. However, the bank still retains the client relationship and cross sells other products, ensuring that the volume is still attractive.

The second more material factor is the ongoing spread compression (Chart 4). Competition, loan mix shifts and the lack of core deposit growth are all to blame. The good news is that this seems to be moderating. We are forecasting that in the upcoming quarter, spreads will again be stable – the fourth quarter in a row that there has been relatively little margin pressure.

We actually believe that spreads will start to widen into 2009 as lack of alternatives for business borrowers, and better deposit growth (at least in relation to loan growth) should reverse some of the previous trends. On a short term basis, it is also helpful that Prime-BA spreads have begun to stabilize after tremendous volatility (largely negative) at the end of 2007 and into 2008. When all is said and done, we expect stable spreads in the third quarter.

Domestic Retail – The Goose That Lays the Golden Eggs

With the strong NII performance and good expense control, the domestic retail business should again provide solid underpinning to the results this quarter (actually about 75% of all earnings this quarter). Note this includes both domestic banking and wealth management businesses. The year-over-year increase of 4% is expected to mask that the P&C Banking segment will be up close to 6% while wealth will be down modestly (Table 2).

The reality is that two variables account for the divergent trends across banks. Specifically, we expect RY to be up double-digit on a percentage basis, while CIBC is likely to be flat to nominally lower. The industry heavyweights in domestic banking market share, TD and Royal, will continue to outperform, reflecting the stability of strategy and leadership position. In addition, banks that have a higher proportion of wealth management, BMO and CM, will continue to face more headwinds given the difficult equity market.

Trading and Securities Write-Offs – Anybody’s Guess

The third quarter will be another “dog’s breakfast” quarter for Trading Revenues. We remind investors that this line includes the valuation adjustment needed to deal with all securities held in the “trading books.”

Exclusive of three specific issues, we expect trading revenues to be somewhat disappointing (down 15% compared to a year ago). Inclusive of these, the numbers will be well down from a year ago, but strongly above the second quarter. The three specific items of note relate to: i) TD and its pre-announced $96 million charge for mispriced securities; ii) CIBC and the on-going writedown of its CDO and CLO book, inclusive of insurance valuation adjustment; and iii) Royal Bank and its MBIA and other market charges. The first of these is already quantified so we won’t deal with it in detail; however, the other two warrant some comment.

i) CIBC and the ongoing writedowns: We believe CIBC will take another $750 million pre-tax charge this quarter – almost entirely related to the CDO (RMBS-backed) book. There have been sensationalistic estimates as high as $2 billion of charges at CIBC. This seems too high to us, as we believe the recapitalization of XL and the favourable impact this has had on CDS spreads for several monolines means that there should not be additional material reserve per-dollar of insurance exposure. Unfortunately, with the ABX- AAA Index having declined quite sharply in the quarter, there is more monoline exposure so some incremental reserve is warranted. On the CLO front, we do not have much visibility and expect a further $200 million here (included in the $750 million charge).

ii) Royal and its charges: Royal on the other hand does seem to be more exposed to the ABX than to the CDS of its main insurer, MBIA. As a result, we believe a valuation adjustment of $200 million could be warranted. In addition, we have assumed a $100 million charge to deal with auction rate securities (ARS). We openly acknowledge that this is a shot in the dark – using the comparable numbers for Citigroup, the ARS charge would be three times our estimates. However, we do believe that Royal’s ARS exposure is relatively high quality in nature. Unfortunately, comparative disclosure is poor.

As we have previously said, inclusive of these three identifiable charges we believe that trading revenues will again be negative – though marginally so (Chart 5). We continue to believe it is imprudent to categorize these items as “one-time” in nature, though one can reasonably argue that some of these charges will reverse.

Non-Interest Revenue Will Be Affected by a Weaker Capital Markets Environment

The second quarter was bad enough, but the third quarter has been downright awful for activity levels in capital markets for Canadian investment dealers. Issuance remained reasonable but M&A activity was very weak. This can be partly explained by seasonality – the summer months tend to be slower – and partly by the difficult credit conditions. In Chart 6, we show our estimates for issuance and advisory fees earned by the Big Six banks for the third quarter. We are estimating capital markets revenues will be below last quarter’s levels and well down from the near record levels reported in the same quarter of last year.

Capital Management and Dividends

Economic and liquidity challenges continued to grind the banking system this quarter, forcing banks to exercise ongoing caution in their capital management practices. Debt capital issuance continued to be elevated and share buyback activity remained at a virtual standstill. On the dividend front, Scotia was the only bank to raise its dividend last quarter. Royal, CIBC and BMO have kept their dividends unchanged for the past four quarters, and National for the past three.

Given the confidence expressed by management in its longer term earnings power, we expect Royal to declare a minor dividend increase this quarter (Table 3). National could increase its dividend, but given the fact that the ABCP situation isn’t completely settled, we have assumed that NA’s board will defer a decision at this time. TD could argue for a minor increase but this seems premature given the need to build capital.

Individual Bank Comments

Below are our individual bank forecasts and analysis for the second quarter. In Appendix A we have also included our Preliminary Scorecard, which lists reporting dates and summarizes our more important estimates. We note that the six large Canadian banks will report over a three-day period. Needless to say, the Labour Day weekend, starting the day after TD, Royal and National report, will hopefully provide more “weekend” than “labour”.

Bank of Montreal (August 26) – Continued Headwinds

BMO leads off this compressed earnings season. We are expecting a relatively weak performance from BMO this quarter, with operating earnings roughly flat from last quarter and down 19% from the same quarter of last year. The bank is unlikely to see much momentum from the domestic P&C business although stable spreads and expense control should support the downside. From its FDIC filings, P&C Chicagoland appears to have had an awful quarter due to a significant ramp-up in loan losses. Difficult market conditions should also take some of the shine off of the Private Client segment this quarter.

Capital Markets revenues should be down this quarter, though this is in relation to two relatively strong comparable quarters. Issuance activity remained solid but, with weakness in the metals sector this quarter, advisory fees appear to be quite weak. On the trading side, we are expecting revenues of $75 million, well down from prior quarters.

One area that could help this quarter relates to the steepening yield curve. Traditionally, the bank has benefitted from this because of its U.S. book. So far, there is some evidence from the FDIC filings that this is occurring (it should show up in Harris NA), but there could be some reluctance to taking such risk given the difficulties the bank has experienced in trading.

The focus this quarter for BMO will likely be on credit. For a bank that has the reputation as being a low-risk credit institution, the past two quarters have been quite disappointing and given guidance at the second quarter, the trend remains negative. This quarter, with the banking system solidly into a downward credit cycle, we will be looking to see if BMO closes the negative gap with its peers. A material jump in provisions at Harris is a possibility. The Harris NA filing suggests the reverse could be occurring. We don’t expect material changes to capital or any increase in dividend given the earnings pressures.

Scotiabank (August 26) – Another Workman-Like Quarter

Scotia should report relatively solid results again this quarter. We expect to see some early signs of the credit cycle affecting formations and provisions, but the diversity of the franchise should also be obvious. From our perspective, the real story is the fact that Scotia has side-stepped the major problems in structured credit.

After a solid second quarter, Domestic Banking business should continue to show improving volumes and spreads. The latter should be at odds with its peers i.e. better than a year ago, reflecting lower short-term rates. Expenses should again be well-controlled. We are somewhat concerned that Scotiabank is prepared to consistently pay up for domestic wealth management businesses – whatever the quality or structure of the deal.

International Banking results should continue to show good growth with higher contribution from recent acquisitions. A more relevant comparison is probably versus the second quarter. Mexico’s contribution of $104 million is roughly stable year over year due to well-controlled credit trends.

Not surprisingly, we are expecting a weaker quarter from Scotia Capital, although issuance and advisory activity at the bank appear to have held in better than at other banks. Lower trading revenues and fewer credit recoveries should weigh on earnings. Corporate earnings should be down from year-ago levels, which included high securities gains, but somewhat better than in the second quarter.

Scotia increased its dividend in the last quarter, so we aren’t expecting any change here. Its capital position remains very robust and we expect internal capital generation to offset strong RWA growth. One area of focus this quarter will probably be credit trends. We expect provisioning to continue to rise (roughly double year-ago levels) and hope for more clarity on the bank’s exposure to the auto sector – both via GMAC and other exposures.

CIBC (August 27) – Another Big Charge

Given the moves in various metrics, we expect CIBC to report a $750 million charge this quarter. If there is one positive, it is that the bank looks like it could even avoid a loss this quarter. The reality is that the bank has yet to put this sad chapter behind it and some of these U.S. mortgage assets will likely be worthless, eventually.

We are expecting Retail Markets (which includes wealth management) to be up over last quarter’s disappointing results and roughly stable with last year. The reality is that the bank has had a challenging time delivering good retail results in a very positive banking environment in Canada. Now, with slower loan growth, higher inflation and more difficult equity markets, we find it hard to argue for much growth out of this segment. The trends at First Caribbean also remain difficult.

On the wholesale front, as detailed above, we expect the structured-credit related charges at CIBC to be more manageable this quarter (in the $750 million ballpark and included in Trading Revenues). Outside of this, we expect World Markets to show lower results as M&A activity appears to have been particularly weak for the bank this quarter. Furthermore, there is some chance that with the new executive appointments, additional “restructuring” charges will be needed.

CIBC’s capital position should remain the highest of the banks but decline to just under 10%. The common equity issuance at the beginning of the year combined with the sub-debt issuance this quarter put the bank in a solid capital position. We continue to believe additional common equity issuance will not be needed. Needless to say, a dividend hike is quite unlikely.

Royal Bank (August 28) – Another Noisy Quarter

As in previous quarters, the results from Royal will again be affected by several charges for its involvement in structured credit. We expect an MBIA charge as well as some additional items for ARS. It will also be difficult to isolate the operating performance of RBC Capital Markets as variable compensation could be affected. In our estimate of $300 million pre-tax however, we have assumed no offset from variable compensation and a 20% tax rate.

Canadian Banking results should be good this quarter – probably best in class. We still believe that this unit can produce a double-digit year-over-year increase, reflecting its leadership position and excellent control of expenses. Excluding the loss on the Visa IPO last quarter, growth should be about 6% over the quarter and 13% over the year. Insurance, which will be broken out into a separate segment this quarter, should be stable, as should Wealth Management. The risk to Wealth Management is to the downside, but only modestly so.

International Banking earnings should be around $60 million this quarter, up from a very weak last quarter but well down from the same quarter of last year. Investors should remember that the second quarter included a Visa IPO gain (as opposed to a loss in Canadian Banking). The inclusion of half a quarter of additional RBTT results should be offset by the on-going challenges at Centura.

Investment banking activity levels in the Global Capital Markets business appear to have been relatively steady when compared to last quarter, but well down from a very strong year-ago result. We have assumed $300 million in identifiable charges, which will be included as Trading Revenues. Exclusive of these items, trading revenues should remain good at $500 million.

The Corporate Support line is always difficult (read impossible) to forecast. Items such as Treasury success, securitization revenues and numerous tax items are volatile and can cause major swings. We are expecting Royal to move on dividend this quarter. While there is a good argument to wait another quarter, we perceive a high degree of confidence at the bank that the current problems are manageable, and that 2009 will be quite a bit better. We assume that the bank’s Tier 1 ratio will be stable at 9.5%.

TD Bank (August 28) – Little Left to the Imagination

There will be various cross-currents to TD’s earnings this quarter, but all in all, with AMTD reported and management have provided crisp guidance for the U.S. P&C business, there should be few surprises. The year-over-year decline in reported Cash EPS reflect the outstanding third-quarter wholesale results of a year ago, rather than any fundamental weakness.

Canadian P&C should show solid results. However, there are several headwinds: some weakness in margins, more moderate operating leverage and the continued rise in loan losses associated with VFC and the enlarged credit card book. All in, the year-over-year increase should be at the mid-single-digit percent level. Wealth Management results should be flat with a year ago, but given the volume sensitivity of the direct brokerage in Canada, there is some room for a modest negative surprise.

With regard to the U.S. P&C segment, this will be the first full quarter that TD Bank U.S. (the re-branded Banknorth/Commerce entity) will be included in earnings. As a result, we expect the contribution from this segment to double despite on-going challenges in the U.S. banking system. Simply put, more capital invested has produced a larger contribution rather than any fundamental improvements. Management has reiterated confidence in its forecasts for this segment so we are not anticipating many surprises.

On the wholesale side, we are expecting results to be above last quarter’s weak showing but well down from year-ago levels. One item of note will be the $96 million pre-tax charge related to the mis-pricing of various financial instruments pre-announced by the bank. Outside of this charge, we are expecting trading revenues of $175 million. Even without the $96 million charge, TD Securities will likely be half as profitable as a year ago, reflecting the difficult operating conditions and the strong year-ago performance.

We expect to see progress on the capital front, as management has clearly heard the street concerns on the additional stresses that the U.S. expansion has placed on reported capital ratios. We don’t expect any dividend increase.

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RBC Capital Markets, 11 August 2008

We expect another difficult quarter with earnings risk greatest for banks with U.S. exposures, both in banking and capital markets.

• In the near term, National Bank and Scotiabank should be less impacted by U.S. credit quality and capital markets writedowns.

• Until the last quarter, banks had been challenged with weak capital markets and U.S. exposures but there was little sign of deterioration in core Canadian banking businesses. Capital Market and U.S. challenges remain in place, but we expect more issues in the core Canadian business over the next 6 to 12 months with increases in credit losses from low levels, slower loan growth, margin pressure and soft wealth management results.

• We believe that stock price direction will be heavily influenced by the strength of domestic retail banking and wealth management results.

• We estimate core EPS will decline by a median 9% versus Q3/07 driven by higher loan losses and lower capital markets results, and reported EPS will be below core EPS for some banks, due primarily to capital markets-related writedowns.

• We expect Scotiabank to grow core EPS at the highest rate, and CIBC the lowest.

• We do not expect any quarterly dividend increases in Q3/08. Canadian banks have high Tier 1 ratios by both global standards and historical standards, but we do not believe banks are looking to return or deploy that capital quickly. We expect Tier 1 ratios will be at least 9% for all six banks in Q3/08E.

Too early to buy Canadian bank stocks

• We believe it is too early to buy Canadian bank stocks due to our expectation for continued pressure on profitability, the potential for further negative earnings revisions, and valuations that are not overly cheap on a historical basis based on price to book, with the banks trading at a median multiple of 2.0x book versus a trough of 1.65x six years ago when credit and equity markets were weak.

• Near term, investors are likely to be best served holding banks with less exposure to U.S. credit and capital markets, although we do not expect this to be a winning strategy in 2009 as we do not expect Canada's economy to be unscathed by U.S. economic woes.

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Financial Post, Jonathan Ratner, 11 August 2008

The risk of future economic weakness has forced Blackmont Capital’s Brad Smith to cut his 2008 and 2009 earnings per share (EPS) estimates and price targets for Canada’s biggest banks. The Big Six domestic banks begin reporting third quarter results on August 26 and the analyst is advising investors to use broader strength in the sector to reposition themselves with exposure to those banks with the strongest capital and best strategy.

“Much of the pending bad news has been well telegraphed already, increasing the probability that bad news, once delivered, could prompt stock rallies such as those observed recently following the release of lower-than-expected loss from a number of global financial service heavyweights...” Mr. Smith said in a research note.

His top picks are Royal Bank and Bank of Nova Scotia, but he downgraded the latter to a “hold” given the positive surprise from its relative share price performance in the past year. Despite the fact that his $50 price target (down from $51) for Scotiabank is unable to support a “buy” recommendation, Mr. Smith continues to think the bank’s earnings and share price potential is better than its domestic peers on average. Its “truly international” retail banking platform and limited exposure to U.S. credit should produce earnings growth outperformance for the foreseeable future, he told clients.

While each of the Big Six had their EPS estimates cut, Toronto-Dominion Bank was the only one that did not see a price target reduction. It remains at $63 per share, while Bank of Montreal falls a dollar to $46, CIBC gets slashed from $74 to $62, National Bank moves from $50 to $46, and Royal falls by $4 to $55. The analyst is concerned about credit risks and capital market pressures they will face in the next 12 to 18 months.

He also said four of the banks are due for a dividend increase and Royal is overdue.

“Failure to raise dividends would in our view signal continued lack of visibility with respect to earnings growth and future capital requirements, which in turn could prove negative for current domestic bank stock valuations,” Mr. Smith said.

In terms of specifics from the banks, BMO’s $10-billion SIV exposure is expected to deteriorate further as a result of widening credit spreads for its assets this quarter.

CIBC may attempt to crystallize its losses through the sale of subprime exposures to third parties as U.S. firms like Merrill Lynch & Co. have done recently, while its writedowns may end up being more aggressive this quarter given that monoline credit spreads on July 30 were similar to levels at the end of April, Mr. Smith noted.

Meanwhile, Royal will likely have mark-to-market losses linked to its monoline hedged subprime exposure, but these are expected to remain manageable.

But like his counterparts, the analyst said credit will be in focus for this round of earnings. He thinks the current credit cycle is in the “very early stages of a cyclical deterioration,” so watch out for a gradual worsening of domestic credit and more deterioration of U.S. loan portfolios. Mr. Smith also sees more upward pressure on credit provision levels, noting that the fiscal first quarter was the first time since early 2003 that Canadian banks as a whole had more in provisions that they wrote off. He suggested that this means they may have to catch up if credit deterioration worsens.

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Banks' Credit Losses Top $500 Billion on Writedowns

Bloomberg, Yalman Onaran, 12 August 2008

Banks' losses from the U.S. subprime crisis and the ensuing credit crunch crossed the $500 billion mark as writedowns spread to more asset types.

The writedowns and credit losses at more than 100 of the world's biggest banks and securities firms rose after UBS AG reported second-quarter earnings today, which included $6 billion of charges on subprime-related assets.

The International Monetary Fund in an April report estimated banks' losses at $510 billion, about half its forecast of $1 trillion for all companies. Predictions have crept up since then, with New York University economist Nouriel Roubini predicting losses to reach $2 trillion.

``It just keeps spreading from one asset to another, so it's hard to know when these writedowns will stop,'' said Makeem Asif, an analyst at KBC Financial Products in London. ``The U.S. economy needs to stabilize first. But even then, Europe could lag and recover later. There's still a lot more downside.''

Auction-rate securities have begun adding to the losses as regulators and prosecutors force banks to buy back bonds they'd sold as safe investments. UBS set aside $900 million to cover potential losses from repurchasing the securities, while Citigroup Inc. and Wachovia Corp. estimated losses at $500 million each.

The collapse of the U.S. subprime mortgage market last year has saddled banks worldwide with $501 billion of losses from declining values of securities tied to all types of home loans and commercial mortgages as well as leveraged-loan commitments.

Banks and brokers have raised $353 billion of capital to cope with the writedowns, according to data compiled by Bloomberg. The gap between losses and capital infusions, which now stands at $148 billion, has regularly narrowed to about $80 billion as capital raising follows writedown announcements.

The following table shows the asset writedowns and credit losses as well as the capital raised in response. All numbers are in billions of U.S. dollars, converted at today's exchange rate if reported in another currency. For quarterly breakdowns for each bank and region, click on WDCI.

Firm               Writedown & Loss      Capital Raised

Citigroup                 55.1               49.1

Merrill Lynch             51.8               29.9

UBS                       44.2               28.3

HSBC                      27.4                3.9

Wachovia                  22.5               11

Bank of America           21.2               20.7

IKB Deutsche              15.3               12.6

Royal Bank of Scotland    14.9               24.3

Washington Mutual         14.8               12.1

Morgan Stanley            14.4                5.6

JPMorgan Chase            14.3                7.9

Deutsche Bank             10.8                3.2

Credit Suisse             10.5                2.7

Wells Fargo               10                  4.1

Barclays                   9.1               18.6

Lehman Brothers            8.2               13.9

Credit Agricole            8                  8.8

Fortis                     7.4                7.2

HBOS                       7.1                7.6

Societe Generale           6.8                9.8

Bayerische Landesbank      6.4                -

Canadian Imperial (CIBC)   6.3                2.8

Mizuho Financial Group     5.9                  -

ING Groep                  5.8                4.8

National City              5.4                8.9

Lloyds TSB                 5                  4.9

IndyMac                    4.9                -

WestLB                     4.7                7.5

Dresdner                   4.1                -

BNP Paribas                4                  -

LB Baden-Wuerttemberg      3.8                -

Goldman Sachs              3.8                0.6

E*Trade                    3.6                2.4

Nomura Holdings            3.3                1.1

Natixis                    3.3                6.7

Bear Stearns               3.2                -

HSH Nordbank               2.8                1.9

Landesbank Sachsen         2.6                -

UniCredit                  2.6                -

Commerzbank                2.4                -

ABN Amro                   2.3                -

DZ Bank                    2                  -

Bank of China              2                  -

Fifth Third                1.9                2.6

Rabobank                   1.7                -

Bank Hapoalim              1.7                2.4

Mitsubishi UFJ             1.6                1.5

Royal Bank of Canada       1.5                -

Marshall & Ilsley          1.4                -

Alliance & Leicester       1.4                -

U.S. Bancorp               1.3                -

Dexia                      1.2                -

Caisse d'Epargne           1.2                -

Keycorp                    1.2                1.7

Sovereign Bancorp          1                  1.9

Hypo Real Estate           1                  -

Gulf International         1                  1

Sumitomo Mitsui            0.9                4.9

Sumitomo Trust             0.7                1

DBS Group                  0.2                1.1

Other European banks*      7.2                2.3

Other Asian banks*         4.6                7.8

Other U.S. banks*          2.9                1.9

Other Canadian banks*      1.8                -
                          ____               ____

TOTAL**                  501.1              352.9

* Please see WDCI Help pages for a list of companies included in
``Other'' categories for Europe, Asia, U.S. and Canada.

** Total reflects figures before rounding. Some company names
have been abbreviated for space.

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Manulife Q2 2008 Earnings

RBC Capital Markets, 8 August 2008

Q2/08 core EPS of $0.66 was below our $0.78 estimate and the consensus estimate of $0.72.

• Three of the four core divisions were at or above expectations, with the miss mostly occurring in the corporate and reinsurance segments.

• This was, like Q1/08, a disappointing quarter from a growing company operating in a tough macro environment, not a miss that causes us to conclude that the company is broken.

• We have lowered our estimated EPS by $0.19 to $2.70 in 2008 and by $0.05 to $3.30 in 2009 mainly to reflect the greater than anticipated impact of equity markets on the earnings of the company and also the weakness in equity markets thus far in Q3/08. Offsetting equity-related exposures would be a more accommodating currency environment if the Canadian dollar remains at its current level against the U.S. dollar.

• Our 12-month target price of $40 is down from $41, reflecting our lower estimated EPS.

• We continue to rate Manulife's shares as Outperform based on the company's sales and earnings growth track record, excess capital holdings, and growth prospects in Asia. Diversity of operations limits (but does not eliminate) downside earnings risk and reserves appear conservative, with large provisions for adverse deviations relative to reserves and a track record of booking experience gains. The company remains well positioned to make acquisitions if attractive opportunities arise.

• Manulife's stock trades at 11.8x NTM EPS, versus 9.4-11.3x for its peers and a 5-year average of 13.4x. We expect lifecos to trade at higher multiples in the medium term, but trading multiples could remain below the 5-year average for some time given probable deterioration in credit quality and uncertain equity markets.)

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Scotia Capital, 8 August 2008

Positives

• Top-line momentum continues. Once again a strong top-line, with individual insurance sales up 22% in the U.S. and 14% in Canada, segregated fund sales up 34% in Canada and U.S. variable annuity sales, while down 10% YOY over an excellent Q2/07 (competitors are down 20%), they were flat QOQ (competitors down 3%) suggesting modest gains in market share. In Japan insurance sales nearly doubled and variable annuity sales were up 139%. Hong Kong insurance sales were up 12% and Other Asia insurance sales were up 29%.

• No credit issues - a recurring theme with MFC. Sub-prime MBS exposure continues to decline, from $692 million at year end to $519 million (a mere 0.3% of invested, similar to Sun Life's 0.4% and significantly below U.S. lifecos at close to 4%), as a result of the combination due of the general amortization of mortgages, pre-payments and declines in market value. Since the majority of the sub-prime assets back policy liabilities, declines in market value do not impact income, as the liability is marked-to-market as well. MBS/ABS accounts for 5% of invested assets or about $8 billion, with 80% of the RMBS and 85% of the CMBS in 2005 and prior vintage. Net impaired assets hurt EPS by $0.015, but would have been $0.025 without the "assistance" of $23 million in pre-John Hancock merger assets, the benefit of which will likely not be recurring going forward. As well, the net impact of upgrades and downgrades in the bond portfolio results in a $50 million increase in actuarial liabilities ($0.02 in EPS) in the quarter.

• Weak equity markets hurt - but not nearly as much as Q1/08. The 11% weigthed average decline in equity markets QOQ in Q1/08 hurt EPS by $0.18. Q2/08 wasn't nearly as bad. The QOQ weighted average change in equity markets was 0.2%, resulting in no material increase in reserves for seg fund/variable annuity reserves, hurting growth in expected profit (which usually assumes 2% increase in equity markets per quarter), and consequently EPS, by $0.02. If we get a 10% jump in equity markets QOQ we could get an additional $0.12 in EPS.

• Company taking advantage of widening credit spreads to increase investment yields. The company maintains it is adding high quality asses at attractive spreads in this environment, and in the quarter added nearly $300 million in less than BBB bonds due to incremental investment activity, increasing its below investment grade bond portfolio to 4.8% of bonds from 4.4%. We take comfort from the fact that the increase was not due downgrades in the company's portfolio. As well, the company's track record of minimal impairments provides further testament.

Negatives

• Even though no operational issues, a miss is still a miss - and it can hurt more when you're at such a premium multiple. We attribute the EPS "miss" of $0.03 versus our estimate and $0.05 versus consensus of $0.02 in a largely one-time tax related item and $0.01 in unusually poor mortality experience in the reinsurance division. As well, a host of items, that could be considered somewhat recurring also contributed, namely $0.02 in increase in credit provision in actuarial reserves (expected), $0.02 in larger-than-expected new business strain (could be sustainable if individual insurance sales continue at their torrid pace), nearly $0.02 in credit impairments (expected and could be somewhat sustainable in this environment), and $0.02 in lower-than-expected realized gains on surplus assets (lumpy, but somewhat expected given markets). Our Source of Earnings Analysis (see Exhibit 1) shows the reported EPS of $0.66 to be a relatively clean number, helped by $0.09 in the combination of experience gains in assumption changes (likely larger investment gains as the company takes advantage of widening spreads, as well as rising interest rates).

• Taking our EPS estimates down by $0.04 in 2H/08 and $0.09 in 2009 - to reflect the combined impact of tougher credit conditions and sluggish equity markets. The current quarter was likely negatively impacted by $0.03 due to credit and $0.02-$0.03 due to weak equity markets. We lowered our estimates given the difficult markets. Given no operational issues (the top-line momentum continues) we see no reason to lower the company's premier multiple. Could see $0.10 more in 09E EPS if C$ trade at US$0.95 versus our par estimate.

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The Globe and Mail, Tara Perkins, 8 August 2008

Manulife Financial Corp. raised its dividend this quarter, even though profit came in below analysts' expectations, as the company remains optimistic a tough economy won't inflict too much damage on its operations.

The move underscored the insurance giant's confidence in its future, chief executive officer Dominic D'Alessandro said yesterday.

"I'm not particularly pleased to read, as I did this morning, the long litany of financial institutions coming forward with more and more problems," he said. "I don't manage those institutions; we manage our own ... and I think we're taking care of our affairs very well."

Toronto-based Manulife boosted its dividend by 8 per cent, to 26 cents a share, despite a 9-per-cent drop in profit to $1.01-billion.

"We look forward to continuing to deliver strong results in the periods ahead, no matter what the economic conditions are," Mr. D'Alessandro said. "Will it be 18-per-cent returns? Well, you know, that might be a little tough. But they'll be respectable returns."

Dividends in the financial services sector have been one of the casualties of a market crisis that's stretched on since last year.

Manulife's rival Sun Life Financial Inc., also of Toronto, which reported its financial results last week, chose not to raise its dividend this quarter. CEO Don Stewart said the company felt the decision was prudent in light of continuing economic uncertainty, and that it would take another look at its dividend rate "as the economic picture evolves."

However, dividend increases are far from extinct; Winnipeg-based insurer Great-West Lifeco Inc., for instance, raised its dividend by 5 per cent this quarter.

But some observers think they do appear increasingly endangered. In a recent note to clients about the Canadian banks' third quarter, which ended last week, Dundee Capital Markets analyst John Aiken asked whether 2008 could "be the year the dividend increases stopped?"

So far in fiscal 2008, only Toronto-Dominion Bank and Bank of Nova Scotia have announced dividend increases, he said.

"There are three banks that have the potential to go over a year without announcing a dividend increase in the third quarter," he said, adding it's "quite possible" that Bank of Montreal and Canadian Imperial Bank of Commerce will choose not to boost theirs. Neither bank has raised its dividend since the third-quarter of 2007.

"Even for those that do, we do not anticipate large increases, as the banks wisely try to conserve capital in the current, uncertain environment," Mr. Aiken said.

At Manulife, Mr. D'Alessandro told analysts to remember that "we don't run the business for quarter-to-quarter purposes, we run it for the long-term."

The insurer's share profit of 66 cents fell short of analysts' consensus forecast of 72 cents, as the company was hit by the effects of weak stock markets in the United States and Asia, as well as Canada's strong Canadian dollar and a rising tax provision.

Manulife's core earnings-per-share growth of 6 per cent was the worst of the four Canadian life insurance companies, RBC Dominion Securities analyst André-Philippe Hardy wrote in a note to clients.

But three of Manulife's four main divisions met or exceeded expectations, he said. The reinsurance operations and Manulife's corporate division - which was hit by lower gains on assets and private equity holdings, as well as the tax provision - pulled down the results.

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RBC Confirms US Subpoena Over Auction Rate Securities

The Globe and Mail, Tara Perkins, 7 August 2008

Royal Bank of Canada was one of a number of financial institutions subpoenaed in the United States in connection with auction-rate securities, the bank confirmed yesterday.

The $330-billion (U.S.) market for auction-rate securities collapsed this year as a result of the liquidity crunch, leaving many American investors stuck with frozen securities.

The Wall Street Journal reported yesterday that Citigroup Inc. is negotiating with federal regulators to settle allegations it wrongly told customers the securities were safe and liquid. Citigroup could wind up buying back more than $5-billion of the securities from investors and paying a fine of up to $100-million, the newspaper reported.

Late last month, New York Attorney-General Andrew Cuomo launched a multibillion-dollar securities fraud lawsuit against UBS AG, alleging it was falsely selling and marketing auction-rate securities as safe. He further alleged that as the market for the securities began to collapse, the bank's top executives quickly sold $21-million of their personal holdings of auction-rate securities while continuing to market them.

"UBS is not alone in this scheme," Mr. Cuomo had told reporters. "There are other institutions which participated, but UBS is a major player."

His office has reportedly subpoenaed dozens of companies since beginning its investigation.

"I can confirm that RBC Capital Markets Corp., along with others, were subpoenaed back in April," Royal Bank spokeswoman Beja Rodeck said in an e-mail yesterday.

Veritas Investment Research analyst Ohad Lederer wrote in a note to clients this week: "We don't know how badly [RBC] will get stung by its involvement in the auction-rate securities market. The facts are few, we admit, but combined with a pinch of imagination and a dash of conjecture, it is not a stretch to see how the issue could adversely weigh on Royal's U.S. strategy and/or results."

The bank's inventory of auction-rate securities built up from a negligible balance to $3.7-billion in the weeks leading up to a decision in early February by a number of U.S. banks to withdraw their support for the market (which precipitated the collapse), Mr. Lederer noted. And RBC has already taken a $212-million writedown on its securities, and has disclosed that it is a "remarketing agent" for a program of $21.3-billion, of which $20.2-billion is student loans.

Mr. Lederer said he assumes elevated funding costs are to blame for most of Royal's writedown.

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Sun Life Q2 2008 Earnings

RBC Capital Markets, 1 August 2008

Core Q2/08 EPS of $0.91 compared to $0.96 a year-ago, our estimate of $1.01 and the consensus estimate of $1.00. Net income in the U.S. division was particularly weak, down 47% YoY and 27% sequentially. Net income was affected by a decline in equity markets, the unfavourable impact of interest rate movements and associated hedges, wider credit spreads and credit-related allowances on actuarial reserving requirements, and credit-related losses on asset sales.

We have lowered our 2008E EPS from $4.10 to $3.85 and our 2009E EPS from $4.60 to $4.35 to reflect the Q2/08 EPS shortfall versus our estimates, and some factors that we expect will continue to be a drag on earnings growth, including credit-related items and the impact of prior declines in equity markets.

We now expect a 2% decline in EPS in 2008, well below what the company has delivered in the past and below management's medium term objective of 10% annual EPS growth.

We maintain our Sector Perform rating, but have lowered our 12-month target price from $50 per share to $47 on the back of lower estimated earnings per share.

Sun Life's stock trades at 9.8x NTM EPS, versus 9.9-12.1x for its peers and a 7-year average of 12.3x. We expect lifecos to trade at higher multiples in the medium term, but trading multiples could remain below the 7-year average for some time given the potential negative impact of lower interest rates, deterioration in credit quality, and uncertain equity markets.

The stock looks cheap but it is difficult to see the catalyst for reversal against peers given that the causes of recent relative earnings disappointments remain in place (deteriorating U.S. credit quality and higher credit spreads have been particularly negative relative to the company's Canadian peers). Positively, Sun Life remains highly capitalized, has exposure to large asset management businesses, and has well-positioned domestic group and wealth management platforms.

We are relatively more positive on the stocks of Industrial Alliance and Manulife (IAG.TO, $34.32, rated Outperform, Average Risk; and MFC.TO, $37.72, rated Outperform, Average Risk).

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Financial Post, Jonathan Ratner, 1 August 2008

Sun Life Financial Inc.’s disappointing second quarter results produced a 6% sell-off in its shares on Thursday, and its gloomy U.S. macroeconomic outlook and decision to keep its dividend at 36¢ per share didn’t help much either. This ends a five-year streak of semi-annual payout hikes.

Analysts responded to the news by cutting their price targets and earnings forecasts on the insurer. Andre-Philippe Hardy moved to $47 per share from $50, along with reductions to his 2008 and 2009 earnings forecasts, noting that credit-related items and the impact of prior declines in equity markets will likely drag on future earnings.

“The stock looks cheap but it is difficult to see the catalyst for reversal against peers given that the causes of recent relative earnings disappointments remain in place,” he told clients.

However, Mr. Hardy also noted Sun Life’s high level of capital and exposure to a large asset management business as some of the positives.

Desjardins Securities analyst Michael Goldberg cut his target to $50 from $53.50 and noted that investors will be looking for similar negative credit factors in Manulife Financial Corp.’s results. However, he does not expect any material credit issues will show up in Manulife’s U.S. results, just as there were none apparent in Great-West Lifeco Inc.’s.

“A situation where Sun Life is seen to be the only one of the major Canadian-based lifecos hurt by U.S. credit issues will probably continue to hurt the relative performance of Sun Life’s shares going forward, at least in the near term,” Mr. Goldberg said in a research note.

He also cut his 2008 and 2009 earnings per share estimates, saying the reduction this year is due to macroeconomic factors that produce lower assets under management and fees.

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