Financial Services Focus

Transcription

1 Research Financial Services Focus AUGUST 16, 2013 Canadian banks 3Q FY13 earnings preview: Earnings growth set to continue; banks remain firmly in capital deployment mode; investors flow of funds remains the key driver of performance For most of the major banks, 3Q FY13 EPS is expected to be up modestly compared with 2Q FY13 as a rebound in capital markets offsets slowing mortgage and consumer loan growth. Canadian banks continue to return capital to shareholders, with increased dividends expected to be announced by BNS, RY and TD, each of which also repurchased 4m or more common shares in the quarter. Canadian banks continue to underperform North American lifecos and US banks on the back of an improving US economy. Our investment thesis remains predicated on the prospect of rising bond yields driving a flow of funds into equities in particular, equities with yield where there is visible dividend growth. Highlights In this issue of the Financial Services Focus, we look at the drivers that are expected to impact 3Q FY13 earnings results for the Canadian banks. We are also publishing our 3Q FY13 EPS estimates for the major Canadian banks. We expect modest EPS increases on a quarter over quarter basis at most of the banks, with notable declines expected at TD Bank and National Bank. At TD, the decline can be attributed to recent weather related claims and the strengthening of auto insurance claims reserves. The decline at National is due to an increase in the fair value of MAV notes recorded in 2Q FY13. In terms of operating metrics, we expect single digit increases in operating revenue to be offset by modestly higher operating expenses; however, we expect improving operating leverage. We also expect a modest downtick in loan quality in the quarter translating into single digit increases in non performing loan (NPL) formations and loan loss provisions. Valuation We are maintaining our FY13 and FY14 estimates for the banks, and our target prices remain unchanged. Relative yield remains our preferred method for long term bank valuation, and we look at both relative yield and P/E multiples in the short term. We continue to believe Canadian banks are inexpensive relative to historical valuations based on all valuation metrics. Our target prices are predicated on a multiple expansion of ~1 2x on FY14 EPS, along with modest earnings and dividend growth. We believe the main driver of this projected multiple expansion will be a shift of funds flowing from the bond market to the stock market, including bank stocks, as bond yields continue to rise and bond prices fall. Recommendation Our target prices for Canadian banks are ~10% higher than consensus due to our expectation of an expansion in P/E multiples. With elevated concerns of a housing slowdown in Canada, we continue to favour Bank of Nova Scotia (The) (Top Pick Average Risk, C$67.50 target), Toronto Dominion Bank (The) (Top Pick Average Risk, C$ target) and, to a lesser extent, Bank of Montreal (Buy Average Risk, C$71.00 target) as their geographic diversity provides exposure to markets growing at a faster pace than the Canadian economy. This report was prepared by an analyst(s) employed by Desjardins Capital Markets and who is (are) not registered as a research analyst(s) under FINRA rules. Please see disclosure section on pages for company specific disclosures, analyst certification and legal disclaimers. (416) michael.goldberg@vmd.desjardins.com (416) bradley.romain@vmd.desjardins.com 1

2 3Q FY13 Canadian bank earnings preview Canadian banks continued to be the performance laggards among North American financials in 3Q FY13 (period from May 1 July 31), with prices increasing a meagre 2.7%. This compares with astonishing increases from Canadian lifecos (up 15.7%), US banks (up 15.6%) and US lifecos (up 21.9%). Even the S&P 500 outperformed the Canadian banks as it climbed 5.5% in the three month period. The saving grace for Canadian banks was that they outperformed the S&P/TSX Composite, which increased by an anaemic 0.2%. In this issue of the Financial Services Focus, we look at the drivers that are expected to impact results for the Canadian banks in 3Q FY13. We are also publishing our 3Q FY13 EPS estimates for the major Canadian banks. Our target prices and ratings remain unchanged. Summary of ratings and target prices Price EPS (C$) P/E (x) P/B Yield Target (C$) Diff Bank Ticker (C$) 12 13E 14E 13E 14E (x) (%) Cons Desjardins (%) Rating 1 Bank of Montreal BMO Buy A Bank of Nova Scotia BNS Top Pick A CIBC CM Buy A Canadian Western Bank CWB Buy A Laurentian Bank LB Buy AA National Bank NA Buy A Royal Bank RY Buy A Toronto Dominion Bank TD Top Pick A Average A = Average Risk, AA = Above average Risk Source: Desjardins Capital Markets, S&P Capital IQ, company reports Earnings release dates and conference call information for 3Q FY13. The earnings reporting period for 3Q FY13 is condensed this quarter, with all banks reporting over a four day timeframe from August BMO is the first to report in the morning on August 27; Laurentian will be the last on the morning of August 30. Details of the calls are included in the table below. 3Q FY13 earnings release dates and conference call information Bank Reporting date Conference call details Bank of Montreal 27 Aug 13 1:30pm; or ; replay or , passcode Bank of Nova Scotia 27 Aug 13 2:30pm; or ; replay or , passcode # CIBC 29 Aug 13 8:30am; or , passcode #; replay or , passcode Canadian Western Bank 28 Aug 13 Aug 29, 2pm; or ; replay or , passcode # Laurentian Bank 30 Aug 13 2pm; or , passcode ; replay or , passcode National Bank 28 Aug 13 1:30pm; or , passcode #; replay or , passcode # Royal Bank 29 Aug 13 7:30am; or ; replay or , passcode Toronto Dominion Bank 29 Aug 13 3pm; or ; replay or , passcode # Our 3Q earnings expectations and annual forecasts for each of the banks are detailed in the following table. For TD, the table shows our estimates for both cash and accrual EPS. We prefer to use cash EPS Financial Services Focus 2

3 because TD s dividend policy (40 50% payout ratio) is based on its definition of adjusted earnings, which adjusts for the customary items of note, including amortization of intangibles, asymmetric hedges, and integration and restructuring charges. To derive cash EPS, the only item we adjust for is the amortization of intangibles. We believe cash EPS is a better indicator of core earnings for TD. 3Q FY13 EPS growth dynamics Chg (%) Growth (%) Year end Oct 31 (C$) 3Q13E 3Q13A 2Q13 3Q E 2014E Qoq Yoy 13E/12 14E/13E Bank of Montreal Bank of Nova Scotia CIBC Canadian Western Bank Laurentian Bank National Bank Royal Bank continuing ops TD Bank accrual TD Bank cash Includes C$0.56 net gains in 3Q FY12; 2 Includes C$0.90 net integration charges; 3 Includes C$0.61 gains on MAV conduits in 2Q FY13 and C$0.18 tax recovery in 3Q FY12; 4 Includes C$0.55 impact of weather related losses and auto insurance reserve strengthening in 3Q FY13 Consensus estimates for each of the banks are summarized below for 3Q FY13, FY13 and FY14. Consensus estimates (fully diluted accrual EPS) Year end Oct 31 (C$) 3Q13E 2013E 2014E Bank of Montreal Bank of Nova Scotia CIBC Canadian Western Bank Laurentian Bank National Bank Royal Bank TD Bank Consensus estimates as at August 15, Note that we forecast diluted cash EPS for TD; Bloomberg consensus shows accrual EPS Capital deployment adjusts focus in the quarter. Canadian banks remain in capital deployment mode as evidenced by share buyback activity in 3Q FY13. TD and National both renewed normal course issuer bids (NCIB) midway through the quarter. TD bolted out of the gate and repurchased 4.2m common shares within a few weeks; however, National held off and did not buy back any shares in the quarter. Financial Services Focus 3

4 Share repurchase information Bank Share type Repurchased in 3Q FY13 Avg cost in 3Q FY13 Repurchase value (C$m) Authorized under NCIB Purchased to 3Q FY13 NCIB expiration BMO Common 4,000, ,000,000 8,000, Jan 14 CM Common 8,100,000 8,100,000 6 Sep 13 CWB Preferred Series 3 28, ,120 32, Feb 14 LB 1 Preferred Series ,000,000 NA NA Common 3,248, Jun 14 RY Common 4,685, ,000,000 6,785, Oct 13 TD Common 4,200, ,000,000 4,200, Jun 14 1 LB preferred shares not repurchased under NCIB Source: Desjardins Capital Markets, SEDI Other capital actions included: Scotiabank announced the redemption of all issued and outstanding Scotiabank Trust Securities Series (Scotia BaTS II) on June 30. The issue was redeemed at its face value of C$750m. Royal Bank announced the redemption of all of its 5.00% subordinated debentures due June 6, The C$1b of debentures outstanding was redeemed at par plus accrued interest. Royal Bank also announced the redemption of all issued and outstanding 5.65% perpetual preferred Series AH shares. The 8.5m shares were redeemed for C$221m, or a price of C$26.00/share that consisted of C$25.00/share in original issue price and a C$1.00/share redemption premium. In 3Q FY13, while there were no announced M&A transactions involving Canadian banks, the most notable M&A highlight was the cancellation of a transaction announced more than 18 months ago. With respect to that transaction, Scotiabank withdrew its application to acquire a 19.99% stake in the Bank of Guangzhou. The acquisition was initially announced in September 2011 and was valued at ~C$720m. The bank mentioned it will continue to look for future opportunities to invest in China. Immediately following the quarter, National announced it would acquire TD s Institutional Services Business for C$250m in cash, subject to adjustment at closing. In conjunction with the acquisition, National announced it would put its common share buyback on hold for 4Q FY13 as it worked to digest the capital impact of this acquisition. This transaction should result in a meaningful gain for TD in 4Q FY13 (over C$200m). We have not included this ~C$0.20/share gain in our FY13 EPS forecast. Dividend growth to continue. For 2Q FY13, we had expected dividend increases from CIBC, Canadian Western, Laurentian and National. Three of the banks increased dividends as expected, namely CIBC (to C$0.96 from C$0.94), Canadian Western (to C$0.18 from C$0.17) and National (to C$0.87 from C$0.83). While Laurentian did announce a dividend increase (to C$0.50 from C$0.49), the increase was C$0.01 less than expected. With the banks in capital deployment mode, we continue to believe they will pay shareholders through consistent dividend growth. Through FY14, we continue to forecast annual dividend growth of ~5 6%; however, we note this is a conservative estimate. Based on the bank index dividend, the annualized dividend growth rate for Canadian banks has averaged ~8% since Despite dividend growth having varied from bank to bank, the banks with the strongest dividend growth have typically been the strongest performers. That observation is illustrated in the two charts below, which use October 1992 as a starting point. Financial Services Focus 4

5 Index of bank dividend growth (Oct 92 = 100%) 900% 700% 500% 300% 100% Index of bank stock prices 1200% 1000% 800% 600% 400% 200% 0% (Oct 92 = 100%) BMO BNS CM NA RY TD LB BMO BNS CM NA RY TD Source: Desjardins Capital Markets, TSX Source: Desjardins Capital Markets, TSX With current dividend yields of % and projected dividend growth of ~5 6% in FY13 and FY14, we believe Canadian bank stocks can generate total returns averaging 9 10% through FY14 without any expansion in P/E multiples. However, the potential returns built into our target prices are much higher because we believe that as bond yields increase and bond prices fall, Canadian bank stocks will be among the beneficiaries of a massive flow of funds out of bonds even if it starts as a trickle. This funds flow should in turn lead to an expansion in P/E multiples. Scotiabank and TD remain our Top Pick rated banks based on their diversified, low risk business platforms, which in our view can continue to deliver above average dividend growth. For the coming quarter, we are expecting an announcement of dividend increases from Scotiabank, Royal Bank and TD. Details of our expectations for announcements of dividend increases in 3Q FY13 and 4Q FY13 are included in the table below. Schedule of our expected dividend announcements Increase (C$) Year end Oct 31 (C$m) From To Announcement Payout objective (%) BMO Announced in 3Q FY Announced in 1Q FY Next: 4Q FY13 BNS Announced in 3Q FY Announced in 1Q FY Next: 3Q FY13 CM Announced in 3Q FY Announced in 2Q FY Next: 4Q FY13 CWB Announced in 4Q FY Announced in 2Q FY Next: 4Q FY13 LB Announced in 4Q FY Announced in 2Q FY Next: 4Q FY13 NA Announced in 4Q FY Announced in 2Q FY Next: 4Q FY13 RY Announced in 3Q FY Announced in 1Q FY Next: 3Q FY13 TD Announced in 3Q FY Announced in 1Q FY Next: 3Q FY13 Financial Services Focus 5

6 Bank dividend changes Year end Oct 31 BMO BNS CM CWB LB NA RY TD 2012 dividend (C$) E dividend (C$) E dividend (C$) E/12 increase (%) E/13E increase (%) payout (%) E payout (%) E payout (%) Source: Desjardins Capital Markets Leverage the latest concern for banks. On June 26, the Basel Committee on Banking Supervision issued a consultative document on leverage that clarified some definitions and proposed a 3% minimum leverage ratio for banks. On July 2, the Fed issued its final Basel III rules and on July 9, it set the minimum leverage ratio for the eight largest US bank holding companies at 5%, and at 6% for their bank operating subsidiaries. The message that we took away from our discussions with banks is that the regulator wants risk based capital to be their binding constraint, not leverage. There are two key points that we want to raise about leverage at this stage: 1. Leverage is increasing as a focus among constraints on banks under Basel III 2. OSFI has not yet set the guidelines or timing for implementation for Canadian banks with regard to leverage Leverage in the form of banks asset to capital multiple (ACM) increased as a result of the adoption of IFRS accounting, which brought securitized assets onto balance sheets. OSFI s recent ruling (please see our Express Pulse on Home Capital Group dated August 7, 2013, OSFI ruling enhances capital flexibility ) would permit lenders to derecognize securitized assets like CMHC insured mortgages by selling strips against prepayment risk on these loans, thereby providing leverage relief to lenders. Over time, regardless of the regulator s desire that risk based capital alone should be the binding constraint on banks, we expect banks will optimize their business mix to take into account all of the constraints arising from Basel III risk based capital, leverage and liquidity together an exercise in linear programming. To the extent that leverage becomes a constraint, the message we hear from banks is that their first approach to dealing with this constraint would be to reduce repo financing and exposure. We believe that the end result of this reduction would ultimately constrain banks capital markets activities. It could also have significant effects on the bond, money and repo markets, and increase the cost to borrowers of commitment fees on backup lines of credit. Defects in Ontario auto insurance market and wet weather to dent TD s earnings. On July 30, TD warned it expects to record a charge in 3Q FY13 related to recent severe weather related claims and to strengthen claim reserves (please see our Morning Pulse comment on July 31, 2013). The total expected charge is estimated to be C$565m before tax (C$418m after tax), or C$0.45/share on a diluted basis. TD is also expected to record a pre tax provision of up to C$125m (C$93m or C$0.10/share after tax) related to loan losses in real estate secured lending due to the flooding in Alberta. The costs reflect estimated claims for evacuation, and home and auto damage due to severe storms in southern Alberta on June 20 and in the Greater Toronto Area on July 8, with charges estimated at C$170m after reinsurance (C$125m or ~C$0.14/share after tax). With regard to auto insurance claims reserves, TD will take a provision of ~C$395m before tax (C$292m or C$0.32/share after tax) to strengthen reserves on bodily injury claims largely related to pre 2010 automobile reform. Financial Services Focus 6

7 Excluding these adjustments, our forecast for 3Q FY13 diluted accrual EPS for TD had been ~C$2.00, or ~C$2.05 on a cash basis. Therefore, this total impact of ~C$0.55/share is significant. These charges also resulted in a reduction in FY13 accrual EPS to C$7.10 (from C$7.65) and cash EPS to C$7.35 (from C$7.90) for TD. The announced charges and provisions are expected to have a modestly negative impact on TD s earnings over the medium term. Nevertheless, we believe TD s diverse earnings profile and strong P&C franchises on both sides of the border should help it rebound from insurance related weakness in 3Q FY13. TD is the only bank so far to have identified and quantified the impact of catastrophic weather. Recently, the Insurance Bureau of Canada described the Toronto storm as the most expensive natural disaster in Ontario s history an estimated C$850m of insured property damage. We expect Royal Bank and Canadian Western were also impacted by weather related insurance claims. The Bank of Montreal has confirmed that there should be no impact on its earnings. We are uncertain of the impact on other banks. Canadian bank valuations We continue to believe Canadian banks are inexpensive relative to historical valuations based on all valuation metrics. Our target prices are predicated on a multiple expansion on FY14 EPS of ~1 2x, along with modest earnings and dividend growth. We believe the main driver of this projected multiple expansion will be a shift of funds flowing from the bond market to the stock market, including into bank stocks, as bond yields continue to rise and bond prices fall. According to S&P Capital IQ, our target prices for the major banks remain ~10% higher than consensus targets. While our earnings forecasts are not materially different from consensus forecasts, the differences arise from expected P/E multiples. Relative yield remains our preferred method for long term bank valuation. In the short term, we look at both relative yield and P/E multiples. While bond yields plunged during the Great Recession, they have been trending higher over the past year and have climbed higher since early June 2013 on expectations of a reduction in quantitative easing by the US Federal Reserve. The relative yield has similarly contracted from its peak of 162% to 141% at the time of writing. The effect of this downward shift in relative yield is equivalent to an expansion in P/E multiples, which have risen from 10.6x at the end of 2Q FY13 to 11.3x currently; P/E multiples on estimated FY14 EPS have also risen from 10.0x at the end of 2Q FY13 to 10.4x at the current time. We continue to expect P/E multiples to move higher and relative yields to decline further based on banks earnings and dividend growth potential. Relative yield 1 180% 160% 140% 120% Undervalued 100% 80% 60% 40% Overvalued Interest equivalent yield as a percentage of long corporate bonds Financial Services Focus 7

8 As shown in the chart below, historically there has been a strong positive correlation (R 2 = 72.99%) between the TTM P/E multiple of the TSX bank stock index and the yield on long corporate bonds. With an estimated long corporate bond yield of 4.65% and a TTM P/E multiple of 11.2x, bank stocks continue to trade at low P/E multiples (relative to bond yields). This regression indicates that the TTM multiple could reasonably be 4 6x multiple points higher given the current level of corporate bond yields, or alternately that current prices are discounting earnings declines of 25 33% or long corporate bond yields that are bps higher. Either way, this measure supports our view that there is a lot of runway for multiple expansion even if bond yields go moderately higher, and that current bank valuations are very attractive. P/E ratios vs corporate bond yields P/E ratio (x) Now 2013E 2014E 4% 6% 8% 10% 12% 14% 16% 18% 20% Yield on long corporate bonds Source: Desjardins Capital Markets, PC BOND y = x R 2 = How did US banks perform in 2Q13? Trading comparison. 2Q13 trading revenue was off sharply for US banks, down 10 20% compared with 1Q13. Revenue from fixed income, currency and commodities was the primary reason for the decline, with JP Morgan down ~10%, Bank of America down ~22% and Citigroup down ~27%. Revenue from equity markets helped offset the decline, with quarter over quarter results that ranged from down ~3% to up ~14%. The underlying trend was generally positive. We are looking for flat numbers from Canadian banks as revenue from Canadian bank trading operations has typically been less volatile than for their peers south of the border. Investment banking comparison. Investment banking revenue in 2Q13 was modestly higher among US banks as prevailing low interest rates continued to stoke M&A activity and as the IPO market stayed out of the deep freeze. Investment banking revenue among Canadian banks is also a lot less volatile than at US banks. The Canadian IPO market showed further signs of life in 2Q13 as public offerings from BRP Inc., Choice Properties REIT and Information Services Corporation all came to the market. In terms of M&A, while both the Sobey s acquisition of Safeway Canada and Loblaw s acquisition of Shoppers Drug Mart were announced in the quarter, the impact of these transactions will likely not be reflected in revenue at Canadian banks until the transactions actually close. We forecast investment banking revenue will be flat at Canadian banks in 3Q FY13 compared with 2Q FY13. Credit quality comparison. Overall credit quality at US banks strengthened in 2Q13. In terms of net NPL formations, the US major banks showed continued improvement, and net formations have shown signs of stability over the past four consecutive quarters. Based on these results, we can expect a positive read through in the credit quality trend of the US operations of TD and BMO. Financial Services Focus 8

9 Since 2Q11, credit quality at US regional banks measured in terms of NPL formation rates has come down to levels similar to that of Canadian banks. Since that time, NPL formation rates at Canadian banks have tracked broadly in line with US regional banks. This is one of the reasons why Canadian banks can be viewed as similar to US super regional banks in the region north of the border. In 2Q FY13, Canadian banks experienced a modest uptick in NPL formations. For 3Q FY13, we expect a further uptick in NPL formations for Canadian banks to levels higher than that of US banks given the underlying concerns about slowing business conditions in Canada. Average net formations as a percentage of loans are expected to rise to 16bps in 3Q FY13; however, we acknowledge our estimates for loan quality may be conservative. NPL formations have averaged 12bps for Canadian banks over the past four years. US banks net formations as percentage of total loans 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13E Regionals + majors Regionals Major banks Canadian banks (+1 quarter) Major Canadian banks NPL formation rates NPL formations as % of avg loans 0.5% 0.4% 0.3% 0.2% 0.1% 0.0% 0.1% 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13E BMO CM BNS NA RY TD Operating metrics 3Q FY13 bank financials Year end Oct 31 (C$m) BMO BNS CM NA RY TD Total 6 Revenue composition Net interest excluding trading 1,960 2,858 1, ,032 3,814 13,895 Chg (yoy%) Chg (qoq%) Banking & other fees 1,220 1,530 1, ,630 1,712 8,607 Chg (yoy%) Chg (qoq%) Capital markets less var comp ,967 Chg (yoy%) Chg (qoq%) Total revenue (ex securities & strategic gains) 3,539 4,747 2,919 1,119 6,241 5,904 24,469 Chg (yoy%) Chg (qoq%) Operating expenses (ex unusuals) 2,020 2,400 1, ,026 3,156 12,744 Chg (yoy%) Chg (qoq%) Expense to revenue ratio (%) (Better) worse year over year (bps) (Better) worse quarter over quarter (bps) Operating profit 1,519 2,347 1, ,215 2,748 11,725 Chg (yoy%) Chg (qoq%) Financial Services Focus 9

10 For 3Q FY13, we expect operating profit at the major Canadian banks to increase 6% qoq and 7% yoy. Our forecasts for margin and loan growth remain subdued on the back of slowing business conditions in Canada. The bulk of the period over period changes within the sector is captured in the commentary below. Net interest revenue is expected to be up 4% qoq and 5% yoy, with growth at Scotiabank and TD leading the way. At Scotiabank, the acquisition of ING Direct is again expected to contribute to the bank s 11% yoy surge while the 3% qoq bump is in line with overall growth. TD is expected to show growth of 7% qoq and 8% yoy as the acquisition of the Target credit card portfolio begins to pay dividends. Revenue from trading operations is estimated to have increased 10% qoq and 10% yoy. On a quarterly comparison, trading revenue at Royal Bank is expected to rebound from a depressed 2Q FY13; on an annual comparison, both Bank of Montreal and Royal Bank had weak quarters in the prior year. Investment banking revenue is expected to be up 1% qoq and 9% yoy. While there are no significant differences compared with 2Q FY13, investment banking revenue at all banks are expected to be modestly higher compared with 3Q FY12 as the comparable period last year was weaker than usual. Overall, net capital markets revenue is expected to increase 11% qoq and 17% yoy despite modest increases in variable compensation (a contra item to brokerage, underwriting and trading revenue), which is expected to be up 1% qoq and 6% yoy. Overall operating revenue is expected to have increased 4% qoq and 8% yoy. The inclusion of ING at Scotiabank and the rebound in trading revenue at Royal Bank are expected to account for most of the increase. In terms of operating expenses, they are expected to have increased 3% qoq and 8% yoy. The increase at Scotiabank is again due to the inclusion of ING in its results. TD has already warned that its revenue will be adversely affected by weather related insurance losses and by significant reserve strengthening for Ontario auto insurance (details are in our Morning Pulse of July 31, 2013). Overall, the banks are expected to have increased operating profit by 6% qoq and 7% yoy. Credit quality Despite underlying concerns about slowing business conditions in Canada, we continue to take a conservative view to credit quality. In 2Q FY13, NPL formations at Canadian banks, with the exception of Bank of Montreal and Scotiabank, experienced a modest uptick, rising 15% qoq, which is less than the 34% qoq move that we had expected. For 3Q FY13, we expect NPL formations to again have risen but to still remain well within manageable levels for the banks. Overall, net NPL formations are expected to have climbed higher by 19% qoq and 6% yoy. Last quarter, we had expected modest increases in loan losses of 4% qoq and 3% yoy. The actual results did rise 4% qoq but were flat compared with the prior year. For the current quarter, we again expect modest increases in loan losses of 8% compared with 2Q FY13; however, we expect a modest decrease of 7% compared with the prior year. Financial Services Focus 10

11 NPL formations and provisions Net NPL formations Loss provisions Formations in excess of provision Year end Oct 31 (C$m) 3Q13E 2Q13 3Q12 Qoq (%) Yoy (%) 3Q13E 2Q13 3Q12 Qoq (%) Yoy (%) 3Q13E 2Q13 3Q12 Bank of Montreal Bank of Nova Scotia CIBC National Bank Royal Bank Toronto Dominion Bank Total 1,554 1,307 1, ,609 1,496 1, While concerns about a hard landing for housing in some Canadian markets persist, we continue to expect a soft landing. As in the US, job growth and house prices are closely related. In our view, job gains are a key driver of higher house prices, and persisting job losses are a necessary precondition for significant reductions in home prices. We recall that this was the case in the early 1980s and the early 1990s. The period in Canada also supports our view. Toronto employment % 10% 8% 6% 4% 2% (m) % 2% 4% 6% 8% % Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Employment (LHS) Year over year chg (RHS) Month over month chg (RHS) Jan 13 Source: Desjardins Capital Markets, Statistics Canada In the period from , there was a 4.5% peak to trough drop in jobs in Toronto. Those job losses, compounded by financial market illiquidity, produced a brief 11% peak to trough decline in house prices in Toronto. Both employment and house prices have since surged. However, as concerns about the pace of home price increases have risen, policy changes by CMHC have tightened the availability of mortgages. More importantly, as banks do not operate in a vacuum, their concerns have also led them to tighten the availability of financing. Recently, this tightening has translated into reduced housing starts and other development metrics. While these reductions have been attributed to more caution by developers, we believe it is important to remember that lenders control the financial spigot without their financing, no shovels go into the ground. Financial Services Focus 11

12 Comparative valuation: North American banks 52 wk Mkt Div/ EPS (C$) Earnings Div Price range (C$) cap sh Desjardins Consensus growth (%) P/E (x) BVPS P/B yield Bank (C$) Sym ($) Low High ($m) ($) 12 13E 14E 13E 14E 13E/12 14/13E 12 13E 14E ($) (x) (%) Bank of Montreal BMO , Bank of Nova Scotia BNS , CIBC CM , Canadian Western Bank CWB , Laurentian Bank LB , National Bank NA , Royal Bank RY , Toronto Dominion Bank TD , Weighted avg Cdn banks US comparables (US$) Bank of America BAC , Bank of New York BK , BB&T Corp BBT , Capital One COF , Citigroup C , Comerica CMA , Fifth Third Bancorp FITB , JP Morgan Chase JPM , Keycorp KEY , M&T Bank MTB , Northern Trust NTRS , PNC Financial Services PNC , Regions Financial RF , State Street STT , SunTrust Banks STI , US Bancorp USB , Wells Fargo WFC , Zions Bancorporation ZION , Weighted avg US banks Source: Desjardins Capital Markets, Bloomberg Financial Services Focus 12

13 DISCLOSURES Distribution of ratings Rating category Desjardins rating Desjardins coverage universe (# of stocks) % distribution Desjardins Investment Banking (# of stocks) % distribution Buy Top Pick/Buy Hold Hold Sell Sell Total COMPANY SPECIFIC DISCLOSURES Legend 1. Desjardins Capital Markets makes a market in the securities of the issuer. 2. Desjardins Capital Markets has performed investment banking services for the issuer in the past 12 months. 3. Desjardins Capital Markets has received compensation for investment banking services from the issuer within the past 12 months. 4. Desjardins Capital Markets has managed or co managed a public offering of securities for the issuer in the past 12 months. 5. Desjardins Capital Markets beneficially owned 1% or more of the common equity (including derivatives exercisable or convertible within 60 days) as of the month end preceding this report. 6a. The Desjardins Capital Markets research analyst(s) and/or associate(s) who covers the issuer discussed has a long position in its common equity securities. 6b. A member of the household of the Desjardins Capital Markets research analyst(s) and/or associate(s) who covers the issuer has a long position in its common equity securities. 7a. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have not been paid for by the issuer. 7b. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have been paid for partially by the issuer. 7c. The Desjardins Capital Markets research analyst(s) and/or associate(s) has viewed a material operation of the issuer, and the related travel expenses have been paid for fully by the issuer. 8. Desjardins Capital Markets has received compensation for non investment banking, non securities related services from the company in the past 12 months. 9. The issuer is a client for which a Desjardins Capital Markets company has performed non investment banking, nonsecurities related services in the past 12 months. 10. The issuer is (or was) a client of Desjardins Capital Markets or an affiliate within the Desjardins Group within the past 12 months and received non securities related services. 11. A partner, director or officer of Desjardins Capital Markets or any analyst(s) involved in the preparation of this publication has provided services (other than for investment advisory or trade execution purposes) to the issuer for remuneration within the past 12 months. 12. An officer or director of Desjardins Capital Markets, outside of the Equity Research Department, or a member of his/her household is an officer or director of the issuer or acts in an advisory capacity to the issuer. 13. The Desjardins Capital Markets research analyst(s) and/or associate(s) had communication with the issuer regarding the verification of factual material in this research publication. 14. The Desjardins Capital Markets research analyst(s) and/or associate(s) had communication with Investment Banking regarding the verification of material in this research publication. 15. A director or officer of the issuer (or any of its affiliates) serves on the board of the Desjardins Group. 16. The issue date for this research publication is within the restricted period for any recent IPO, secondary offering or lock up agreement between the issuer and Desjardins Capital Markets. 17. The Desjardins Capital Markets supervisory analyst serves as an officer, director or employee of the issuer or acts in an advisory capacity to the issuer. Disclosures for issuers discussed in this publication Bank of Montreal: 2, 3, 7a, 8, 9, 10 Laurentian Bank of Canada: 2, 3, 7a, 8, 9, 10 Bank of Nova Scotia (The): 2, 3, 4, 6a 6b, 7a National Bank of Canada: 2, 3, 4, 7a, 8, 9, 10 Canadian Imperial Bank Of Commerce: 7a, 8, 9, 10 Royal Bank of Canada: 2, 3, 4, 6a 6b, 7a, 8, 9, 10 Canadian Western Bank: 2, 3, 4, 7a, 8, 9, 10 Toronto Dominion Bank (The): 2, 3, 4, 6a 6b, 7a, 8, 9, 10 Price graphs: For full disclosure, please visit our website at securities.ca Full disclosures for research of all companies covered by Desjardins Capital Markets can be viewed at Disclosures/English.aspx or securities.ca/disclosures/francais.aspx 13

14 STOCK RATING SYSTEM Top Pick Buy Hold Sell Not Rated Desjardins best investment ideas Stocks that are expected Stocks that are expected Stocks that are expected Stock is being stocks that offer the best risk/reward to outperform their to perform in line with to underperform their covered exclusively ratio and that are expected to respective peer group* their respective peer respective peer group* on an informational significantly outperform their over a 12 month period group* over a 12 month over a 12 month period basis respective peer group* over a 12 period month period RISK QUALIFIERS Average Risk Above average Risk Speculative Risk represented by the stock is in line with its peer group* in terms of volatility, liquidity and earnings predictability Risk represented by the stock is greater than that of its peer group* in terms of volatility, liquidity and earnings predictability High degree of risk represented by the stock, marked by an exceptionally low level of predictability * Peer group refers to all of the companies that an analyst has under coverage and does not necessarily correspond to what would typically be considered an industry group. Where an analyst s coverage universe is such that relative performance against a peer group is not meaningful, the analyst will benchmark the rating against the most appropriate market index LEGAL DISCLAIMERS Desjardins Capital Markets TM is a trademark used by Desjardins Securities Inc., Desjardins Securities International Inc. and Caisse Centrale Desjardins, wholly owned subsidiaries of Mouvement des caisses Desjardins. Dissemination of Research Desjardins Capital Markets makes all reasonable effort to provide research simultaneously to all eligible clients. Research is available to our institutional clients via Bloomberg, FactSet, FirstCall Research Direct, Reuters and Thomson ONE. In addition, sales personnel distribute research to institutional clients via , fax and regular mail. Analyst Certification Each Desjardins Capital Markets research analyst named on the front page of this research publication, or at the beginning of any subsection hereof, hereby certifies that (i) the recommendations and opinions expressed herein accurately reflect such research analyst s personal views about the company and securities that are the subject of this publication and all other companies and securities mentioned in this publication that are covered by such research analyst, and (ii) no part of the research analyst s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by such research analyst in this publication. Additional Disclosures Desjardins Capital Markets equity research analysts are compensated from revenues generated by various Desjardins Capital Markets businesses, including Desjardins Capital Markets Investment Banking Department. Desjardins Capital Markets will, at any given time, have a long or short position or trade as principal in the securities discussed herein, related securities or options, futures, or other derivative instruments based thereon. The reader should not rely solely on this publication in evaluating whether or not to buy or sell the securities of the subject company. Desjardins Capital Markets expects to receive or will seek compensation for investment banking services within the next three months from all issuers covered by Desjardins Capital Markets Research. Legal Matters This publication is issued and approved for distribution in Canada by Desjardins Securities Inc., a member of the Investment Industry Regulatory Organization of Canada (IIROC) and a member of the Canadian Investor Protection Fund (CIPF). In the US, this publication is issued via the exemptive relief described in SEC Rule 15a 6, and through reliance on Desjardins Securities International Inc., a member of FINRA and SIPC. This publication is provided for informational purposes only, and does not constitute an offer or solicitation to buy or sell any securities discussed herein in any jurisdiction where such offer or solicitation would be prohibited. The securities mentioned in this publication may not be suitable for all types of investors; their prices, value and/or income they produce may fluctuate and/or be adversely affected by exchange rates. This publication does not take into account the investment objectives, financial situation or specific needs of any particular client of Desjardins Capital Markets. Before making an investment decision on the basis of any recommendation made in this publication, the recipient should consider whether such recommendation is appropriate, given the recipient s particular investment needs, objectives and financial circumstances. Desjardins Capital Markets suggests that, prior to acting on any of the recommendations herein, you contact one of our client advisors in your jurisdiction to discuss your particular circumstances. Since the levels and bases of taxation can change, any reference in this publication to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors. Past performance is not a guarantee of future results. This publication may contain statistical data cited from third party sources believed to be reliable, but Desjardins Capital Markets does not represent that any such third party statistical information is accurate or complete, and it should not be relied upon as such. All estimates, opinions and recommendations expressed herein constitute judgments as of the date of this publication and are subject to change without notice. US institutional customers: Desjardins Securities International Inc. (a wholly owned subsidiary of Desjardins Securities Inc.) accepts responsibility for the contents of this report subject to the terms and limitations set out above. Institutions receiving this report should effect transactions in securities in the report through Desjardins Securities International Inc., an institutional broker/dealer registered with FINRA and the US Securities and Exchange Commission. Although each company issuing this publication is a wholly owned subsidiary of Mouvement des caisses Desjardins, each is solely responsible for its contractual obligations and commitments, and any securities products offered or recommended to or purchased or sold in any client accounts (i) will not be insured by the Federal Deposit Insurance Corporation ( FDIC ), the Canada Deposit Insurance Corporation or other similar deposit insurance, (ii) will not be deposits or other obligations of Mouvement des caisses Desjardins, (iii) will not be endorsed or guaranteed by Mouvement des caisses Desjardins, and (iv) will be subject to investment risks, including possible loss of the principal invested. The Desjardins trademark is used under licence Desjardins Securities Inc. All rights reserved. Unauthorized use, distribution, duplication or disclosure without the prior written permission of Desjardins Securities is prohibited by law and may result in prosecution. OFFICES Montreal 1170 Peel Street Suite 300 Montreal, Quebec H3B 0A9 (514) Toronto 25 York Street Suite 1000 Toronto, Ontario M5J 2V5 (416) Calgary 110 9th Avenue SW Suite 410 Calgary, Alberta T2P 0T1 (877) Vancouver 401 West Georgia Street Suite 1060 Vancouver, British Columbia V6B 5A1 (604)