26 October 2009

Where Do Bank Stocks Go From Here?

  
Financial Post, John Greenwood, 26 Octber 2009

Like their peers around the world, Canadian banks got clobbered on stock markets as the financial crisis raged. But as the gloom cleared, their shares -- unlike those of many foreign banks that had the misfortune of owning toxic credit investments -- rocketed skyward, leading the way in one of the most spectacular stock market rallies in decades.

By early August, they had regained nearly all the ground lost since the storm broke in September 2008, collectively rising about 65% from the lows of March.

But for nearly three months since then, bank shares have mostly treaded water -- the sole exception Royal Bank of Canada, which peaked at the end of August instead of the beginning. As the broader Toronto market ploughed ahead, investors have been left wondering if that's all there is for the bank rally.

Brad Smith, an analyst at Blackmont Capital Inc., said he's not surprised.

"More than anything else, what you are seeing is a natural period of consolidation that you would expect to occur after a significant advance driven by improved earnings multiples going forward," said Mr. Smith. "So it's not surprising we are seeing this temporary lull."

Shares in Royal Bank last week closed at $53.39, down 59¢. Bank of Montreal ended at $52.03, down $1.01. Canadian Imperial Bank of Commerce was $1.09 lower at $64.36. Toronto-Dominion Bank was down 67¢ at $64.97, while Bank of Nova Scotia finished at $46.34, down 53¢.

Mr. Smith said the market is still trying to decide if the early optimism around the Canadian banks and their lack of exposure to subprime mortgages justifies the spectacular rise in shares, arguing that the upcoming forth-quarter earnings --due in early November -- will provide a lot of the answers.

One concern is that much of the good news that analysts are expecting has already been factored into the shares, so unless the results include some positive surprises, it could be bad news for investors.

"The banks are trading at roughly 13 times expected 2010 earnings but the reality is that, historically, the range is between eight and 15 times earnings, so we are much closer to peak multiple levels than troughs," said Mr. Smith.

Another issue that will likely affect the banks is proposed new regulations that have come out of Group of 20 nations discussions. In recent weeks, the focus has been on executive bonuses but the rules are expected to cover everything from how much capital banks are required to hold to the amount of leverage they can take on.

"These are the kinds of things that really do affect profitability," said an analyst who asked not to be identified. "No one knows [what the regulations will ultimately look like], so until you get some clarification you just have to hold your breath."

For its part, the federal government has argued that since banks in this country didn't get mixed up in the kind of toxic investments and reckless risk-taking that brought down so many of their global peers, Canadian regulations aren't in need of the kind of overhaul they're getting in the United States and Europe.

But critics say that unless Ottawa follows suit with its fellow G20 countries, it risks upsetting the global balance and becoming a magnet for foreign firms that want to sidestep the rules in their home jurisdictions.

"Capital markets is a global business," said Mr. Smith. "You can't have pockets of regulation that are different from the rest because all the capital will tilt into those jurisdictions."

Another explanation for why bank shares haven't moved is that investment dollars are being drawn toward more attractive sectors such as energy.

At a time when there is so much uncertainty over financial services, the logic around oil and gas is simple. Against the backdrop of an improving global economy, oil prices have been moving steadily higher over the past few months.

"At the end of the day, a guy pulling oil out of the ground [in today's economy] has less risk than a guy sitting on a bunch of loans."
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24 October 2009

TD Canada Trust Tests New Branch Format

  
The Toronto Star, Rita Trichur, 24 October 2009

Inside Toronto-Dominion Bank's corporate headquarters, its secret code name is "Bravo." But on the streets of Brampton, folks are calling it the "branch of the future."

Canada's second-largest bank has chosen this fast-growing GTA city as the testing ground for a daring new experiment that is set to revolutionize personal banking in this country.

Its new prototype branch, at 135 Father Tobin Rd., features an ultramodern design that could eventually become standard fare at all TD locations across Canada. The new "Bravo" branch resembles a cross between Starbucks and Ikea with plenty of high-tech banking gizmos.

Borrowing a page from those venerable retailers, TD's goal is to make its new branch a destination for consumers by giving them a trendy place to hang out with their family and friends.

Its open-concept layout includes marketing gimmicks like a lounge area with complimentary coffee-based beverages, a special kids' zone, a community room and a free coin counter that are also available to non-clients.

Executives are hoping that fresh approach to customer service will translate into more sales of financial products like mortgages, lines of credit and mutual funds. It is an unconventional business strategy made famous by Commerce Bancorp, the New Jersey-based bank that TD bought in 2007.

For the Canadian banking industry, however, the approach marks a dramatic shift from the late 1990s when banks were actively pushing consumers out of branches to lower-cost platforms like online, telephone banking and automatic teller machines.

Tim Hockey, president and chief executive officer of TD Canada Trust, says the new pilot branch is designed to take the "stress" out of branch banking for consumers.

"There was a concept that Starbucks used that I always thought was kind of interesting. And that is `the third place,'" Hockey said.

"And the concept there is you've got your home, you've got your work (but) everybody needs a third place. A place to go where, just like that old Cheers sitcom, `Everybody knows your name.'"

Old-fashioned relationship-building not only makes clients feel appreciated, but it also makes it easier for banks to sell them a wider range of products and services.

And while clients continue to use the Internet, telephone and ATM channels, nearly 85 per cent of TD Canada Trust's revenues "are still generated at the branch level," BMO Capital Markets analyst John Reucassel said in a report this week. He noted the "key" to TD's financial performance is its "focus on service and convenience."

TD's new pilot branch attempts to take customer service to the next level. There are state-of-the-art videophones that can be used to connect customers to live investment experts.

Clients can also use free computers to surf the web or relax in its lounge to catch up on their reading. The bank supplies a range of high-end magazines in addition to local community newspapers.

"You can just sit and have a coffee," said branch manager Nupi Dhillon, as she gestured to the free beverage machine. Children, meanwhile, are free to explore the adjacent kids' area that features an array of books, toys and a pint-sized computer.

In an effort to build stronger ties with the local community, both customers and non-customers alike are invited to use the branch's high-tech community room to hold meetings. The no-cost service is expected to be a hit with non-profit groups and small-business owners.

Other signature items include a document shredder and a free coin counter – an idea inspired by the Commerce's wildly popular Penny Arcade coin machine.

Commerce, established in 1973, based its business model on a stable of Burger King outlets also owned by its founder, Vernon Hill. Its banking strategy was based on a "Wow" culture that often included free treats for children and dogs.

TD has often mused about importing those ideas to Canada. It hopes its new branch experiment will succeed in generating priceless word-of-mouth advertising to attract new clients.

"Quite frankly, the average Canadian consumer doesn't feel all that warmly disposed to their average bank,'' Hockey said. ``So, we're trying to change that, one customer at a time."

Other banks also appear to be sharpening their focus on luring customers back to branches at a time when the recession has taken a bite out of their investment banking profits.

For instance, larger rival Royal Bank of Canada opened 25 new branches this year, while renovating and remodelling more than 100 others. Another 20 new branches are planned for 2010.

Canadian Imperial Bank of Commerce, Canada's fifth-largest bank, has accelerated its branch strategy. CIBC originally said it would open, expand or relocate 70 branches by 2011. It now plans to complete all 70 by the end of next year, with 41 of those branches ready by the end of 2009.

Christina Kramer, CIBC's executive vice-president of retail markets, said the bank has invested $280 million in its strategy. It is the biggest branch investment in CIBC's history.

"Clients do like coming into a branch to have a face-to-face discussion with an adviser," Kramer said. "It helps establish a relationship. It also helps us spend some quality time really understanding their personal goals and needs."

It is an industry about-face from the late 1990s when banks, especially those in concentrated markets, had an incentive "to lower branch-service quality" in order to steer consumers toward lower-cost online banking, suggests research from the Bank of Canada.

"Between 1998 and 2006, the top eight Canadian banks have on average reduced the number of retail branches they operate by 23 per cent, despite a 37 per cent increase in deposits," says the working paper authored by Jason Allen, Robert Clark and Jean-Francois Houde.

Customers, it seems, pushed back. While Canada is one of the "most developed" online banking markets in the world, banks are facing the stark reality that many older customers still prefer traditional teller service, according to ComScore Inc. That repudiation has helped make bricks-and-mortar branches all the rage again, proving the Internet has yet to render old-fashioned branch service obsolete.

"In the 1990s, everybody in the industry believed that branches – because the Internet was so hot – everybody believed that nobody would want to go in the branch anymore," Hockey said.

"Here we are 10 years later easily, and they're never more popular."
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19 October 2009

Preview of Life Insurance Cos Q3 2009 Earnings

  
Scotia Capital, 19 October 2009

Canadian Lifecos – Another Noisy Quarter – Economic Backdrop Improving – Valuations Remain Very Attractive

• Another quarter with a lot of moving parts. As was the case in Q2/09, we expect the continued rebound in equity markets in Q3/09 will be offset to some extent by reserve increases, primarily related to declining long-term corporate rates, but also due to increasing policy persistency on lapse-supported products. Some have pre-announced, suggesting in Q2/09 earrnings releases that, given the pronounced market volatility, Q3/09 results would be affected by prospective actuarial assumption changes. In particular, MFC suggested in its Q2/09 release that preliminary information suggested a change in lapse assumptions for variable annuity/segregated fund guarantee business may result in a Q3/09 charge not to exceed $500 million ($0.30 EPS). MFC also suggested that changes in assumptions for other factors, which could not be estimated at that time, could result in additional charges to earnings. Our best guess is these charges, which we estimate to be $0.62 EPS, will be interest rate driven, as long corporate bond yields continue to fall. SLF also “pre-announced” at Q2/09, suggesting the company expects to take a Q3/09 charge of $350 million to $450 million ($0.80-$0.98 EPS) as it updates its stochastic economic scenario generator in accordance with updated professional guidance – guidance which we can gather applies only to SLF’s stochastic methodology, all others using a deterministic approach to which the revised guidelines do not apply. We’re somewhat uncertain as to whether IAG, the most sensitive of all the lifecos to interest rate changes, will book a charge for lower bond yields, in particular as they relate to long-term Quebec bonds (which generally support actuarial liabilities). However, our guess is that IAG will not, since it generally reviews this assumption at Q4, and the yields on these bonds have started to climb since the end of Q3/09. GWO, the least sensitive to changes in equity markets and interest rates, will likely have the least amount of noise in its results. Finally, we expect the Q3/09 to be marked with credit hits (although not nearly as high as in previous quarters) as companies continue to increase default provisions as bonds are downgraded and credit conditions – at least in the eyes of the rating agencies (often the last to move) – remain uncertain.

• Focus will be on underlying earnings. For Q3/09, we expect this to be $0.49 for GWO, $0.60 for IAG, $0.50 for MFC, and $0.72 for SLF. We expect SLF to provide some sort of clarification as to what the underlying earnings are/will be going forward.

• Modestly trimming 2010 EPS estimates – largely due to currency. We reduced our 2010E EPS estimates by $0.05 for MFC and SLF and $0.04 for GWO, largely to reflect the impact of currency. In keeping with Scotia Economics’ recent move, we bumped our average Canadian dollar estimate for 2010 to US$0.98 (from US$0.96) and £0.59 (from £0.56), and are keeping it at ¥87.

• While it could be argued to wait on the group until we get a quarter with good earnings visibility that further reinforces that underlying earnings are not only achievable, but more importantly beatable, we think it’s better to be early. We know lifecos are complicated enough as it is, and noisy quarters make it worse. And while it can be argued we need to wait for good earnings visibility, one could argue it’s better to be early, especially given the fact that equity markets continue to climb, and, perhaps even more importantly, long-term interest rates are climbing, which is clearly a positive for the group. In the last two weeks, U.S. long-term corporate A and AA yields have increased 25 basis points (bp), Canadian long-term provincial bond yields have increased 16 bp, and Canadian and U.S. long-term treasury yields have increased 20 bp. There are signs of momentum in the group as well. While Canadian lifecos have underperformed the U.S. lifecos and the Canadian banks by 30% and 5%, respectively, in the last three months, they have outperformed in the last 30 days, bettering the U.S. lifecos by 2% and the Canadian banks by 6%. And finally, they’re still very attractive relative to these other financials. There’s still a significant discount between the Canadian Lifecos (10x 2010E EPS) and where they historically trade vis-à-vis the U.S. lifecos (Canadian lifecos currently at a 4% premium on a P/E basis, well below the average 13% premium) and the banks (Canadian lifecos are at a 20% discount, well below the 1% discount average).

Great-West Lifeco Inc.
1-Sector Outperform – $31 one-year target, based on 2.3x 9/30/10E BVPS and 12.2x 2010E EPS
• We’re looking for EPS of $0.43 for Q3/09, $0.05 below consensus, with underlying EPS of $0.49. Our 2010 EPS estimate is $2.30, $0.02 below consensus.
• Should be a relatively clean quarter – unlike the other lifecos. GWO is the least sensitive in the group to changes in equity markets and interest rates
• Still some minor credit hits (we estimate $0.09 in EPS), largely related to U.K. hybrids, but should be of less concern as market values of these securities continue to climb.
• Good sales momentum in Canada likely to continue.
• Putnam margins likely to remain under pressure, but net sales could be encouraging (expect them to be negative US$1B-$US1.5B, the best they've been since early 2008)

Industrial-Alliance Insurance and Financial Services Inc.
2-Sector Perform – $33 one-year target, based on 1.5x 9/30/10E BVPS and 10.3x 2010E EPS
• We’re looking for EPS of $0.61 in Q3/09, $0.05 below consensus, with underlying EPS of $0.60. Our 2010 EPS estimate is $3.00, $0.16 above consensus.
• No credit hits expected, primarily based on IAG’s “Canada only” asset portfolio.
• Expect no Q3/09 EPS hit from declining interest rates (IAG is the most sensitive by far) – but keeping a close eye particularly on long-term Quebec bond yields – which have declined 28 bp in Q3/09. The fact that these rates have climbed 18 bp since Sep 30 is encouraging, but if they remain flat through Dec 31/09 we'd expect a $0.30 EPS hit.
• Sales likely to remain weak but could be plateauing.

Manulife Financial Corporation
1-Sector Outperform – $28 one-year target, based on 1.7x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for EPS of $0.34 for Q3/09, $0.04 below consensus, with underlying EPS of $0.50. Our 2010E EPS estimate is $2.30, $0.11 above consensus.
• A noisy quarter. We expect an estimated $0.81 EPS gain from equity markets will be offset by $0.92 EPS charge due to actuarial reserve assumption adjustments, which include $0.30 EPS in pre-announced lapse rate assumption changes on VA business and an estimated $0.62 EPS in reserve assumption changes related to declining interest rates
• The recent rise in long term Corporate rates (Corporate A rates up 23 bp since Sep 30) is very positive for MFC.
• We expect to hear more about steps the company is taking to mitigate the sensitivity of the company’s capital to changes in equity markets. The new structure we believe will reduce MCCSR sensitivity such that a 10% drop in equity markets will reduce the MCCSR ratio by 13% (new structure) as opposed to 20% (old structure).
• Sales will likely remain mixed. Strong in Asia but weak in the U.S.

Sun Life Financial Inc.
2-Sector Perform – $37 one-year target, based on 1.3x 9/30/10E BVPS and 11.0x 2010E EPS
• We are looking for Q3/09 EPS loss of $0.06, $0.05 above consensus, with underlying EPS of $0.72. Our 2010E EPS estimate of $3.10 is in line with consensus.
• Another messy quarter – a lot of moving parts. We estimate a $0.90 EPS hit for reserve assumption changes related to new actuarial guidelines (affect SLF only), $0.06 EPS hit for declining interest rates, $0.25 EPS credit hits, offset by $0.36 EPS in equity market gains and $0.07 EPS gain from narrowing credit spreads.
• Company track record continues to make us a little nervous with respect to credit – we look for $0.25 EPS in credit-related hits.
• Looking for some “guidance” as to what is sustainable EPS.
• U.S. sales momentum likely to continue.
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08 October 2009

Canadian Banks Rebound From Crisis Ahead of Rivals

  
Bloomberg, Matt Walcoff and Sean B. Pasternak, 8 October 2009

For Canada’s banks, it’s almost as if the financial crisis never happened.

The Chart of the Day shows bank stocks in Canada’s Standard & Poor’s/TSX Composite Index have recouped almost all of their losses since Aug. 8, 2007, the day before credit markets began seizing up. The nine stocks in the bank index trade at 91 percent of their level on that day, rebounding from a six-year low on Feb. 23. That compares with 53 percent for the MSCI World Bank Index and 35 percent for the S&P 500 Banks Index.


“It’s easier to be comfortable in the banking sector in Canada, because while they all have different strategies, they are all relatively conservative,” said Todd Johnson, who helps manage C$125 million ($115 million) at BCV Asset Management in Winnipeg.

Canada has the soundest banking system of the 133 countries surveyed in the Global Competitiveness Report of the World Economic Forum, which runs the Davos meetings of world leaders. The U.S. ranks 108th. No Canadian bank has failed since the early 1990s, and none of Canada’s 21 domestic banks has asked for a government bailout.

Royal Bank of Canada, the country’s largest lender, surpassed its August 2007 stock price on Aug. 27, and last week reached the highest price since July 2007. National Bank of Canada, the nation’s sixth-biggest bank, only needs to rise 1.3 percent to reach its Aug. 8, 2007, level. National Bank has surged 88 percent in 2009, the most among lenders in the S&P/TSX and S&P 500.

Analysts are betting the surge isn’t over. Canadian bank stocks with at least five analyst recommendations have an average rating of 3.49, with 5 as the top ranking. The average U.S. bank stock has a rating of 3.22 and the average European bank is at 3.03, according to Bloomberg surveys.
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15 September 2009

Review of Banks' Q3 2009 Earnings

  
Scotia Capital, 15 September 2009

Earnings Stellar – Inflection Point – Outlook Improving

• Canadian banks reported stellar third quarter earnings, substantially better than Street estimates. This was the third straight quarter of beating estimates, but it was by far the largest beat. Based on the strength of third quarter earnings it appears that Q2/09 was the bottom for the cycle on an operating earnings basis, with Q1/08 the bottom of the cycle on a reported earnings basis, including all writedowns. The banks’ previous quarterly results (Q2) provided some optimism that earnings were near the cyclical bottom based on an improved outlook for the net interest margin, credit cost absorption, and sequential improvement in wealth management, which were all fully delivered in the third quarter with added strength from the continued high level of trading revenue.

• Thus, it appears the Canadian banks have weathered the banking siege in a strong fashion. The quarterly bottom in reported return on equity would be 10.5% in Q1/08 and 17.1% in Q2/09 on an operating basis. This reinforces the strength of the Canadian banking system and the banks’ business models.

• The most significant development this quarter, we believe, was the improvement in the net interest margin, which reversed an eight-year descent. The positive impacts of loan repricing, a steep yield curve, lower funding costs, and lowering of liquidity costs were instrumental in improving the banks’ NIM. This represents an important inflection point and bodes well for bank earnings going forward. The potential beginning of a trend of expanding bank net interest margins is not expected to be meaningfully interrupted in the event interest rates begin to rise, especially if they rise in a controlled and orderly fashion.

• Another potential positive inflection point this quarter was on credit, as gross impaired loan formations declined for the second consecutive quarter and loan loss provisions were flat with the previous quarter, suggesting loan losses may be peaking at the $10 billion annualized rate. Thus, we believe loan loss provisions should start to decline by the last half of 2010.

• The banks’ main earnings driver in the third quarter continued to be wholesale banking, with record results due mainly to the continued high level of trading revenue supported by very modest loan losses. Retail banking results were also solid in the quarter, although muted by relatively high retail loan losses, particularly in credit cards. Wealth management earnings rebounded sequentially and are expected to show strong momentum off the bottom.

• The banks reported a fully loaded return on equity after all writedowns and adjustments of 16.3%, with operating return on equity of 18.6% despite what we believe are near-peak loan losses.

• The market, we believe, has discounted bank earnings strength in the first two quarters of 2009, citing low quality due to high trading and securitization revenue. However, if we balance this out somewhat with the probability that a portion of the very strong trading revenue has a structural component and is not all cyclical, and that banks are arguably absorbing peak loan losses, weak wealth management earnings, and generally booking security losses in their available-for-sale securities portfolio, we conclude that earnings quality is only marginally lower. Also, we believe the actual income statement/net income impact of trading and securitization revenue (exhibits 15 and 16) is much lower than the market is generally factoring in. Thus, we conclude third quarter earnings were stellar with reasonable quality and that bank earnings are poised to rise.

Recommendation

• Bank stocks have increased 50% year-to-date 2009, substantially outperforming the TSX, which has increased 24%. Despite the share price performance, we believe valuations remain attractive on both a dividend yield and a P/E multiple basis.

• Dividend yields of 4.1% are compelling, especially with the prospects of dividend increases as early as the next several quarters and the particularly low yield on government bonds. The sustainability of bank dividends, scarcity of reliable yield, and the resumption of superior dividend growth are expected to be the catalysts for significantly higher bank share prices.

• Bank P/E multiples have rebounded to 12.3x trailing from the 6.0x low reached in late February. We estimate the valuation contagion overshoot was three to four multiple points. We believe fundamentals support higher valuation as the market refocuses on fundamentals and earnings power.

• We continue to expect bank P/E multiple expansion similar to that experienced post the 2002 cycle. We expect bank P/E multiples to expand to 14x trailing over the next 12 months and eventually reach 15x to 16x. Thus, with P/E multiple expansion and bank earnings bottoming, we believe this bodes well for continued strong share price gains over the next several years.

• In summary, we believe the positive earnings outlook that is unfolding and the continued high profitability will lead to dividend increases, complemented by low yields on treasuries, and will be supportive to continued expansion or recovery in bank P/E multiples. We do not expect meaningful share price resistance and consolidation until the bank P/E recovers to the 14x range, allowing for a further 28% ROR from the bank group.

• We continue to recommend an overweight position in bank stocks based on strong fundamentals and attractive valuation. In terms of stock selection, RY continues to be a standout given the strong reinvestment, competitive positioning in all its major business lines, and resulting industry-high profitability and capital.

• We have 1-Sector Outperform ratings on RY and BMO, with 2-Sector Perform ratings on BNS, CWB, LB, TD, and NA, and a 3-Sector Underperform rating on CM. Our order of preference is RY, BMO, BNS, CWB, LB, TD, NA, and CM.
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Financial Post, David Pett, 11 September 2009

Investors anxious for Canadian banks to start raising their dividends should not hold their breath, says Desjardins Securities analyst Michael Goldberg.

"The impact on operating profit of unsustainably high trading revenue and sustained pressure on loan loss provisions, we do not believe that earnings quality or quantity are yet sufficient to support dividend increases," he said in a note to clients.

Mr. Goldberg added that future dividend increases are dependent on the direction of capital regulation.

"If we assume that OSFI maintains its current minimum standards of 7% Tier 1 and 10% total capital and that the banks will want to maintain a comfortable margin of safety above that level (because the consequences of falling below it are so draconian), then this is another reason for banks not to increase their dividends and it may not even justify issuiing more common equity to strengthen that margin of safety," he wrote.
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TD Securities, 8 September 2009

• Q3/09 well through expectation. Exceptional trading results helped drive bottom-line numbers that were 21% better than expected on average. We are most encouraged by the credit trends which were broadly better than feared. Domestic P&C banking segments were also solid.

• Hard to see outsized returns. Outsized returns come on the back of outsized earnings growth or upward revaluation. We see limited prospects for either from current levels with the group seemingly already pricing in what we expect will be a relatively shallow earnings trough in 1H10.

• Introducing 2011 estimates. Our visibility is pretty limited that far out, particularly given what we view as heightened uncertainty around the macro outlook. Nonetheless, we are comfortable that credit costs will decline materially and that offers potentially significant bottom-line leverage for the group.

• Credit largely on pace. In most cases, the pace of deterioration appears to be easing and the outlooks are generally steady. We still expect conditions to deteriorate further (particularly on the commercial side), with losses ultimately peaking in 1H10. We still see credit topping out comfortably below the peaks of prior downturns.

• Staying with leverage to the recovery. We think Scotia and TD continue to offer the best leverage to a positive turn in economic growth. Both are trading at reasonable valuation in our view, but we see more potential for upward revaluation in TD (as ROE improves over time).

Executive Summary

Q3/09 results were largely better than expected, helped by exceptionally strong Trading/Wholesale results. These trends are likely to ease, but credit and core domestic P&C banking were also generally good. The stocks rebounded through results season, outperforming slightly. We are comfortable with how the fundamental story is unfolding. From here we still see valuation as the biggest constraint to outsized returns. We remain market weight.

Q3/09 results were largely better than expected with four out of the six Large-Cap Canadian Banks beating consensus estimate by an average of more than 21%. Through earnings week, the stocks were up roughly 4%, slightly outperforming the local index.

We made relatively minor changes on the quarter with no rating changes. We raised our estimates and Target Prices across Royal, National Bank and TD Bank. We reduced our estimates slightly at CIBC (target unchanged). Consensus estimates continue to rebound.

The composition of the results was still a bit questionable again this quarter, with strong trading results accounting for a large portion of the out-performance. Most management teams referred to the pace of trading results as unsustainable, noting that they are already seeing some softening.

Credit was also very encouraging. Most names reported inline or better than expected PCLs and most were still running below our assumed run rate for 2010 (we only increased our PCL estimates meaningfully in the case of CIBC). Furthermore, the underlying trends were generally encouraging with the pace of deterioration starting to slow. We also note that most banks appear to be well reserved.

We were also encouraged by the solid momentum evident in most P&C banking platforms, with particularly good volume growth which suggests good revenue momentum heading into 2010.

Overall we are comfortable with how the core fundamental story is unfolding. Domestic banking is enjoying a bit more momentum than we had expected, but we suspect some of the volume growth reflects the effect of lower rates and pent-up demand driving a bit of bounce in the housing/mortgage market. We expect trends to moderate in the coming quarters. Credit should also continue to deteriorate (particularly in commercial portfolios). However, the situation seems well in hand based on the underlying trends and management outlook. We expect credit costs to peak in 1H10, slightly above current run rates, and comfortably below prior peaks.

With this report we are rolling out our first look at 2011 estimates. It is still a ways off, but we have focused on what we expect will be the biggest single driver of what we believe will be an earnings recovery, and that is declining credit costs. As a result, we see 2011 EPS up in the order of 25-30% across the group. We remain market weight on the group. The biggest constraint to outsized returns in our view is valuations. The group is currently trading at 2.1x book value which is above the 15-year average of 1.8x book. In our view, a move toward peak valuations would require a more favorable environment than we currently expect (i.e. stronger economic growth and fewer risks). We see average returns on the order of 5-20%, including an average dividend yield of 4.4%.

In terms of stocks, our stance remains the same. We want to remain positioned with the best operating leverage to a recovering global economy. In our view Scotia and TD are the best ideas in this approach. Scotia suffered from some credit disappointment on the quarter with an uptick in GILs in the International commercial loan book. However, the issues appear to be quite concentrated (the rest of the book actually improved) and the related costs are likely manageable (the Q3/09 PCL run rate was still below our standing assumptions for 2010). Ultimately we believe Scotia will manage the credit downturn (likely better than feared) and will be well served by its favorable International positioning and corporate/commercial lending business.

TD saw a strong quarter with positive trading results helping to offset higher credit costs (but came in below expectations) and we see good upside in a recovery scenario. Credit trends remain well controlled and although we believe the bank will face greater pressure in the coming quarters, they will likely remain manageable in the context of the banks largely stable and sizeable Domestic Retail earnings base. In our view, the bank’s U.S. strategy will be key to the outlook of the stock and the integration of the U.S. platform is nearly complete. We believe TD will be able to generate greater value from its U.S. Retail franchise and offer potentially higher ROEs (and valuation multiple) in a recovery scenario.

CIBC remains the most interesting name to watch in our view. The quarter offered a new source of disappointment with surprising credit losses coming out of its leveraged loan book and deterioration in its U.S. commercial real estate business. However, the bank is exceptionally well capitalized with potential sizeable recoveries over the coming years with a large retail platform, although it is underperforming expectations under very tight risk management.
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01 September 2009

Scotiabank Q3 2009 Earnings

  
BMO Capital Markets, 1 September 2009

For the quarter ended July, the Canadian bank sector reported operating earnings that were roughly unchanged from a year ago, compared to Street expectations of a double-digit percent decline. Much better-than-expected trading revenues, and to a lesser extent smaller-than-expected loan loss provisions, keyed the upside surprise. We are adding to our bank holdings in order to keep our sector weight at market.

As our positions in the TD, RBC, BMO and National are relatively full, we have added a new and small position in Scotiabank. Scotiabank was recently upgraded to Market Perform from Underperform, with Ian de Verteuil raising his earnings per share forecast to $3.28 for fiscal 2009 and $3.20 for fiscal 2010. Scotiabank is the only Canadian bank with material operations in emerging markets. While this is a solid positive over the long run, it appears that the credit cycle is still ahead of us in those markets.
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TD Securities, 31 August 2009

Last Friday, the bank reported core cash FD-EPS of C$0.96 vs. TD Newcrest of C$0.82 and consensus at C$0.84.

Impact

Neutral. A good quarter, but it failed to meet the very high bar set by the group. Credit was the biggest concern with a sizeable PCL charge, although it was still below our 2010 run rate. In our view, management is being conservative, and credit issues appear fairly concentrated. Wholesale/Trading was a big help, but Domestic continues to impress. International should provide leverage in a recovery scenario. No change in estimates or Target Price. In our view, the stock offers decent upside on one of the best platforms in the group. Reiterate Buy.

Details

Domestic momentum continues. The bank turned in solid Domestic P&C/Wealth results. Good volume growth, cost control and reported margin improvement delivered some of the best bottom-line growth on the quarter and accounted for over 50% of earnings. Recent minor acquisitions are just starting to feed into the numbers and help the outlook. We see additional potential in Scotia’s interests in CI and Dundee Wealth over time. Credit still manageable. PCLs came in nearly C$145 million ahead of our estimate, but the underlying trends are less ominous; gross formations on over 85% of book were down sequentially. The commercial book in International was the exception and we continue to expect it to get worse over the coming quarters. However, management sees no indication of a looming credit spike and they continue to build reserves (with specific reserves above the group average).

Earning through downturn; good leverage to a recovery. Albeit helped by favorable trading, the bank earned through a large PCL expense. Eventually credit concerns will pass and as the world recovers, we expect the market to become increasingly attracted to the favorable International positioning of the platform in a growth world. This should help the stock sustain/improve its relative multiple.

Conference Call Highlights

Credit outlook. One the whole, the bank suggested that credit conditions have largely begun to stabilize across their Canadian Retail book, Domestic Commercial book and Scotia Capital. International (which has lagged the cycle relative to Canada and the U.S.) will likely see additional credit pressure in the near term with delinquencies either stable or up slightly across all products and regions. However, management does not expect to see another large increase in credit costs for 2010.

Guidance. Management was confident in saying they will likely meet their 2009 target objectives (which included ROE of 16%-20%, EPS growth of 7% to 12% and a productivity ratio of less than 58%) given their performance to date and further expects Q4/09 to post substantially better results than Q4/08. On a reported basis, management’s EPS growth objective implies FD-cash EPS for Q4/09 of approximately C$0.81 to C$0.96.

International. Management expects International growth to see some challenges near term primarily on back of rising credit costs, working through recent acquisitions and the impact of a stronger Canadian dollar. However, the bank has been aggressively reducing expenses in International and is meeting its targets.

Acquisitions. The bank remains watchful and patient for opportunistic acquisitions that are in-line with their current strategy. Management does not believe a large transformational acquisition is a high probability for the bank and likely prefers smaller ad-hoc deals.

Quarterly Highlights (year-on-year unless noted)

Domestic – another solid quarter. Assets +9% and revenues +7% and NI +8%. Margins improved sequentially as the bank continues to work itself out of some of its funding/margin pressures from earlier this year.

International – working through higher PCLs. On an adjusted basis NI was down slightly at -2.9% as PCLs rose +220%. Volume trends still look decent with average residential mortgages +8%, personal loans +12% and business loans & acceptances +14%.

Wholesale – an exceptional performance. Driven by strong trading numbers, NI was up 56%. Outlook. We have made no changes to our estimates or Target Price. Our estimates assume a run rate below the Q3 pace largely on elevated PCLs in 1H10 and lower Trading revenues.

Segments. We expect Domestic P&C to see further progress with continued investment and management focus by the bank (which has done several recent ad-hoc acquisitions in Wealth). Scotia Capital is likely to trend lower as the current level of trading revenues is unlikely sustainable. International will reflect a challenging environment largely on back of credit.

Credit. We expect the bank to face further credit pressure in 1H/10 largely on back of International, with some easing in the back half of the year.

Capital. The bank remains comfortably capitalized with a Tier 1 ratio of 10.4%.

Justification of Target Price

In determining our Target Price we establish a Fair Value P/BVPS multiple based on our expectations regarding long-term sustainable ROE, growth and COE. Our expectations currently stand at 17.5%, 4.5% and 10.0% respectively implying a Fair Value P/BVPS multiple on the order of 2.60x.

Key Risks to Target Price

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

In our view, management is being conservative, and credit issues appear fairly concentrated. Wholesale/Trading was a big help, but Domestic continues to impress. International should provide leverage in a recovery scenario. In our view, the stock offers decent upside on one of the best platforms in the group. Reiterate Buy.
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Globe and Mail, Tara Perkins, 29 August 2009

Rick Waugh is that rare breed of CEO with no desire to pull off a big deal.

Scoop up a major rival that's in distress and transform Bank of Nova Scotia into a much bigger player, or vault it into new markets? No thanks, not for him.

“I call it discipline,” he told analysts on a conference call yesterday.

It's a strategy that doesn't make the headlines, or a big impact on the bank's year-over-year profit growth, he acknowledged. But acquisitions are like a treadmill, and “I would rather take it a little slower on the treadmill.”

These days, the chief executive officer of Canada's most international bank is doing a lot of his walking at home.

When the subprime mortgage crisis began hammering the value of U.S. financial institutions, Mr. Waugh was one of the first executives to go shopping. He took a close look at Cleveland-based lender National City Corp. in early 2008. But he had trouble coming to terms with the unknowns on U.S. banks' balance sheets, and once the government started injecting equity into the banks, he lost his appetite to do a deal there.

So he focused on his top priority in Canada – building up a substantial wealth-management business. Compared to some other countries Scotiabank is in, where even basic financial products such as consumer loans are relatively new, opportunities for growth in Canada are few and far between. Having conquered the lending business here long ago, banks have been turning their sights to wealth management and insurance in an effort to retain control of baby boomers' retirement savings and cash in on them to the full extent possible.

With that in mind, Scotiabank has made a number of deals in recent years, including the acquisition of TradeFreedom Securities Inc., Dundee Corp.'s bank and a stake in its wealth-management operations, a chunk of CI Financial Corp., and all of E*Trade Canada. While each was notable, none were large enough to radically change the bank.

The acquisition spree petered out this year, and some opportunities went to its rivals. Just this month, Manulife Financial Corp. managed to scoop up AIC Ltd.'s mutual fund business for a song.

Chris Hodgson, the head of Scotiabank's Canadian operations, said it's true that good opportunities are still popping up in the wealth management space. But the bank is now “more than comfortable” that it can boost profits in the next few years with what it has already got.

Indeed, its acquisitions aren't contributing all that much to its earnings growth yet. And it is plowing additional money into people, technology and new products such as a flex-GIC (a guaranteed investment certificate that can be redeemed prior to maturity) to squeeze more growth from the business.

Importantly, it is also putting muscle into building a significant insurance business this year, and is now pitching a full lineup of home, auto and life insurance products. That's a significant new growth avenue for the bank, which lagged a couple of its rivals in this respect.

In the hunt for growth in the basic banking and deposit business – the most profitable and jealously guarded operations of the big banks – Mr. Waugh and Mr. Hodgson are looking to steal customers from the competition in the most Canadian way possible: by tugging on the heart strings of the country's hockey moms and dads. Scotiabank, now the official bank of the NHL, is calling itself “Canada's Hockey Bank,” making its support felt in rinks across the country, and has struck a deal with a hockey equipment chain to offer discounts to its customers.

It appears the bank's domestic strategy is paying off. Scotiabank said yesterday that it earned $500-million in Canada in its latest quarter, a new record, despite socking away $169-million for troubled loans. (In total, Scotia's profit was $931-million, down from $1.01-billion a year ago, on record revenue of $3.8-billion.)

In Canada, Scotiabank held $119.9-billion in mortgages, up from $112.3-billion a year ago. Personal loans rose 21 per cent to $35.8-billion.

Analysts are asking executives at the big banks what they intend to spend their excess capital on.

It's a good question, Mr. Waugh suggested. “The world is into a new norm. Repricing has taken place, so sellers' expectations and buyers' expectations may be starting to narrow in and that may create some opportunities.”

He has looked at some significant ones, and he'll continue to take a look at big deals in the future, he said.

But will he crank up the speed on his treadmill by actually following through on a major acquisition? “Never say never,” he said. “But I would put it at a low probability.”

• Company Performance

Like all the Canadian banks, Bank of Nova Scotia suffered a sharp decline in profits during the financial crisis. But it has rebounded in a big way. Key to its strong third-quarter result was a record quarterly profit of $500-million in its Canadian banking unit. Its international banking division, which includes large operations in Mexico and the Caribbean, hasn’t bounced back as swiftly.

• Stock Performance

After being crushed in the banking meltdown, Scotiabank shares have nearly doubled since late February, and closed at $46.40 yesterday – about $8 short of the all-time high. Some analysts wonder if they’ve gone too far, too fast. BMO Nesbitt Burns analyst Ian de Verteuil, pointing to growing credit problems in Scotiabank’s portfolio of international business loans, wrote: “The issue for investors is whether now is the right time to have exposure to emerging markets.” He has a $42 price target on the stock.

• Banking Sector

Canadian banks’ continue to expand their balance sheets, despite the recession. In fact, their assets are growing partly because of the recession. Competing lenders have disappeared and alternative sources of capital have dried up. One eyebrow-raising figure: Bank of Canada data show personal credit lines by chartered banks have increased 21 per cent in the past year
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29 August 2009

BMO's Bill Downe

  
Toronto Star, Rita Trichur, 28 August 2009



It doesn't take long to figure out what makes Bill Downe tick.

Minutes into a talk with him, the Bank of Montreal's president and chief executive officer pitches me on switching my mortgage to his bank. He tells his public relations chief to make a note of my renewal date. Midway through a talk with him, he brings it up again.

"In fact, I'm hoping after we've converted your mortgage, when you are standing on the soccer field and your little guy is playing, you might ask the person next to you: `Say, where do you bank? Are you happy?'" Downe said, sporting a rascally grin.

Downe takes a personal interest in customer relations and credits that type of old-fashioned service for turning around a bank that only two years ago was considered a laggard.

This is a story about how Canada's oldest bank got its groove back and the man who made it happen. After two tumultuous years, BMO is regaining its self-confidence. And at age 192, it finally knows what it wants to be when it grows up – a traditional bank.

Enter Downe, a man who shatters the stereotype of the stodgy Bay Street banker. For an interview this week, the 57-year-old makes himself at home in a cubicle in the branch at First Canadian Place. When a passing customer recognizes him, he quips that he's in his new office.

Reflecting on the past two years, he concedes BMO had its "fair share" of challenges. His saving grace was never promising shareholders a silver bullet. Instead, he devised a long-term plan to get back on track.

"Coming through a period like the one that we've just come through gives you an opportunity to not only test yourself but test your colleagues," he said. "And I think we've been extraordinarily successful in a demanding environment."

The accolades didn't always flow.

Rewind to early 2007, when BMO was still reeling from two botched merger attempts – one with Royal Bank of Canada in 1998 and the other with Bank of Nova Scotia in 2002. Some say it took too long for BMO's top management team to let go of the possibility of a big merger.

In the meantime, its mainstay personal and commercial business suffered from neglect. And while outgoing CEO Tony Comper began the overhaul, Downe was left to do the heavy lifting.

Problem is, from the day he took the reins in March 2007, Downe was doing damage control. His inauspicious start was marked by the bank's first earnings decline in six quarters.

By April, Downe was busy putting out a new fire after disclosing commodity-trading losses involving U.S. brokerage Optionable Inc. The scandal cost BMO $853 million.

The global credit crunch hit that summer. Suddenly, BMO's profitability was being tripped up by a slew of debt-related writedowns of $2.84 billion since 2007. BMO missed most of its annual targets for 2007 and 2008. As the economy soured, its stock price nose-dived, hitting a low of $24.05 in February 2009. That's a far cry from April 18, 2007, when it reached $72.75.

Earlier this year, its dividend yield topped 10 per cent, fuelling speculation of a potential cut.

With their shareholdings in the toilet, some investors chastised the bank in March for awarding Downe a 9 per cent raise, increasing his compensation to about $6.38 million in a year when BMO's profits fell by more than 7 per cent. About a week after announcing his pay packet, Downe voluntarily gave up some $4.1 million. Other bank CEOs made similar gestures amid the tough economic climate.

For much of that time, it seemed as if BMO's old French moniker of "Baie Maux," or "Bay of Pains," was starting to ring true again. Nonetheless, industry rivals credit Downe for maintaining a steady hand throughout the turmoil.

"I think Bill, to his credit, has just sort of put his head down and worked his way through issues," said Gordon Nixon, chief executive of Royal Bank.


Fast-forward to the present and even hardened BMO naysayers are applauding. Not only did its third-quarter profit climb nearly 7 per cent from last year, it set aside less money to cover bad loans.

During its May-to-July quarter, BMO's domestic retail bank recorded a 15 per cent increase in loans compared with the same period last year. It gained market share in both personal deposits and commercial banking.

It did so partly by staying focused on its customers during the recession, including a concerted effort to teach them how to save money and pay down debt. And as its rivals tightened credit for commercial clients, BMO signalled that it was open for business. It beefed up on commercial bankers and designated dedicated commercial districts in Toronto, Montreal and Vancouver.

"We tip our hats to BMO's management team, which has done an excellent job of generating much stronger (and higher quality) earnings than we had anticipated," John Aiken of Dundee Capital Markets wrote in a note to clients.

Ask Downe about his business strategy going forward and he circles back to good customer service. That includes warm welcomes and sincere "thank yous" – even from the top dog himself. Downe is known for calling irate customers and promoting BMO to complete strangers on the street.

"I came down Bay Street in a taxi last Wednesday and the cab driver dropped me off right here," he said. "And I asked him where he banked and he told me. And I asked him what it would take for us to have the opportunity to be his banker. And I tell ya what, he warmed right up and said he would think about it."

Two weeks before that, he gave the hard sell to a Chicago cab driver who was thinking about getting a mortgage with its Harris Bank. He didn't tell either about his position with the bank.

"There isn't anyone that I wouldn't approach. If the president of the bank across the street (Rick Waugh) came along, I'd ask him if we could have his business, too," he said gesturing at the Bank of Nova Scotia.

That's no put-on, say those who know him.

"I'd be surprised if he didn't ask you for business," remarked Bob Bissett, senior vice-president of commercial banking for the Greater Toronto Area.

While he likes to portray himself as a customer advocate, Downe has been accused of having a tin ear on one issue this past year. In March, the bank hiked interest rates on personal lines of credit by one percentage point at a time when the Bank of Canada was cutting interest rates.

BMO blamed the rate hike on "changing market realities" and increases in the cost of raising funds. Funding costs, however, have come down from crisis levels and customers are still smarting over the move.

That beef aside, Finance Minister Jim Flaherty says Canadians ought to take pride in Downe's contributions throughout the financial crisis. In particular, he notes Downe's vast knowledge of the U.S. banking system, acquired during postings with U.S.-based Security Pacific Bank and BMO in Los Angeles, Houston, Denver and Chicago.

"That's been quite helpful in terms of our discussions concerning what was happening in the United States during the height of the credit crisis and what actions we should take in Canada."

Still, Downe is not about to sit on his laurels. While he's optimistic about the outlook, he maintains an air of caution. "You have to remember that in the rear-view mirror, two years looks like just a moment," he said. "Going ahead 90 days seems like a very long time."
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28 August 2009

TD Bank Q3 2009 Earnings

  
Scotia Capital, 28 August 2009

Q3/09 - Strong Results - TD Securities Record Earnings - Upgrading to 2-Sector Perform

• Toronto-Dominion Bank (TD) third quarter operating earnings were strong, driven by record wholesale banking earnings, and record earnings at TDCT, partially offset by weak results from U.S. P&C with Wealth Management earnings down YOY but rebounding sequentially. Loan loss provisions were lower sequentially with slightly higher impaired loan formations particularly in the U.S. ROE was 14.3% with RRWA of 2.55%.

• TD's cash operating earnings increased 3% to $1.47 per share, well above our estimate of $1.20 per share and consensus due to record wholesale banking results driven by record trading revenues. Wholesale banking earnings tripled from a year earlier and almost doubled from the previous quarter with TDCT earnings increasing 5%. Reported earnings were $1.16 per share including restructuring charge, general reserve, and losses from hedges.

• We are increasing our 2009 and 2010 earnings estimates to $5.35 and $5.70 per share from $5.00 and $5.40 per share, respectively, due to strength in wholesale business although not sustainable at current level in our opinion. We are also increasing our share price target to $80 from $70 per share, representing 14.0x our 2010 earnings estimate.

• We are upgrading TD to 2-Sector Perform from 3-Sector Underperform due to less-than-expected deterioration in the U.S. business and improvement in the earnings power of its wholesale business, aided by the bank's high counterparty credit rating.

Items of Note

• Reported cash earnings were $1.16 per share including $43 million after-tax or $0.05 per share loss on economic hedge related to reclassified AFS debt securities, $70 million after-tax or $0.08 per share restructuring charge related to Commerce Bancorp, $75 million after-tax or $0.09 per share loss in fair value of CDS hedging the corporate loan book, $35 million after-tax or $0.04 per share charge from FDIC special assessment, and an increase in general allowance of $65 million or $46 million after-tax or $0.05 per share.

Canadian P&C Earnings Increase 5%

• Canadian P&C's solid performance was primarily driven by strong volume growth in personal and business deposits, and real estate secured lending. However, the bank indicated that volume growth is expected to slow down and LLPs are expected to continue to rise.

• Canadian P&C earnings increased 5% to $677 million from $644 million a year earlier.

• Retail net interest margin increased 2 basis points (bp) sequentially and declined 2 bp from a year earlier to 2.96%.

• Revenues increased by 8.2% year over year (YOY) to $2.5 billion, and expenses increased 3.6% to $1.2 billion.

• Card service revenue increased 13% YOY to $197 million.

• LLPs increased to $290 million from $286 million in Q2/09 and from $194 million a year earlier.

Total Wealth Management Earnings Decline 19%

• Wealth Management earnings, including the bank’s equity share of TD Ameritrade, declined 19% to $163 million.

Canadian Wealth Management Earnings Decline

• Domestic Wealth Management earnings declined 25% YOY to $95 million due to a significant decline in assets under management and administration, lower average fees earned, net interest margin compression, and lower margin loans.

• Operating leverage was negative 8.4%, with revenue declining 7.7% and expenses increasing 0.7%.

• Mutual fund revenue declined 19% to $183 million from a year earlier.

• Mutual fund assets under management (IFIC, includes PIC assets) declined 8.1% YOY to $56.2 billion.

TD Ameritrade – Earnings Decline 8%

• TD Ameritrade contributed $68 million or $0.08 per share to earnings in the quarter versus $48 million or $0.06 per share in the previous quarter and $74 million or $0.09 per share a year earlier. TD Ameritrade’s contribution represented 5% of total bank earnings.

U.S. P&C Earnings Decline 11%

• U.S. P&C earnings, which now include the contribution from Commerce Bancorp, declined to $242 million or $0.28 per share from $273 million a year earlier, representing 17% of total bank earnings. U.S. P&C earnings declined for the third straight quarter due to a higher Canadian dollar and higher credit losses. Gross impaired loans increased 9% sequentially to $961 million while net impaired loans increased 6% sequentially to $748 million.

• Loan loss provisions in the U.S. declined 9% QOQ to $183 million or 1.24% of loans versus $201 million in the previous quarter and $76 million a year earlier.

• Net interest margin declined 18 bp from the previous quarter and 52 bp from a year earlier to 3.40% due to lower interest rates and increased levels of impaired loans.

• The bank incurred a $55 million ($35 million after-tax or $0.04 per share) FDIC special assessment charge this quarter.

U.S. Platforms Combine to Represent 22% of Earnings

• U.S. P&C and TD Ameritrade contributed $310 million or $0.36 per share in the quarter, representing 22% of total bank earnings in the third quarter, down from a high of 29% in Q1/09.

Wholesale Banking Record Earnings

• Wholesale banking earnings continue to impress as strong customer activity, wider margins, higher liquidity, and normalized pricing in credit markets positively impacted interest rate, credit and FX trading, and capital market fee revenues.

• Wholesale banking earnings were very strong, increasing 89% sequentially to $327 million from $173 million the previous quarter, and up significantly from $102 million a year earlier.

Trading Revenue – Record

• Trading revenue remains very strong at $633 million versus $412 million in the previous quarter and $139 million a year earlier.

• Interest rate and credit trading revenue was very strong at $440 million versus a loss of $102 million a year earlier and a gain of $165 million in the previous quarter. Equity and other trading revenue declined to $39 million from $68 million a year earlier and from $93 million in the previous quarter. Foreign exchange trading revenue increased to $154 million from $77 million a year earlier and was flat from Q2/09.

Capital Markets Revenue

• Capital markets revenue was $389 million versus $374 million in the previous quarter and $365 million a year earlier.

Security Gains

• Security gains were a loss of $90 million or $0.07 per share versus a loss of $168 million or $0.13 per share in the previous quarter and a gain of $14 million or $0.01 per share a year earlier.

Unrealized Surplus – $177 million

• Unrealized surplus increased to $177 million from $75 million in the previous quarter and declined from $698 million a year earlier.

Securitization Revenue and Economic Impact

• Loan securitization revenue declined significantly in the quarter to $92 million from $184 million in the previous quarter, although up modestly from $77 million a year earlier.

• Securitization economic impact was a positive $48 million pre-tax or estimated $31 million after-tax or $0.04 per share, significantly lower than the previous quarter impact of $0.12 per share. Securitization activity is recorded in the Corporate segment.

Loan Loss Provisions

• Specific LLPs declined to $492 million or 0.80% of loans versus $546 million or 0.93% of loans the previous quarter, although they continue to run ahead of $288 million or 0.50% of loans a year earlier. However, excluding the currency impact, U.S. LLPs increased slightly to US$163 million from $161 million. Total LLPs were $557 million, which included a general allowance of $65 million ($46 million after tax or $0.05 per share).

• We are reducing our 2009 & 2010 LLP estimates to $2,030 million or 0.82% of loans and $2,100 million or 0.82% of loans from $2,100 million and $2,300 million, respectively.

Loan Formations Remain High

• Gross impaired loan formations increased to $969 million from $927 million in the previous quarter. U.S. gross impaired loan formations increased to US$387 million from US$288 million in the previous quarter. Net impaired loan formations declined to $603 million from $633 million in the previous quarter.

• Gross impaired loans increased to $1,947 million or 0.80% of loans from $1,875 million or 0.78% of loans in the previous quarter. Net impaired loans were negative $306 million.

Tier 1 Capital – Solid 11.2%

• Tier 1 ratio (Basel II) was 11.2% versus 10.9% in the previous quarter. Total capital ratio was 14.7% versus 14.1% in the previous quarter.

• Tangible common equity to risk-weighted assets (TCE/RWA) was 9.3% versus 9.0% in the previous quarter, while common equity to RWA was flat at 18.1% from the previous quarter.

• Book value increased 10% from a year earlier to $40.27.

• Risk-weighted assets increased 3% from a year earlier to $189.7 billion but declined 5% QOQ.
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RBC Q3 2009 Earnings

  
Scotia Capital, 28 August 2009

Earnings Estimate and Target Price

• We are increasing our 2009 and 2010 earnings estimate to $4.40 per share and $4.80 per share from $4.15 per share and $4.65 per share, respectively due to strength in its core earnings particularly in Capital Markets.

• We are increasing our 12-month share price target to $75 from $65, representing 17.0x our 2009 earnings estimate and 15.6 x our 2010 earnings estimate.

Third Quarter Results

• Canadian Banking earnings declined 5% to $671 million from a year earlier. Retail NIM declined 24 bp year over year and 7 bp sequentially to 2.71%. Insurance earnings were $167 million, an increase of 22%. Wealth Management earnings moderated declining 11% to $179 million but rebounded 30% sequentially. RBC Capital Markets increased 50% to $622 million (excluding writedowns) due to very strong trading revenue. International Banking recorded a loss of $43 million.

Canadian Banking Earnings Decline 5%

• Canadian Banking earnings declined 5% to $671 million from $710 million a year earlier due to a decline in retail net interest margin and higher loan loss provisions.

• Revenues in the Canadian Banking segment increased 1.6%, with non-interest expenses declining 1.4% from a year earlier, resulting in positive operating leverage of 3.0%.

• Loan loss provisions (LLPs) declined 3% to $340 million from $351 million in the previous quarter.

Canadian Retail NIM Declines 24 basis points

• Retail NIM declined 24 bp year over year (YOY) and 7 bp sequentially to 2.71%.

Insurance

• Insurance earnings were strong at $167 million versus $113 million in the previous quarter and $137 million a year earlier.

Wealth Management Earnings Decline 11%, Rebound Sequentially

• Wealth Management cash earnings declined 11% to $179 million from $201 million a year earlier due to large declines in AUM, but improved 29% sequentially from $139 million.

• Revenues were flat year over year with operating expenses increasing 2.5% for negative operating leverage of 2.5%.

• U.S. Wealth Management revenue improved 18%, with Canadian Wealth Management declining 15%, and Global Asset Management declining 13%.

• Mutual fund revenue declined 19% from a year earlier to $335 million. Mutual Fund assets (IFIC) declined 6.4% from a year earlier to $101.6 billion including PH&N.

International Banking Remains in Loss Position, LLPs Improve QOQ

• International Banking recorded a loss of $43 million versus a loss of $97 million in the previous quarter and net income of $37 million a year earlier. The loss position was driven by the continued high level of LLPs although down from the previous quarter. LLPs were $230 million in the quarter, down 20% from Q2 level of $289 million but up significantly from $137 million a year earlier. LLPs remained at an extremely high level of 2.80% of loans and are expected to remain high throughout the remainder of 2009 and into 2010.

• Net interest margin increased 16 bp from a year earlier, and 21 bp sequentially to 3.88%.

RBC Capital Markets Earnings Very Strong

• RBC Capital Markets earnings increased 50% (excluding writedowns) to $622 million, up from $415 million a year earlier due to very strong trading revenue.

Underlying Trading Revenue Very Strong at $1.5 Billion

• Trading revenue remains high at $1,476 million (excluding writedowns) versus $1,414 million in the previous quarter and $717 million a year earlier. The high trading revenue we believe is being driven by structural factors (U.K. and U.S. platforms) as well as cyclical.

• Trading revenue was extremely high in all products: interest rate, credit and equities, and foreign exchange.

Capital Markets Revenue

• Capital markets revenue was $636 million versus $568 million in the previous quarter and $588 million a year earlier.

• Securities brokerage commissions declined 2% to $337 million from $345 million a year earlier, with underwriting and other advisory fees at $299 million, increasing by 23%.

Security Losses Negligible

• AFS security loss was $57 million or $0.03 per share versus a loss of $0.03 per share in the previous quarter and nil per share a year earlier.

• Unrealized security surplus was a deficit of $629 million versus a deficit of $1,786 million in the previous quarter.

Securitization Net Income Declines

• Securitization net income impact declined to $47 million or $0.02 per share versus $354 million or $0.16 per share in the previous quarter.

Loan Loss Provisions Stabilize

• Specific loan loss provisions (LLPs) were $709 million or 0.99% of loans versus $751 million or 1.07% of loans in the previous quarter and $334 million or 0.47% of loans a year earlier. The bank recorded a $61 million general provision ($40 million or $0.03 per share) relating to U.S. banking. Total loan loss provisions were $770 million or 1.07% of loans.

• LLPs in Canadian Banking declined 3% sequentially to $340 million from $351 million. Credit card loss ratio increased to 4.67% from 4.37% in the previous quarter but remains substantially below CM at the 7.44% level. Specific LLPs in International Banking declined 20% QOQ to $230 million or 2.80% of loans from $289 million or 3.08% of loans.

• Our 2009 and 2010 LLP estimates are unchanged at $2,800 million or 0.99% of loans and $2,600 million or 0.88% of loans, respectively.

Loan Formations Decline

• Gross impaired loan formations declined to $1,229 million from $1,800 million in the previous quarter but increased from $753 million a year earlier. Gross impaired loans declined 1% quarter over quarter (QOQ) to $4,158 million or 1.46% of loans versus $4,217 million or 1.46% of loans in the previous quarter.

• Net impaired loan formations declined to $600 million from $1,467 million in the previous quarter. Net impaired loans declined to $1,246 million or 0.44% of loans from $1,341 million or 0.46% of loans.

Tier 1 Ratio Very Strong at 12.9%

• Tier 1 capital was very strong at 12.9% versus 11.4% in the previous quarter and 9.5% a year earlier due partially to a 9% sequential decline in risk-weighted assets mainly from currency impact.

• Risk-weighted assets declined 4% year over year to $243.0 billion. Market-at-risk assets were flat YOY and declined 12% QOQ to $17.6 billion.

• The common equity to risk-weighted assets (CE/RWA) ratio was 12.7% versus 11.2% in the previous quarter and 10.4% a year earlier.

Additional Disclosure on High-Risk Assets

• The bank provided additional disclosure on its exposure to U.S. sub-prime CDOs of ABS, RMBS, and U.S. insurance and pension solutions. The notional and fair value exposures to these areas as well as writedowns are detailed in Exhibit 2. We believe that RY has a good handle on exposure and that cumulative and potential writedowns are manageable.
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Financial Post, Jonathan Ratner, 27 August 2009

The relative strength of Royal Bank’s third quarter results should be repeatable in future quarters, according to Dundee Securities analyst John Aiken, who upgraded the stock to Neutral from Sell and boosted his price target from $40 to $54.

He told clients to expect the bank’s absolute and relative valuation multiples to increase coming out of the quarter, but continues to believe absolute valuations for the banks as a whole are too high. As a result, the analyst finds it difficult to rate any banks a Buy, although he is tempted to for some, like Royal, on a relative basis.

Mr. Aiken remains concerned about how rising unemployment in Canada and the United States will impact retail and corporate credit quality in the next year.

He does have one major complaint against Royal – the level of trading revenues, which came in at $1.6-billion for the quarter, or roughly 21% of all revenue.

“We continue to believe that Royal’s earnings quality is dampened by the significant level of revenues generated by its trading activities,” the analyst wrote. “However, RY’s trading revenues continue to be frustratingly less volatile than its peers, despite their absolute size.”

Mr. Aiken thinks the market will look beyond this and focus on the bank’s comment regarding the “decline in the pace of credit deterioration” in its U.S. portfolios.

While corporate loan quality improved marginally in the quarter, he noted that retail credit continues to deteriorate and will continue to be impacted by unemployment levels. However, the analyst pointed out that Royal’s balance sheet strength provides a significant cushion.
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The Globe and Mail, Tara Perkins, 27 August 2009

Canadian banks, bolstered by surprisingly strong demand for housing and robust trading businesses, are breaking profit records in the midst of a recession.

Royal Bank of Canada, National Bank of Canada and Toronto-Dominion Bank all reported earnings that topped analysts' expectations yesterday.

The first two actually managed to churn out higher profits than ever before despite the economic gloom.

“At the beginning of 2009 I would have found it hard to believe that by the third quarter I'd be talking about year-over-year increases in our earnings per share, even after issuing shares last year,” said Toronto-Dominion Bank chief executive officer Ed Clark. “But it certainly looks like we're going to be there.”

Serious questions remain about the sustainability of the banks' trading revenues, and the damage that rising unemployment levels will inflict on loans such as credit cards and corporate lines of credit.

But this quarter's earnings are the clearest evidence to date that the big banks are not only weathering the downturn but, in many ways, prospering without the aid of government equity and other forms of support that banks in other countries are receiving.One of the reasons for the sector's stellar performance is the surprising strength of the Canadian resale housing market.

It has been helping to keep both the economy and bank profits aloft, Mr. Clark suggested yesterday.

Mortgages are the largest component of the banks' personal and commercial loan portfolios.

TD held $52.1-billion of Canadian mortgages in the latest quarter and $53.5-billion in home equity lines of credit, up from $44.8-billion and $49.1-billion, respectively, in the prior quarter.

“The Canadian economy's come through I would say an almost surprisingly robust spring mortgage season across the country,” said David McKay, the head of Royal Bank's Canadian lending business. “I think as long as unemployment trends stabilize, and Canadians get back to work, you should see relatively strong growth.”

That's allowing the banks to wean themselves off the programs that the government did roll out.

At the height of the crisis last fall, Ottawa introduced a new program to buy mortgages from the banks in order to lower their funding costs and allow them to make more loans. That program is scheduled to end next month, and markets have improved to the point that Royal Bank, for one, had much less need for it in the latest quarter, said chief financial officer Janice Fukakusa.

The bank sold $18.3-billion worth of residential mortgages to that program and the Canada Mortgage Bond program in the first three quarters of the fiscal year, but only $2.3-billion of those were sold in the latest quarter.

The improved funding conditions should help further support bank profit margins in the coming quarters.

One area where the banks' earnings are potentially more precarious is trading revenues, which were a key profit driver for each of the three that reported yesterday. National Bank pulled in trading revenue of $164-million, well above its six-quarter average of $120-million, noted Credit Suisse analyst Jim Bantis. Royal Bank's trading revenues amounted to $1.6-billion, or nearly 21 per cent of its overall revenue, noted Dundee Securities analyst John Aiken.

The trading revenues stem partially from the high degree of volatility in the markets, and many analysts question whether the banks can maintain those levels. Mr. Clark himself suggested it's unlikely, telling investors to expect earnings from TD Securities, the bank's capital markets business, to be lower in the future.

Royal Bank CEO Gordon Nixon said that capital markets businesses tend to be the first to rebound coming out of a recession. Profits from wealth management and basic banking will take more time to improve to the same degree, he suggested.

However, both he and executives at TD also noted that with markets stabilizing, more financial institutions, particularly U.S. banks, are resuming their trading operations or kicking them up a notch, creating competition that could take some of the wind out of the Canadian banks' sails.

Mr. Nixon pointed out that Royal Bank earned $1-billion even without its investment banking and capital markets activities. “So I wouldn't characterize us as the Goldman Sachs of the north,” he said, referring to the U.S. bank that has long thrived off of trading activity.
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National Bank Q3 2009 Earnings

  
Scotia Capital, 28 August 2009

• National Bank (NA) operating earnings increased 17% to $1.79 per share, substantially above expectations. Operating ROE was 22.2% with RRWA of 1.99%. Reported earnings were $1.78 per share including a $1 million after-tax or $0.01 per share charge related to holding ABCP.

Implications

• NA third quarter earnings were extremely strong driven by record results from the Financial Markets segment, solid retail bank earnings, offset by weak Wealth Management Earnings. Earnings were also supported by very low loan loss provisions.

Recommendation

• We are increasing our 2009E and 2010E EPS to $6.35/share and $6.40/share from $5.55/share and $6.00/share, respectively, based on the strong wholesale platform and lower-than-expected credit losses. We are increasing our share price target to $75 from $70, representing 11.7x our 2010 earnings estimate.

• We upgraded NA to 2-Sector Perform intraday yesterday due to its stellar results, high credit quality, and record results from wholesale.
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27 August 2009

CIBC Q3 2009 Earnings

  
Scotia Capital, 27 August 2009

Q3/09 Earnings Weak, Higher Loan Losses, Revenue Challenged

• Canadian Imperial Bank of Commerce (CM) third quarter earnings were disappointing due to significant deterioration in credit quality and spike in loan losses that overshadowed the improvement in the net interest margin and strong capital ratio. In addition, the bank disclosed that it is facing a potential and substantial tax reassessment from 2005 related to the Enron settlement, once again reminding the market of the bank's legacy and propensity for risk and negative financial surprises. The high credit losses in the quarter and Enron reminder appears to have lowered the market confidence about the emergence of a "De-risked CIBC". We believe CM remains the most revenue challenged of the bank group. On the positive side, reported earnings appear to be stabilizing with the bank covering its common dividend for the first time in fiscal 2009 with a payout ratio of 84% (64% on operating).

• CM reported a decline in cash operating earnings of 18% to $1.36 per share below our estimate and consensus of $1.41 per share due to a spike in loan loss provisions and lower security gains. Higher-than-expected loan losses reduced earnings by $0.14 per share. However, quality of earnings improved due to significantly less reliance on security gains at $0.05 per share versus $0.32 per share last quarter.

• Specific LLPs spiked to $422 million or 1.01% of loans from $329 million or 0.83% of loans in the previous quarter and $203 million or 0.46% of loans a year earlier. Total LLPs were $547 million or1.31% of loans including a general provision of $42 million and $83 million of loan losses within the leveraged loan and other run-offs portfolio that the bank identified as an item of note.

• CIBC Retail Markets earnings continued to disappoint, declining 22% YOY due mainly to credit losses and decline in revenue, with CIBC World Markets earnings more than doubling from a year earlier and now representing 30% of operating earnings.

Items of Note

• Reported cash earnings were $1.04 per share, including items of note/charges totaling $0.32 per share (see Exhibit 1). Total charges included $155 million ($106 million after-tax or $0.27 per share) on mark-to-market losses on credit derivatives in CIBC's corporate loan hedging program, $95 million ($65 million after-tax or $0.17 per share) gain on structured credit run-off activities, $83 million ($56 million after-tax or $0.15 per share) loan losses within the leveraged loan and other run-off portfolios, $42 million ($29 million or $0.07 per share) general provision, and additional net recoveries of $3 million after-tax or nil per share.

Retail Markets Earnings Decline 22%

• Earnings at CIBC Retail Markets were disappointing at $431 million, a decline of 22% YOY due to a doubling of loan loss provisions and decline in revenue.

• Retail loan loss provisions increased 16% quarter over quarter (QOQ) and 89% YOY to $423 million. The major weakness in the portfolio was credit cards, with a loss ratio of 7.4%, a new Canadian record.

• Retail Markets revenue declined 1.3%, with non-interest expense declining 3.8%. Wealth Management revenue declined 19%, with FirstCaribbean revenue increasing 2%. Wealth Management and FirstCaribbean represented 14% and 7% of Retail Markets revenue, respectively.

• Deposit and payment fees improved 1% YOY to $199 million. Card fees were $80 million compared with $85 million in the previous quarter and $81 million a year earlier.

• Mutual fund revenue, which is contained in Wealth Management revenue, declined 20% from a year earlier to $166 million. Mutual fund assets (IFIC) declined 14% YOY to $43.0 billion. Investment management and custodian fees declined 20% from a year earlier to $103 million.

Canadian Retail NIM Improved

• Retail net interest margin (NIM) (loan balances restated) increased a significant 35 basis points (bp) sequentially and 2 bp from a year earlier to 2.80%.

CIBC World Markets

• CIBC World Markets earnings were $181 million, down from $222 million in the previous quarter but up from $77 million a year earlier.

• Corporate and investment banking revenue doubled to $221 million from $110 million a year earlier.

Underlying Trading Revenue Strong

• Trading revenue (excluding writedowns) was strong this quarter at $219 million versus $178 million in the previous quarter and $121 million a year earlier. Strong trading revenue was driven by fixed income with solid support from foreign exchange and equity.

Capital Markets Revenue

• Capital markets revenue was $254 million versus $218 million in the previous quarter and $202 million a year earlier.

• Underwriting and advisory fees were $132 million in the quarter versus $112 million in the previous quarter and $68 million a year earlier.

Security Gains Moderate

• AFS/FVO gains included in operating earnings moderated to $32 million or $0.05 per share from $186 million or $0.32 per share in the previous quarter, but were higher than the $1 million or nil per share a year earlier.

Unrealized Security Deficit

• The unrealized security deficit improved to $244 million at quarter-end versus a deficit of $720 million in the previous quarter and a surplus of $417 million a year earlier.

Corporate and Other Business Segment

• The corporate and other segment recorded a loss of $48 million versus a loss of $80 million in the previous quarter and a gain of $33 million a year earlier.

• Securitization revenue declined in Q3/09 to $113 million versus $137 million in the previous quarter and $161 million a year earlier. The bank calculated the net income statement impact at a loss of $31 million in Q3/09 versus a gain $25 million in Q2/09.

Loan Loss Provisions Spike

• Specific LLPs spiked to $422 million or 1.01% of loans from $329 million or 0.83% of loans in the previous quarter and $203 million or 0.46% of loans a year earlier. Total LLPs were $547 million or 1.31% of loans including a general provision of $42 million and $83 million of loan losses within the leveraged loan and other run-offs portfolio that the bank identified as an item of note.

• The increase in loan losses was due mainly to credit cards and personal lending, leveraged loans and other run-off portfolios, and U.S. real estate finance business. Credit card loss ratio hit a Canadian record at 7.4%.

• Retail LLPs were $423 million with CIBC World Markets LLPs at $46 million, with the corporate segment recording a $47 million recovery.

• We are increasing our 2009 LLP estimates to $1,400 million or 0.84% of loans from $1,300 million or 0.79% of loans. We are reducing our 2010 LLP estimate to $1,400 million or 0.81% of loans from $1,500 million or 0.88% of loans, respectively.

Impaired Loans Increase

• Gross impaired loans increased 32% to $1,668 million or 1.00% of loans in the quarter versus $1,263 million in the previous quarter and $889 million a year earlier. Gross impaired loans increased materially in the quarter in the business lines of publishing, printing & broadcasting, and real estate and construction.

• Net impaired loans were negative $312 million versus negative $505 million in the previous quarter and negative $595 million a year earlier.

Loan Formations Increase

• Gross impaired loan formations increased to $967 million this quarter from $541 million in the previous quarter and $328 million a year earlier. Net impaired loan formations also increased to $741 million from $407 million in the previous quarter and $206 million a year earlier.

Tier 1 Ratio 12.0%

• Tier 1 ratio increased to 12.0% from 11.5% in the previous quarter, due mainly to the 3% sequential decline in risk-weighted assets.

• The common equity to risk-weighted assets (CE/RWA) ratio was 9.2% compared with 8.9% in the previous quarter and 9.1% a year earlier.

• Total risk-weighted assets declined 3% sequentially and YOY to $115.4 billion, while market-at-risk assets declined 32% sequentially and 41% YOY to $1.7 billion.

• Book value was flat QOQ and declined 2% YOY to $27.87 per share.

Enron Settlement - Tax Reassessment?

• On August 5, 2009, Canada Revenue Agency (CRA) issued draft reassessments proposing to disallow the deduction of the 2005 Enron settlement payments of approximately $3 billion. CIBC is contesting. If entirely successful, CIBC would recognize an additional tax benefit of $214 million or $0.56 per share, plus interest. If entirely unsuccessful, CIBC would incur a tax expense of $826 million or $2.17 per share plus interest. If entirely unsuccessful this would result in a 70 bp reduction in Tier 1 Capital bringing CIBC's ratio down to 11.3%.

Recommendation

• We are trimming our 2009 earnings estimate to $5.90 per share from $6.00 per share due to higher-than-expected loan loss provisions in Q3/09. Our 2010 earnings estimate remains unchanged at $6.30 per share.

• Our 12-month share price target remains unchanged at $75, representing 12.7x our 2009 earnings estimate and 11.9x our 2010 earnings estimate.

• We maintain our 2-Sector Perform rating based on stabilizing earnings base and leverage to lower loan losses as the credit cycle turns, offset by weak revenue growth outlook and weaker operating platforms.
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Financial Post, John Greenwood, 26 August 2009

Four years after Canadian Imperial Bank of Commerce paid a record $3-billion settlement to disentangle itself from Enron litigation, the spectre of the failed U.S. energy trader has come back to haunt Canada's fifth-largest bank.

CIBC disclosed Wednesday that it is preparing to go to court with the Canada Revenue Agency to defend its position that the settlement is tax-deductible.

If the bank wins it will recognize a tax benefit of $214-million, but if the government prevails CIBC could end up having to pay $826-million.

"This is not a small amount to CIBC, representing roughly 8% of its book value," said Jim Bantis, an analyst at Credit Suisse.

The matter was disclosed in CIBC's third-quarter results.

Speaking on a conference call with analysts, Gerry McCaughey, chief executive, said CIBC has for some time been "anticipating reassessment would be probable" but went public after it became almost certain on Aug. 5 that the CRA would challenge the deduction.

CIBC reported net income for the third quarter of $434-million, or $1.02 a share, up from $71-million (11¢) last year.

At the same time, the bank made total loan loss provisions of $547-million in the quarter, more than double the comparable figure for last year and significantly higher than analysts expected.

The results came out a day after Bank of Montreal kicked off earnings season with earnings that were well ahead of analyst estimates.

Shares in CIBC declined 5.3%, ending the day at $65.01 after diving nearly 10% at the opening of trading on the Toronto Stock Exchange.

John Aiken, an analyst at Dundee Capital Markets, said he was "disappointed" by CIBC's rising loan loss provisions. "Based on BMO having almost everything going right, you start to believe that this is what to expect and that the [troubled economy] is not going to bite the banks but CIBC demonstrated a very different experience," he said.

Total revenue for the quarter was $2.86-billion, up from $1.9-billion a year ago. Canada's fifth largest bank had a Tier 1 ratio of 12% and declared a dividend of 87¢ for the current quarter.

Of Canada's major banks CIBC suffered the worst from the financial crisis, with about $10-billion of writedowns related to structured credit products over the past 18 months.

The quarter contained some good news on that front as there were no major writedowns.

In the three months ended July 31, CIBC did have $155-million of mark to market losses on credit derivatives due to narrowing spreads in the bank's loan hedging portfolio. This was partly offset by a $95-million gain on what the bank called structured credit runoff activities.

With worst of the red ink from credit derivitives mostly behind it, Mr. McCaughey said CIBC sees securitization as an opportunity. At its peak, the bank had about $17-billion of assets in its securitization trusts, which has since been run down to about $4-billion.

Bank officials said conditions in the market suggest demand for securitized products is re-emerging along with profit margins.

The results come a day after the Bank of Canada warned that the recovery in the Canadian economy could be derailed by a soaring loonie. The bank's deputy governor Timothy Lane said on Tuesday that the BOC may have to intervene to halt the rise.

Analysts said that of all the major banks CIBC is particularly sensitive to changes in economic conditions because of its high exposure to consumer credit cards. As a rule, consumers are much more likely to default on their credit cards than other forms of debt such as mortgages and car loans.

CIBC's retail markets business reported net income of $416-million, down 26% from last year because of deteriorating economic conditions and rising loan losses.

In wholesale banking, CIBC had a net profit of $86-million, compared with a loss of $541-million for the same period last year. The improved result was primarily due to gains in structured credit operations.

On the conference call, Mr. McCaughey said the bank is on the lookout for growth opportunities but declined to comment specifically on rumours earlier this month that the bank is looking to acquire a minority stake in an Irish bank.
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26 August 2009

BMO Q3 2009 Earnings

  
TD Securities, 26 August 2009

Looking for a C$1.00 run rate; modest ROE. There were a few gives/takes on the quarter (see Exhibit 5). We are increasingly reluctant to look through general reserves here (given we are in the midst of a credit downturn, and coverage ratios at BMO are thin). We see Q3/09 at C$0.95 and remain comfortable with our C$4.00 number for 2010. However, this still implies a relatively modest 12-13% ROE; a constraint to valuation in our view and management will have to find ways to rev-up earnings and/or deploy capital more aggressively.

Updating Apex. Quarter saw a small net charge of C$8 million. BMO has now hedged the first C$515 million of losses on their exposure under the funding facility (up to C$1.03 billion) and hedged their C$815 million in exposure to the medium term notes.

Updating Links/Parkland. As at Q3/09, the amounts drawn on the liquidity facilities increased to US$6.4 billion for Links and €622 million for Parkland relative to market values of US$5.6 billion and €598 million respectively (up slightly). Management continues to believe the capital notes offer sufficient first loss protection. No reserves have been taken at this point.

Quarterly Highlights (growth is year on year unless noted)

• Canadian P&C - A solid bottom-line.
NI was up 13% (adjusting prior periods for re-class of insurance to Wealth) on 8% revenue growth (+10% NII, +4% Other). Margins continue to drive the revenue story, improving 33bp over Q3/08 helped by improved funding, rate environment, loan mix and re-pricing.

Earning Assets in the segment were down slightly. In managed balances, personal loans grew a strong 15%, but mortgage balances were down nearly 2% (ongoing exit of broker network). Cards were +4% and Commercial loans were flat.

Commercial continues to be a strong revenue driver with 17% growth helped by re-pricing in the loan book, with Cards +11% while Personal was a modest +2%.

• U.S. P&C. Decent revenue growth at 10% (on back of improved loan spreads, deposit retention and gains on sale of mortgages) offset by higher credit costs. NI was down 11%.

• Wholesale. Driven mostly by strong trading numbers in interest rate products, NI was up 20%. The quarter also saw several capital markets related adjustments that largely offset.

• Wealth/Insurance. Adjusting for an income tax recovery, NI was down 22%. Top line growth was down 8% reflecting continued challenges in equity markets.

Operating Outlook. Our updated Q4/09 adds C$0.02 (primarily on slightly lower PCLs). 2010 remains unchanged at C$4.00. Key drivers in 2010 are a move to peak credit costs in 1H10 and some easing of Trading/Capital markets revenues while NIMs trend slightly higher from current levels. With above normal capital levels, ROE is likely to remain modest (12-13%). More aggressive volume growth/capital deployment offer potential upside to our forecast.

Segments. Canadian P&C appears positioned to deliver at a slightly higher pace. We assume modest uptick in Q4. The addition of Insurance (including a full quarter of the AIG acquisition) has lifted Wealth which should be helped by improving markets. Wholesale has room to ease following a very strong Trading quarter.

Credit. Encouraging trends as Gross Formations continue to ease. GILs declined with further write-offs and decent recoveries. However, the GILs/Loans ratio ticked up slightly and coverage ratios remain relatively thin. We remain concerned about U.S. Consumer Loans (US$16 billion, 10% of Total Loans) where delinquency ratios continued to climb and U.S. C&I/Commercial Real Estate (US$17.8 billion, 11%/US$4 billion, 2%) where we expect conditions to deteriorate over the coming quarters. We took down our Q4 PCL estimate slightly, but still expect credit costs to remain elevated.

Capital. The bank is over-capitalized, helped by lower RWA (including some favorable FX moves). Management expects ratios to decline as growth picks-up through 2010 and/or additional acquisition driven growth.

Justification of Target Price

In determining our Target Price we establish a Fair Value P/BVPS multiple based on our expectations regarding long-term sustainable ROE, growth and COE. Our expectations currently stand at 13.0%, 3.0% and 10.25% respectively implying a Fair Value P/BVPS multiple on the order of 1.55x.

Key Risks to Target Price

1) Additional losses or write-downs from key risk exposures 2) significant competition in the Chicagoland market and 3) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

Despite decent earnings, we still see relatively modest ROE (12-13%). At 1.7x book, the stock looks fully priced to us and we have made no changes to our 2010 estimates or Target. Maintain Hold.
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Scotia Capital, 26 August 2009

• BMO reported a 5% decline in cash operating earnings to $1.05 per share significantly above consensus of $0.95 per share but below our estimate of $1.16 per share due mainly to a loss from securitization.

Implications

• Underlying earnings were extremely strong at $1.18 per share adjusted for securitization losses, security losses, CDS hedge loss, mark-to-market loss on balance sheet hedge, FDIC special assessment, P&C Canada severance costs, CVA gains, a tax recovery in the Private Client Group and a restructuring charge reversal. We estimate the December 2008 equity issue diluted earnings this quarter by $0.07 per share.

• Reported cash earnings were $0.98 per share including a general allowance of $60 million ($39 million after-tax or $0.07 per share).

• Earnings were led by BMO Capital Markets with YOY growth of 16%, P&C Canada at 13%, with Private Client Group earnings declining 4% and P&C U.S. earnings declining 11%.

Recommendation

• Strong underlying earnings, absence of capital charges of note, stabilizing credit, improving net interest margin, and large capital position support higher valuation. We reiterate our 1-Sector Outperform rating.
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Financial Post, David Pett, 26 August 2009

Looking for quality not quantity, some analysts are expressing concern about Bank of Montreal's future profits in the wake of better-than-expected third quarter results that sent markets soaring on Tuesday.

"We believe earnings quality continues to be below average," said Brad Smith, Blackmont Capital analyst.

"In particular, we are concerned about the adequacy of credit allowances and the sustainability of reported net interest margins, which have benefited heavily from the steepening of the yield curve.

With BMO shares trading at valuations modestly higher than its peers, Mr. Smith thinks the market is not adequately discounting for the noted risks to BMO's future earnings, dividend growth and profitability.

"This leaves us little choice but to maintain our Sector Underperform investment rating and $43.00 per share target price."

Of the 16 analysts covering Bank of Montreal, five have Sell ratings, seven have Hold ratings and four analysts recommend the bank as a BUY.

Jim Bantis, Credit Suisse analyst, also reiterated his Underperform rating on the stock, but did raise his target price from $36 to $42 to reflect an increase in his 2010 earnings forecast.

"We note that despite this quarter’s record revenues ($2.98 billion) and low tax rate (16%), earnings momentum remains flat and profitability remains challenged (only a 12% ROE)," he told clients in a research note.

He said BMO's current valuation ignores reduced earnings power due to continued balance sheet de-leveraging, increasing credit losses from the bank’s US commercial mortgages and C&I loan portfolio, and unsustainable trading revenues.
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