Wednesday, December 03, 2008

Scotiabank Q4 2008 Earnings

RBC Capital Markets, 3 December 2008

Core cash EPS of $0.94 were in line with our estimate of $0.93 and the $0.94 reported in Q4/07.

• GAAP EPS of $0.28 were negatively impacted by write downs relating to certain trading activities and valuation adjustments which had largely been pre-released.

• Provisions for credit losses of $207 million were 118% ahead of Q4/07, and 25-30% ahead of our expectations and Q3/08. Formations of new impaired loans were in line with Q3/08 and did not witness acceleration in the quarter. However, we expect formations to increase in 2009.

• The Tier 1 ratio of 9.3% was down 0.5% sequentially, in line with our expectations.

Management is targeting a 2009 EPS range of $3.26-$3.42, which is well-below what street estimates were going into the quarter ($3.94 per share).

• We believe that the cautious earnings outlook is a reflection of rapidly deteriorating global economies, which has negative implications for banks, particularly loan losses.

• Our 2009 EPS estimate going into the quarter was $3.45, and we have lowered it by $0.20 to reflect higher expected loan losses. We believe that the street's estimates will have to come down by a larger amount.

Our Underperform rating on Scotiabank's stock has primarily reflected our view that the high valuation multiple leaves little room for disappointment.

• We believe that Scotiabank is not as well positioned to outperform its peers from an operating perspective in 2009 compared to 2008, because: (1) We believe that structured finance/off-balance sheet conduit issues are likely to cause lower writeoffs for the bank's peers than in 2008. (2) We expect the credit cycle to broaden to areas beyond U.S. residential real estate/U.S. consumer/U.S. residential construction lending, into areas where Scotiabank has more exposure such as traditional business lending in the U.S., Canada, Latin America and the Caribbean. (3) The economic environment in Latin America has deteriorated rapidly, which has negative implications in our mind for both earnings risk and the bank's multiple relative to peers. (4) Capital ratios are likely to decline to the low end of the Big 6 bank range after the close of the acquisition of a stake in CI Financial.
Dow Jones Newswire, 3 December 2008

Analysts applaud Bank of Nova Scotia for "creative" approach to raising capital by issuing equity to Sun Life Financial to fund stake in CI Financial Income Fund. But some say bank could still issue common equity to the public, if markets continue their move lower. Desjardins Securities says all Canadian banks will see decline in traditional sources of capital -- unrealized equity gains and surplus allowances -- amid a depressed earnings environment. Meanwhile, the bar for capital at banks has been raised, analyst says. Quality of capital also key, an issue to watch at Bank of Montreal and CIBC.
Ther Globe and Mail, Tara Pekins, 3 December 2008

Bank of Nova Scotia is changing the way it will pay for its $2.3-billion stake in mutual fund firm CI Financial Income Fund in order to boost its capital levels.

Scotiabank announced back in early October that it would be paying $2.3-billion in cash to insurer Sun Life Financial to pick up its 37-per-cent stake in CI Financial. On Wednesday, Scotiabank announced that it plans to close that deal next week, but it will only hand over $1.55-billion in cash. The remainder of the purchase price will be paid for with $500-million worth of common shares and $250-million in preferred shares.

By preserving cash, the bank will bolster its capital levels, keeping more of a financial cushion that buffers it from unforeseen events.

The move “enables us to keep some capital available for future initiatives,” said Scotiabank spokesman Frank Switzer.

“What the deal does is adds $750-million to Scotiabank's regulatory capital, improving the bank's ratios,” Dundee Capital Markets analyst John Aiken wrote in a note to clients. “This will alleviate some of the concerns surrounding the bank's capitalization that arose out of its quarterly earnings released yesterday and should remove on of the pressures on its valuation.”

Scotiabank announced a 67-per-cent drop in fourth-quarter profit Tuesday, after being hit by a $642-million after-tax writedown.

While Scotiabank might still issue preferred shares to continue to shore up its capital ratios, there is no longer a sense of immediacy, Mr. Aiken wrote.

National Bank Financial analyst Robert Sedran said Scotiabank's Tier 1 capital ratio, the key measure that regulator's watch, had been expected to dip to 8.8 per cent if the deal for the stake in CI had been all-cash. With the changes, Scotiabank's Tier 1 ratio will now be about 9.1 per cent, he said. Regulators require the ratio, which is a measure of a bank's capital against its assets weighted by the risk they pose, to stay above 7 per cent.

Scotiabank said it will issue $500-million in common shares to Sun Life at $34.60 per share, and $250-million in 6.25 per cent rate reset preferred shares.

The $34.60 equity price is almost 7 per cent higher to yesterday's closing price, Mr. Aiken noted.

Scotiabank is purchasing the stake in CI Financial, which is the country's No. 3 mutual fund company by assets under management, to bolster its Canadian wealth management operations, which are a key priority for the bank.
Dow Jones Newswires, 3 December 2008

Analysts now worrying about capital levels at Bank of Nova Scotia as credit conditions deteriorate. BMO Capital Markets notes BNS " has grown its risk-weighted assets quite aggressively in recent quarters" and ratios have declined. BMO says after buying CI Income Fund stake, BNS Tier 1 capital ratio will fall to 8.8% -- too low for investor comfort in these uncertain times. BMO suggests BNS could issue capital, likely innovative Tier 1 hybrids. If so, BNS follows Manulife Financial and Toronto-Dominion, which sold common equity, and RBC and Bank of Montreal, which issued preferreds. BMO says BNS could issue up to C$1.25B of hybrids.
Financial Post, Eoin Callan, 3 December 2008

Bank of Nova Scotia is pulling back on lending to consumers and warning investors to brace for softer earnings next year as the economy slides into recession.

The third-largest bank in the country provided the clearest signal yet of any major Canadian financial institution that it is reining in offers of loans to customers for big-ticket items like homes.

Rick Waugh, chief executive, said the bank was becoming increasingly cautious amid profound economic uncertainty and worsening credit conditions.

Senior executives said the bank had stopped competing with Bay Street rivals to increase the bank's share of mortgages issued to Canadians.

"We lost a little bit of market share, and we've done that consciously," said Chris Hodgson, head of Canadian banking.

The disclosures indicate the bank has made a major strategic decision that separates it from Toronto-Dominion Bank. In particular, chief executive Ed Clark has promised investors he will dramatically increase the bank's share of the retail market.

The retreat by Scotia could leave the field open for TD and BMO to compete most aggressively to offer Canadians new loans, if RBC and CIBC follow Scotia's lead and ease back next year.

Rob Pitfield, the head of international banking at Scotia, said managers were also becoming "very circumspect" in providing consumer loans in Latin America and had "taken alot of action to tighten up."

In some respects, Scotia's executive team is putting into words what many bank executives around the world have been reluctant to say publicly, for fear of drawing political ire at a time when policymakers are encouraging financial institutions to ease the supply of credit.

The chief executive said interference from politicians was emerging as a major headache for international banks that had been compelled to turn to their governments for capital injections amid one of the worst financial crises of the century.

"I don't think government capital comes cheap," said Mr. Waugh, citing pressure on banks to make more loans to mitigate the impact of a recession.

"Politically, it comes with a true cost," he added, saying some foreign banks had been forced by governments to take capital they "didn't want" to guard against potential future losses.

Yet despite the warnings about the after-effects of state interventions, Scotia appears likely to be a beneficiary of moves by the Federal Reserve and United States Treasury to supply extra liqudity to the auto finance industry.

Scotia has more than $20-billion in exposures to the auto finance industry, mainly in the form of loans to consumers to buy cars and to auto dealers to keep their lots filled with vehicles.

The bank has extended about $5.2-billion in loans to consumers, parts manufacturers and dealers, plus exposures of $7.8-billion in off-balance sheet vehicles and another $7.8-billion in an on-balance sheet portfolios made up of securitized credit.

The exposures are a source of "concern" but have so far been managed without unexpected losses, said Peter Routledge, a senior credit officer at Moody's, the ratings agency. "If we have a normal turn in the credit cycle tied to a recessionary period, then that would suggest they would not have difficulties managing credit losses. If it is an unusually bad cycle and credit losses are much higher, than conceivably it might put some negative pressure on the [credit] rating," said Mr. Routledge.

Brian Porter, Scotia's chief risk officer and a rising force within the bank, said the next year "is going to be a focus on credit, credit and credit."

But he said while there would be a rise in loan losses across the board, he did not anticipate any nasty surprises.

The chief executive said Scotia would not raise capital by issuing common equity, but had ample scope to take advantage of new looser capital rules by selling preferred shares.

Analysts said they expected the bank to act soon to pad its capital base in this way, as its reserves appeared set to dip below the level of 9% of risk-weighted assets, a trigger for other institutions to raise cash.

Scotia Tuesday said profit fell 66% due to a worse-than-expected charge of $642-million incurred amid turbulent markets. The bank said net income for the quarter ended Oct. 31 was $315-million (28 cents) compared with $954-million (95 cents) in the year-earlier quarter.
The Globe and Mail, Steve Ladurantaye, 3 December 2008

Bank of Nova Scotia shares were hit hard yesterday after the bank reported a 67-per-cent drop in fourth-quarter profit, with bad investments leading to a $642-million after-tax writedown.

"Clearly, 2008 was a difficult year, particularly with the writedowns we took in the fourth quarter," chief executive officer Rick Waugh said. "While Canadian banks have fared better than their counterparts in other parts of the world, none of us have been immune to the forces buffeting global markets."

The company's shares fell 7 per cent as analysts warned that the bank faces more difficulties, despite its relatively upbeat forecast and a prediction that it could increase earnings per share by up to 12 per cent in 2009.

"Surprisingly, BNS did provide targets for 2009, but we are taking them with a grain of salt, given that we see much more volatility in and less visibility for earnings in the upcoming year," said Dundee Securities Corp. analyst John Aiken, who reiterated his "sell" rating on the shares in a note to clients.

Profit was $315-million or 28 cents a share, compared with $954-million or 95 cents in the same quarter last year. Total revenue fell to $2.49-billion from $3.08-billion.

The $642-million writedown was 7.9 per cent higher than the $595-million charge the bank warned investors to expect when it prereleased earnings in late November. Without the writedown, Canada's third-largest bank said it would have earned 93 cents a share.

The bank's Scotia Capital division took the biggest hit in the fourth quarter, with profit down 80 per cent to $44-million from $229-million. International banking revenue was off 15 per cent, with profit at $227-million, down from $359-million a year ago.

However, the Canadian banking division saw profit increase by 6 per cent, helped by the acquisitions of Dundee Bank, Travelers Leasing, TradeFreedom and E*Trade Canada. Profit was $466-million in the division, up from $439-million last year.

"In 2009, we will be emphasizing two of our traditional strengths as key additional priorities: risk management and expense control," Mr. Waugh said. "These priorities will be key success factors in the current environment."

Calling the bank's performance "remarkably good despite charges on certain structured credit instruments, settlement losses on the Lehman Brothers bankruptcy and generally weak capital markets," Mr. Waugh said the bank's 49-cent quarterly dividend will remain unchanged.

With the bank's shares closing at $32.38 on the Toronto Stock Exchange yesterday, they yield 6 per cent.

"Our dividend remains well supported by both our earnings and high capital levels, which remain strong by global standards," Mr. Waugh said.

Provisions in the quarter for credit losses of $207-million were 118 per cent higher than a year ago, reflecting the problems facing consumers and business as the economy has worsened.

"Management expects loan losses to be higher in 2009 but within risk tolerances," RBC Dominion Securities Inc. analyst André-Philippe Hardy wrote in a note. "Slowing economies and lower recoveries are likely to drive loan losses higher."

For the full year, the bank said it took $822-million in writedowns. Profit fell 22.5 per cent to $3.14-billion or $3.05 a share from $4.05-billion or $4.01 a share.

"The financial sector and the global economy will likely continue to experience significant uncertainty in 2009," Mr. Waugh said.

"However, Scotiabank's diversity - by business line, by product and by geography, including our presence in higher-growth emerging markets - leads us to anticipate moderate overall growth for the bank in 2009."
Dow Jones Newswires, 2 December 2008

Turns out Bank of Nova Scotia is less bullish on 2009 than it first seemed. Some observers thought BNS was being aggressive with its outlook of 7%-12% earnings growth for a year in which North American economy's likely to sink. But CEO clarifies that growth rate based on reported EPS -- which includes C$822M in after-tax charges. That means F2009 EPS will be closer to C$3.35/share than the current C$3.94 mean estimate.

John Aiken at Dundee Securities is taking Bank of Nova Scotia's 2009 forecast with a "grain of salt." He sees "much more volatility in and less visibility for earnings" next year than BNS appears to. Key worry is credit quality weakening faster than expected, a theme also seen with Bank of Montreal. But BMO gave no 2009 guidance, citing uncertain outlook for markets. BNS also surprised with write-downs C$50M higher than when bank warned a few weeks back. That news seems to offset strong performance in domestic and investment banking units.