Bank of Nova Scotia (BNS) 2002 Q3 法說會逐字稿

Good afternoon. Welcome to the presentation of Scotiabank Third quarter results. I'm Sarabjit Marwah, chief financial officer. (inaudible) Bob Chisholm, vice chairman, (inaudible) vice chairman, David Wilson, vice chairman (inaudible) and Bob Brooks (inaudible). Highlights of our results, followed by review of the financial (inaudible). Review of asset quality by John (inaudible). Concluding remarks and our outlook for the rest of the year by Peter. We will then be glad to take questions.

This presentation is available at www.scotiabank.ca.

Thanks. Good afternoon. Let me start with a few remarks on corporate governance because the bulk today is timely. First, we at Scotiabank and I think it is true of my peer group, are proud of a long history of integrity of the reporting of numbers and open disclosure and communicating in a clear and consistent way, with you, our shareholders and the media. We have strong processes and controls in place, very strong. We have no problem with certification, that is required under the laws of the SEC and the (inaudible) laws. We have done that to our own board and are quite prepared secondly, on stock options, again, it is not a big issue with Scotiabank. We will begin expensing in fiscal 2003, as we were expensing this year (inaudible). I do hope and encourage the (inaudible) international standards have come up with the standards, otherwise, we will get back into pro forma expensing of options, as you can change many variables under the standards (inaudible).

I do hope that does come. Nevertheless, (inaudible) and we will expense them. Turning then to the third quarter results, while we produced a solid is euphemism for an average. Earning per share of $1.05 and ROE of 16.2, it was a tough quarter. There is no question it was a tough quarter. On the credit side in the U.S., it shows us clearly in our numbers, where we suffered a number of setbacks. We are not at all happy with the rising of impaired loans, which you should expect (inaudible). It was a tough quarter in the valuation of the emerging markets, with part of the equity (inaudible) in the latter part of June, and in particularly July. The value melt down, particularly in Latin America (inaudible). On the positive side, really most of our businesses are doing remarkably well. Very strong contributions from the domestic and the more you dig into the numbers, you more you will be impressed with the quality of international numbers (inaudible) Argentina and the situation aside. Large part to Scotia Capital. The Canadians and global trading are performing very well.

Our capital ratios are good. We have a lot of capital. Overall, we have a lot of work to do in dealing with creditors. We will. We will be attacking them aggressively over the next few quarters and we are confident and we know exactly where it is. There is no surprise. We know where the reserves should be, what the impaireds are and what we have to do. Meanwhile, we will continue to earn because our fundamental earnings are strong.

Next slide, then, shows the trend in the earnings of 564 million this quarter. Down a bit from the first two quarters adjusting for Argentine write-off. Continuing our record of consistency across these areas of business, partially because of diversity and partially because they are moving very well. Slide 5 makes this point to the business line. Business lines are doing well, international and domestic are in good shape and producing very good quality earnings. Scotia Capital is - if we didn't have (inaudible) in the U.S. lending, right now. But, that is a challenge is the problem we cut a deal with and that is showing up in the numbers clearly, that weakness.

Briefly on Argentina and Rick Waugh is here if there are detailed questions. It has minimal impact on earnings this quarter the way the accounting is. We are in the - nor should it have because I decide if in the first quarter to deal with it. We are in the process of finalizing arrangements with local financial institutions with a trust structure with a number of things to exit the country completely.

Our claim has always been in the time we sort of dealt with this in December, I guess at the annual meeting with you, after our annual results, where we said this would be the maximum impact. Our aim always was to maximize jobs for our employees and treat them as profitably as we could and returns for various strategy, with the shareholders having lost money already. Set ourselves at agonizing nine months from the beginning of November, it went very well there. A couple of (inaudible) and I feel very sorry for the people. We expect to complete the transaction in the next week or so, but things are never over until they are over in Argentina. So, we are not dealing with it in the public relations point of view or reporting it other than to you and to the public at large and continue to negotiate with the government in a constructive way.

We do believe and continue to be totally committed to our international operations, which you can see from the numbers that is Argentina, are behaving well and our part of our growth platform is a very important element for the future. That is our targets overall. We are on track to meeting them, which is the way we report to our employees the vast bulk of them are tied into our general ability to produce returns on equity and earnings for shareholders, ex-Argentina for that exercise because most of them were not involved in it.

Using that measurement, then, our return on equity year to date is 16.8. It is the upper end of our band of targets. We are not into the guidance, but targets of 15 to 17. 9% earnings growth is what we adjusted last year. productivity in Tier 1, we are industry leaders. We are very strong in both areas and remain comfortably ahead of target. Low losses were obviously well behind target. Given these numbers, we remain confident we will reach our whole year objective, excluding Argentina and notwithstanding what we saw as a rough third quarter and a tougher quarter than we ever anticipated.

So, with that I will pass to (inaudible) to talk about performance in detail. Sabi.

Thank you. We have maintained steady trend and tough revenue in full interest and other income (inaudible) current state of weaker capital markets. As these revenues are geographically disbursed, as well. As Peter mentioned, the diversification of revenue base is important in supporting our earnings. Looking at slide 10, our overall margin remained flat from last quarter and came down 10 basis points from last year, due to the spread of the Latin market. Canadian spreads remain stable.

Slide 11, other income, including items of security gains, trading revenue, settlement interest and (inaudible) over the last year. (inaudible) due to weaker capital market activity. Growth in a number of areas, including revenue, (inaudible). On the quarter underlying (inaudible) 2%, due to number of small variables. Our expenses (inaudible), but down 7 over of the quarter and 8% from last year, due to reductions in performance-based compensation and structure base evaluation in Argentina. Base expenses remain well controlled, as always.

Cost approach shows most clearly ratios on slide 15, remain lowest possible (inaudible) Canadian bank. Looking at slide 14, capital ratio remains strong. Tier 1 is 9.8%, up substantially from 9.1% a year ago and the best of the major banks. Common equities are 8%, up from 7.6% last year. I should mention that a Tier 1 ratio (inaudible) basis points we redeemed 300 million in existing preferred shares by year-end. We will still have the strongest ratio. Also of note, we repurchased approximately 2 million shares in Q3 to offset normal dilution from exercise of options.

Turning to slide 15, as Peter mentioned, the (inaudible) positive, that is decline in securities. With the recent decline in market prices of emerging market debt and global equity (inaudible), the market value and the book value of (inaudible) Securities as of July 31st, compared to 565 million last quarter end. I show above the drop emerging market debt led by Brazil and to a lesser extent in equity. Both events took place largely in July and we had a sublease at the end of June. Since July 31, the market value of securities have improved from being in small provision.

Turning to (inaudible) business slide, slide 17. Domestic banking includes wealth management business. It carried on with solid performance. Generated 62 million in earnings this quarter, up 24% over last year. We continue to see strong growth in net interest income, up 10% year-over-year driven by growth and revolving personal credit. Credit quality remains strong, especially in retail. We expect full-year losses to be about 21 basis points, similar to last year and still well below the peer group.

Operating expenses are well controlled rising 3% year over year. (inaudible) earnings improved 3% due to three additional days in the quarter. Looking at highlights in domestic, with recent market share, many products during the (inaudible) up 28 basis points, personal loans up 29 basis points, mutual funds up 24 basis points. This success innovative product offerings, such as total equity I plan. We also continuing using new products (inaudible) position of credit card market we began offering 1% cash back (inaudible) Visa card. We launched no fee, no rate card in Canada. Note the better sales on small business customers (inaudible) select loans at a rate discount on Visa cards (inaudible). This resulted in 60% increase in approval of financing.

Wealth management we successfully completed integration of Charles Schwab, Canada and (inaudible) and strong slide retention. We also made several key enhancements to online broker service. New research (inaudible) and so on. That has paid off as we rose to the rankings (inaudible) yesterday.

Turning to slide 19, as Peter mentioned, Scotia Capital had a tough quarter. Net income of $56 million was down from last year with credit quality in the U.S. being made (inaudible). Revenues (inaudible) decline in trading, they have held reasonably well given the weak market environment. Margin increased by 200 million, (inaudible) portfolio and John will have more to say about credit quality in a moment. Expenses fell 9%, due to lower performance related compensation. Turning to international operations on slide 20, the caribbean, we had another strong quarter with net income up 29% year over year. (inaudible) rose by 11% while loan losses and expenses declined. In Latin America, Scotiabank had a solid quarter of (inaudible) million. Earnings from (inaudible) in (inaudible) were up including from the sale of some PKI bonds. (inaudible) due to lower loan loss provision. 521 showed (inaudible) from Inverlat, our Mexican operations. No reporting earnings growth was higher, but offset by decline in the peso during the quarter. In the (inaudible) strong growth in lending and deposits.

Lending was up 25%. Commercial and corporate 15%. Checking up 30%. As well, Q3 ROE was good at 18%. So far, we are pleased with progress we are making in Mexican operations. With that, over to John Crean, risk management.

Thank you. I will start with slide 23. The story this quarter is credit condition s in the U.S. were more difficult than previously expected, with particular weakness in telecom sector. As with many financial institutions, we were affected by well publicized fraud in several U.S. borrowers. As a result, net impaired loans excluding Argentina, increased by 568 million, from Q2, to 751 with fraud having material impact in formation. These formations and after a full portfolio review, we increased specific provisions to 400 million from last quarter's level of 370.

Slide 24, we show the break down of the Scotia Capital net formation of 835, which is the bulk of the quarter. 80% was in the telecom sector per dollar in the U.S., and for provisions this quarter. U.S. formations consisted of three well publicized accounts, which were fraud related. The remaining 20% were across several sectors.

Formation of domestic and international (inaudible) on the slide, they were modest and given the size of the portfolio in the (inaudible) norms. The higher levels of provisioning were mainly in the U.S., on chart 25. You have the graph of provisioning and maintained provisioning at a high level over the last year, mainly due to the U.S. portfolio.

Let me turn specifically to telecom on the next chart, slide 26. Our total cable and telecom exposure of 4.7 billion remained basically unchanged from last quarter. Credit and quality of the portfolio was mainly affected by the financial irregularities of two U.S. borrowers in the sector. This resulted in credit downgrades of some of the previously investment grade customers. As a result, gross impaired loans increased from 287 last quarter to 756 and net impaired loans to 563. The majority of investment grade accounts are traditional regulated company [W-S] stable cash flow, strong customer bases and acceptable access to capital markets. North America cable operators continue to have stable operating cash flows.

Our exposure here is limited to service operators and is well diversified geographically. There is some financial weakness in the European cable sector. In most cases, (inaudible) operate companies which continue to perform. On slide (inaudible), we did infer the breakdown of the telecom sector, showing high risk telecom sectors and unregulated telephone, wireless long haul (fibele) and (selax), local carriers. We reduced exposure to these sectors through payments and added new provisioning and taken write-offs. We have good coverage, 61%, against unregulated telephone. 81% against wireless. 80 against long haul fiber and 83 against plex. No paging exposure.

Loans to borrowers have generally been structured senior facilities with security. Despite this, the losses are high. The action we have taken reflects these risks and overall the coverage at 72% is very reasonable. Power and energy trading is also a great deal of comment. To give you breakdown in this sector, on slide 28, we have shown the exposure. Almost 30% of this portfolio is to regulated utilities with three- quarters being investment grade.

Almost half of the loans are extended to energy-producing operating entities. (inaudible) assets and significant equity contribution by sponsors. The group of loans indicate having power purchase agreements are credits to entities with sufficient power sole over the term of the credit facility, fully provide for the retirement of the debt. The other power group of loans are extended projects, most of which have substantial power purchase agreements, uptake agreements, but there remains unsold or merchant risk. Our lending standard for these projects call for a higher level of initial equity contribution from the sponsors.

Diversified generation includes loans to major power producing (inaudible) facilities. On a number of borrowers in the category are trading operations, none of our credits are to these tray trading subsidiaries. Our loss experienced is historically low, using assistance of security for high proportion of the portfolio and strong marketability of the assets. Turn to page 29, which is a subject we discussed at last quarter's meeting. You will see a chart which proves exposure to Brazil. This is the one area in which markets we have some concern. O-R-U Our exposure to Brazil is limited to government bonds, trade finance and trade finance being particularly carefully managed and is slightly down as you can see the chart from last quarter. Turning to slide 30, we have our market risk numbers. You can see distribution of daily net trading revenue for the quarter. Most had positive results. No single day did the loss exceed one-day VAR. It occurred at the beginning of the quarter, when there was significant widening of credit spread combined with short-term interest rates and the markets reacted negatively in the U.S. economy, with concerns about the telecom sector.

Page 31, you have the VAR trends trading revenues remained good. We did not increase VAR risk reported. It was less than 10 million small by any standard. Summarize by saying the credit quality in the domestic retail portfolio remains strong. Our domestic commercial and international portfolio excluding Argentina, remain stable condition. We are managing U.S. portfolio closely. We have remained cautious in our classification and in our provisioning. We anticipate going forward significant reduction in net impaired loans over the next several quarters through asset sales, portfolio management and provisioning and with the run-off of older impaired loans that reached term and come out of the classification. We expect significant reduction in net impairs for Q4. In part, also, our nonperformance will drop by 200 in Q4 given we expect to no longer consolidate from Argentina. Let me hand back to Peter to comment on the outlook for the rest of the year.

Thanks, John. We are here to look at the economy. As far as we can see, the Canadian economy will perform well. It is good after the g-7. U.S. is still a good economy. Canadians most important because that is retail commercial bank and how it is operated. It looks very good.

In U.S. and Asia (cut in of talking) - before the alarm. We are still alive and well managing the bank.

So, we see Europe is weaker than we would have expected and we have got a global economy that is subject to event risk and a number of other things. We see this in the volatility of the financial markets even though they have diminished most recently. We continue to run the bank defensively. Doesn't show with all the loan loss totals. Defensively on a bearish forecast level, we are not looking to market the capitalize that or save us from bad debts and that is why we are paying close attention to cost and we are spending every working day looking at the loan assets and individual and what we can do with them and how we work them and defeat them.

So, that is our number one priority. Get the impaireds down. We are looking at reducing them in the hundreds of millions, on top of the 200 million we are getting by not consolidating Argentina, which (inaudible) happened. We are confident we can do that because if you put this had perspective, large part of the increase was to fraudulent companies which had been rated and wasn't a breakdown in fundament underwriting. Notwithstanding, we have to deal with it and raise the reserve and sell assets. The conclusion of the Argentinan situation is long overdue. I think if we do conclude it, it is an elephant solution, even though we have lost our money. Importantly to all of us, I think Rick Waugh has been living with this day and night, probably seven days per week, 24 hours. It has been a horrendous mess, the pressure on our people. It will release a lot of people, very good people to deploy to other parts of the international, which will be very good for shareholders and good for the bank. It has been a big drain on us, big drain.

As always, we will control the cost. We are very confident of the fundament underlying earnings and what they are doing, where they are and what they will produce over the next few quarters. We have been able to deliver solid earnings and as I said earlier, domestic and international banks and the majority of Scotia Capital ex-the wholesale lending in the U.S., is actually performing well. We do expect to meet our 2002 targets, excluding Argentina. We will challenge the credits aggressively. We stand by those targets and as far as we can see looking forward, we should be able to meet them beyond next quarter and onward, notwithstanding the impact we suffered on the credit side. I will open to questions, which will go to John Crean, I am sure.

Begin by giving your name and your firm. Michael.

Last year in the first quarter, you had a high level of formation. You laid out trajectory for us in terms of expectations of improved MPLs over the balance of the year. I wonder if you would be prepared to do something like that again at this time? If you could give us some idea of where the improvements would come from in terms of cures, sales and additional provisions that may be required?

Thank you, John. We will continue with reasonably heavy level of provisioning because we are earning enough to afford that and because it is necessitated by the impaired. I think you can see that in our numbers. Although, I expect reductions to start coming. John referred to some maturing loans. There are a number that we know. We know where they are. We know what they are. We know that they cash cover. We know what the businesses are. They might be technically called impaired. They frankly are closer to coming out of the debt trading levels are moving up. Part of what happened last quarter, we don't speak of specific credits, but you can guess there is certainly one in there where we have reserves against it. Modest - more than modest, they will do money good. It is a question of when it technically is sold. We are at the offering of virtually all of these. We are pretty comfortable over the next couple of quarters and we will be in the hundreds of millions here. Really, very predictable and we didn't go out further than that because we will end up into our next year planning session and give you guidance after the next quarter. I think we will be in a position to play that out and say here is where we are and here is our expectation.

Inferring that by saying we are not at this stage looking at 15 or 17% equity return and a 7 to 12% earnings per share target that we set last year as being unattainable at all. You don't see a reason at this stage, we can't do that and should be able to do that on a sustainable basis.

I have one thing, Michael. You will remember that Q1 list that we gave you last time, the quarters went on and we sold some assets. Provisioning levels had been sufficient and in a number of cases, ahead of market prices. We were able to sell without any provisioning to the bank. So, this is where we believe we are today And so we have flexibility in deciding how we wish to take this number down.

(inaudible). First quarter 2001, if I recall, the new formations were largely nontelecom related? This is an old industry. The secondary markets, as I understand it, are (inaudible) and telecom credit. So, I guess the question is are you planning on selling down telecom credits? If so, will you have to give a substantial (inaudible) in order to get (inaudible)?

Good question. When we put that big question in Q1 in a number of markets, there wasn't much liquidity. You could sell small amounts, but not large amounts in the market. On telecom, as with all of our accounts, we look at the sale decision as against what we think we will be able to realize on the account. And in some issue - some occasions, we expected the market price is really too severe and in those cases, we won't sell. I would expect we will sell some telecom and in fact, we are in the process of selling modest exposures as we speak. But, I wouldn't want to say that we are setting out to do much of a large sales exercise any particular sector. I don't want to signal that. We will sell when values look great to us and we have flexibility in how we sell.

(inaudible) follow-up to that. Without naming names of credits that became impaired this quarter, as I understand it, these credits are traded in at last recovery levels and I think a lot of banks are anticipating - the question is do you disagree with where the creditors (inaudible) market? Or -

Depending on the type of telecom, the price will vary enormously. If you are looking at cable transaction, with good cash flow and asset coverage, frankly that type of asset we expect full recovery on. And there are other telecom accounts where it is clear and it is more difficult to say whether the market price is a good reflection of value (inaudible) in the court. There is no specific question to you. In some cases, market price reasonable. Other cases, too low.

John , can you provide a segment break down of heavy write-offs?

The write-offs are fairly broad spread. We don't publish a sectoral lay-off. It would be a good chunk within telecom. Some in - not a large amount, in energy. But, very broadly, what we have done with gross accruals down somewhat over the year, what we have done is go over the entire portfolio account by account and look to see what we might be able to realize. We brought the value down.

Part of an exercise (inaudible).

I have a question for (inaudible). Exiting Argentina, do you see likely impact of relationship with other international banks?

So far we have not in international banks.

(inaudible). and again, as Peter said, our objective (inaudible), but on individual discussions, the place to have a stipulation, but it is not jeopardized (inaudible) and have no implication (inaudible).

Quintin Brogue, (inaudible). Peter, when you put up slide 7 and talked about 2002 targets and employees, you said Argentina doesn't count. Except for me and Rick. At our level it counts. Glad I didn't lay it on Rick. Thank you. Taken under advisement. If the bank has taken two large corporate hits to the same tune of 500 million dollars for a vast majority of employees not engaged in corporate lending (inaudible), would that have been taken out of your operating results for the purpose of payment?

No, we have never done that. Had is unique in our broad base in which the vast majority of the people from the tellers to the branches to the accountants in Jamaica to the workers in El Salvador are tied into this, which we picked as broad prophecy to the bank, so they could feel it is transparent to them. We always said if the ROE wasn't there, I shouldn't get my bonus and you don't get your bonus. You write the board, why should I get my bonus when shareholders are not lending. We determined in the first quarter, with the board, this was above and beyond (inaudible), complete melt down of the country. None of us have ever seen anything like this in modern history, really truly haven't. It is not over yet. The INS is changing plans and dealing with Brazil. We said to them, the executives should be held accountable because shareholders are paying a price here. We will see how that behaves. To that, both of the employees, this event risk shouldn't count against them if they do the job we think they are capable of. I can honestly say it is employees in the international and domestic, they have done a superb job. Scotia Capital is driven by specific bonus pool in specific areas and the overall partnership. We thought that was the fair and right thing to do.

So, the event risk (inaudible) cited as being (inaudible) is that fair?

Yeah.

Follow-up. Where do you go (inaudible) -

I was only kidding.

Just in terms of the corporate platform, you said it would be great without lending. But, does that -

I am not suppose tod deviate from the notes. You are getting me in trouble.

Are you pulling out of corporate banking in terms of capital, as you have been a large vendor? Are you looking at selling? What is the plan in terms of the large (inaudible)?

Why don't I let David answer that. We are on it and have been for some period of time. Doesn't show, but we have been.

We have done a lot of things. (inaudible) down 20% in the U.S. (inaudible) evolution of revolution. We will take both (inaudible) down in the U.S., we are exiting accounts. We have 1400 accounts and will exit 500 of them. It will be evolutionary. We will produce portfolio management and get it up and running and manage that loan book in the risk. Introduce new metrics on planned profitability. We are doing a lot of things to change the business and incrementally over the next 24 to 36 months, it will change quite a lot.

Take some questions off the phone.

We have a question from Jamie Keating from Merrill Lynch. Please go ahead with your question.

Thank you. I wonder if I could ask about - you related -

Could you speak up.

The gross impaired loan to the extent proportionate dollar amount current, could you just discuss a little bit around that? Maybe helpful in understanding how this will develop? Also, curious to what the credit protection to the extent you have any purchase or written, curious to know if there is any and if you expect that to kick in? Finally, perhaps for Mr. Crean, discuss airline exposure dollar amount or whether it has changed, that would be helpful to understand a bit about that. If I may briefly, PDI bon sales, I am curious about the pre or post-gains recognized on PDI bond sales in the current quarter?

Could you be clear about what you are looking for in the formations questions?

Didn't mean formation specifically, but in the portfolio of gross loans, how many are current on interest payments, if any, in dollar amounts?

I don't carry that number. Fairly large percentage of them would still be paying some level of interest. We can get back to our method t. is not a number - I should say that the way Canadian accounting rules work, when you do your provisioning, you have to take account for the time value of your interest in that provisioning. So, have got some type there you already accorded in the numbers for those that are not paying interest.

It is a pretty scratchy answer. There are numbers of accounts. One of the major nonaccrual formations this year in telecom in the U.S. is paying interest. While it is court protection, the court has given us adequate protection for that interest to be paid. That is not unusual. We are finding more and more frequently in the U.S. that the regulators are requiring such accounts even though there is current pay to be carried on impaired loan basis. So, the percentage of current paid will have gone up over the last years.

In terms of airline exposure, U.S. exposure is less than 25 million. I think that is where most of the common carry risk are centered.

It is David Wilson. On credit default. We have just begun to use that market to hedge the risk of portfolio with the new loan portfolio group that started in March. The number is 300 million on the portfolio. We also have about north of 500 million of purchased credit risk which we view as loan equivalence as part of the loan portfolio.

Second number of 500 million, can you tell it again?

500 million (inaudible) attractive prices loan equivalent.

Got you. 300 million of protection. On PDI bond sales.

I should point out that is part of the overall gain on security. We don't view it in isolation. It is really due (inaudible) quarter PDI, sometime necessary equity, sometime in bond. It is gains as entity, rather than isolated elements offered.

Thank you.

Just (inaudible) decline in unrealized gains on the portfolio, I am surprised to see that given the way they (inaudible)? (inaudible) and of the decline in the 300 million decline surplus on the major market, how much was from the total and how much was (inaudible) value (inaudible)?

Bob. There is a (inaudible) in the presentation and in page 16 of the supplementary, Ian. That relates to the Brady bonds that are not in the so-called LVC basket, which is Mexico and to a lesser extent, Brazil. On page 16, where you see fixed income securities, it includes those emerging market bonds, as well as regular portfolio. That is why there is discrepency between that number and the number on the slide and on the other page. As far as a bond portfolio, our bond portfolio excluding emerging markets bonds varies depending on liquidity situation on global basis from 4 billion to 8 billion dollars over a period of time. 95% of that is government securities. We do very little credit. Obviously there is a small amount of credit in the portfolio. You are correct, the U.S. spread rule out on the credit and accounted for great part of the decline in market value. we don't anticipate any losses in any of the credits.

They are all investment grade accounts. But, spreads have widened across the board.

In the numbers, Ian, we wrote down 90 million in this quarter alone. We have written well over a quarter of a billion down, out of earnings without - we have been writing down all the time. Hasn't been reaping gaining. We are well aware the optics are virtually all the gains are done before June, when we still had 200 million plus surplus, which we lost nicely in July. So, it has bounced back today.

Following up on the (inaudible) Brady Bond - (inaudible) with that 20 million after tax, would it be in international business?

That is correct.

Great.

As Peter said, net gains are (inaudible) in the same portfolio and they have been material over the last 2 years.

Questions on the phone?

Question from Neil Matthewson from Standard Life Investment. Please go ahead.

Thank you. Good afternoon. Over the last two quarters you pulled down allowance for credit losses by roughly billion dollars. Going forward, do you expect to continue to pull that down as part of writing down the gross net exposure or is it a case of at some point, you would actually want to maintain or build up that reserve further?

When you do write-offs, you take down the gross and allowance. We're, as I mentioned earlier, going through the portfolio and doing a review of what we think ultimately might be recoverable and in many cases, taking write-offs. That program will continue. You will see the impact on both sides.

The question is what stage do you feel you are adequately reserved? Is there a point you feel you were not adequately reserved?

I am trying to say as we do provisioning, we provide, as we go through adequately to reflect what we expect will be recovered on these accounts. And the provisions plus the write-offs give us the coverage of the original amount. We will continue to provide and put up 400 this quarter. And in addition to that, we are looking to see what write-offs we should do to reflect the ultimate amount on optimistic basis that we might recover and will continue to take write-offs. So, you have got on the one hand, provisions being added and on the other hand, write-offs taken against the gross and the allowance.

Just to follow-up to that might help a bit. Roughly what proportion of the formation this quarter were these two fraud-type cases you talked about?

It reflects a very large percentage of the Scotia Capital formations. It would be over 50%, over sect%.

Of the Scotia Capital?

Of the 835 Scotia Capital. Just a clarification. Yes, we feel we are adequately reserved. We are certifying statements, Sabi and I. We looked at each loan and know where we are and knew what the impaireds were. We are not happy with it by any stretch of the imagination, but the 400 million wasn't arrived at lightly. I would rather be 200 million frankly, be much happier. We have been reserving heavily. We sat back in January even with the position then, we thought we would be down to high 200s.

Sure. If you were to roll on with maybe not a billion a quarter formations, but high numbers of formations, would you have to rethink -

We do not see that. We know where the migrations are and know what it is. We have the luxury of having some recoveries because making a (inaudible) but we have a rather large older portfolio of impaired, which is back to the telecom and other things that have been in the works for quite a period of time. We know where each machine is what it is cash flow and what it could be sold for. We can get rid of some of that, where we really are now if there are more events, I will add frauds are complete surprises on the field. They are difficult to predict. But, I'm confident frankly with the certification with the (inaudible) and the president said put them in handcuffs and send them to jail. There are not many more left out there. We found them all, that is another question. I will not bore you with that.

Okay. Thank you.

I am still not clear on the realized and unrealized gains in the (inaudible) section. Can I get clarification? You have 105 million of realized gains, including (inaudible) sales of TBI. Also, it includes and here is what where I want clarification, 90 million of write-offs that are netted against - fairly high level of other realized gains during the quarter. Okay. Then, I am looking - you mentioned a lot of the decline in the unrealized gains related to fixed income or at least the impression I have is that may be due to (inaudible) in Brazil. Could you quantify -

Let me clarify. Look at page 16 of the supplementary under reserves. You see at the top of the section, designated surplus deficit bonds. We went from a deficit of $28 million at the end of last quarter to 222 million this quarter. Okay. That's Mexican - that's the Brady we are talking about where the market blew out and declined. PDI bonds declined from 262 to 187. A portion was sale and the value of the bonds declined in July. Skip two lines under investment securities to fixed income, which went from 296, down to 75. Still a surplus. That 210 million reflects widening spreads that I talked to Ian about on traditional bonds. And the sale, gross sales that were just referred to.

Close to couple hundred million dollars. Sales before the write-down. Okay. Does that help you?

Yes, it does. I have one other question looking at the power slide that you presented. Fairly high level of noninvestment grade exposure there. To what extent does that exposure fall (inaudible) as opposed to bonds that were originally investment grade?

There is clearly migration taking place in that portfolio over the last three or four months. That has happened. We, in our grading, are clearly aggressive in down grading and classifying into noninvestment grade, if you think that is an appropriate place to put them.

Okay. If I could finish up with one other question. Looking at all these numbers, why should we feel comfortable that over the next couple of quarters that you are not going to mitigate the high level of net impaired and the deterioration in the unrealized gains, especially on the equity side that I see now without some write-downs on the equity side and without fairly high level of provisions on the credit side?

I think, one, you have to take our track record at a certain perspective. Yes, we go through troublesome patches, no question. Love to avoid them, but they happen. You deal with them and you go on. You concentrate on the basics. The basics here are fundamentally really pretty good in the vast majority of our businesses. Then you come back and say yes, there has been a loss of surpluses in the equity accounts, does that project into there is more losses to come here? No. I mean, it was a July incident, almost totally, which is a combination of emerging markets and credit spreads. They had actually all moved a bit in small surpluses. That, combined with the fact we have written down our merchant banking and our investment portfolios almost consistently now for two years to the tune, as I said, another 90 million this quarter. We have been taking that without great flashlight or saying here is an extraordinary thing that happened that we had to write-down. All portfolios have been gone through. They are clean relatively. You turn back to the credit issue. And obviously in a peer group sense, we don't look good. We have high net impaireds and gross net, pick your number.

We had this bulge again this quarter, of which part is explainable, but fallen angel. The point of fact is we are going to have this sort of thing and have to deal with it. We know our portfolios inside out. We really have been on this since the end of 2000. Doesn't make (inaudible). It does mean it is not for lack of knowledge that we are not going to deal with this. If we say we can deal with it to the tune of hundreds of million, you can take that as a firm given. I wouldn't stand here and John wouldn't stand here unless we have gone three reams of this personally. Again, back to it, didn't want to and didn't think we would be here. Meanwhile, we have also looked forward at our earnings and dynamics of the spread fundamental ability to control cost that are capital expenditures, everything we can think of, and say is this fraud guidance because we are not into the quarterly guidance, is this 7 to 12% earnings per share, is this 15 to 17% return on equity, is it realistic? Are we going to come back and say, well, we should have got them. No, we think we have that. We think we have that ability. We think our mixture of assets and liabilities, our people and portfolio of businesses can achieve that nowithstanding what we see as a set back and obviously attack of dead-on credibility with cause because we didn't expect this. We sure didn't expect the numbers to go that way. We are also confident we have very solid earnings power and we have a handle on them. And will produce the results for shareholders.

One last question.

You mentioned the sale of about 200 million or gain on sale of about 200 million dollars of what sounds like largely government bonds. Doesn't that effectively mean you are selling higher coupon bonds and doesn't that mean you are then going to replace them with lower coupon bonds than just show up in the margin?

Yeah, we move the bond portfolios around. We maintain government bond portfolios and multiple portfolios for liquidity purposes and cash management purposes. We accountively manage them in the context of market view on interest rates essentially. So, with the bond market having rallied the way it did in the period, certain of our government bonds have had a big move. We sold them and replaced them with other government bonds before that.

To clarify, group treasury where most of this is, operates that portfolio ex-what our earnings expectations are. There is just a block number in there. So, they actually were surprising us on the upside through June because they felt there were certain markets they wanted to trigger. Of course, surpluses disappeared. We are not very keen to see more sales. We really do tend to stay away from it to less than right the puts and calls and move in and out of the index without it trying to be pro-trading. We have that in one area. We don't try to do it in there. Okay.

Any other questions on the phone?

We have a question from Melanie Ward from RBC Capital markets.

Can we expect another quarter in the 400 million dollar range for loan loss provisions?

Welcome back, Melanie. I think it should be lower. I don't know, obviously. The devil is in the detail. But, we are one month through the quarter. You know where we are. I think we would hope we are looking at lower rates as we go forward next quarter into the next year. But, I take that with a hint of always, if some of that comes up or something, we will deal with it and we must. We do not want to be under reserve.

Thanks.

Didn't help you, did I?

That is okay.

That's fine.

Any other questions?

Question from Jim Bantis from CFFB. Please go ahead, sir.

Good afternoon. You have given sketchy details, but confidence in terms of net impaired loan positions coming down over the next few quarters in an orderly fashion. You have quite hefty capital ratios at this point. There was talk about taking over the minority interest in Inverlat over the next few quarters as U.S. expansion. Can you talk about the use of capital in the near-term given the credit issues you are facing?

Rick here. We are in negotiations to take over the balance of the Mexican bank. We see that as good deployment of capital. We are still generating capital, if you look at the numbers again, even with the loan losses. We are generating capital between 4 and 500 million a quarter. So, we are still a very large capital generation machine. What is coming out is some referreds or redeemed it. Our fundament earnings power says notwithstanding the credit setback we could afford to buy a smaller sized U.S. bank, where we have been actively looking for months now.

Bob Chisholm is here and has been working with Warren Walker on that and visited a number, as we said from the beginning - it is not an end strategy. It is deployment of excess capital because we are sitting at the highest rates in Canada . If you look at intangible common, it is very good against any system anywhere in the world. The intangible common, which is probably the true thing because it is not using any of the other things that go into Tier 1. It is a percent, far ahead of regulatory needs and quite a bit above most major banks have.

So, we will maintain that and we actually do think that we are at the end of the fallen angels, I hope. With that done, we know where our migrations are, our portfolios are not perfect. Back to what clinton says, we are on top of which accounts to exit where to go. We are careful on underwriting. We are certain this will self correct. It always does in time. I just thought it would be this year. We are toward the end now and I think it is next year where we will see lower loan losses.

Jim, we had a modest buyback in the quarter, as well.

That is right. No, I just wanted to see if anything was put on hold outside of the credit issues. Great. Thanks very much.

Other questions on the phone?

Yes, a question from Steve Collie from TD Newcrest. Please go ahead.

On page 16 of the report, note 4, there is reference to special purpose entities. I don't mean to sound alarmist here, but could you just comment on that? If that note wasn't in the last financial statements, is there potential qualification you can give on this?

Quarterly.

On note four? We don't - (inaudible) presentation to the board yesterday and really there is no issue for us in the overall scheme of things material at all.

Great. Second question. You say 500 of 1400 corporate relationships in the U.S. that you hope will be run off the books. Is that roughly the same proportion in terms of capital?

Roughly the same. It is about a third of the client list and a third of the risk capital, economic capital of the book. We are well on our way to doing that. We started the exit process eight months ago. It takes discipline and time for the loans to mature. We are exiting the relationship (inaudible).

Okay. We have seen disclosure as well from the other companies on pensions and changing of assumptions and increased expenses that were incurred this quarter as a result of changing assumptions. Can you comment on on where you sit on pension obligation?

Look at last year's annual report and we were in substantial surplus, very large surplus as a result of that, the bank has been enjoying a modest pension credit, rather than pension expense for the last number of years. We current - we adjust our estimates of the pension assets typically once a year with effect from the beginning of the year. We will review that in the next month or so to decide what to do for next year. We did lower it slightly next year, reducing the credit slightly. We haven't decided what we will do next year. Our best - we stressed this things six ways to Sunday, we see no particular material negative effect given the likely range of possibilities, although the credit may well drop down 20 or 30 million dollars, depending on what we settle on.

It is safe to say under the numbers you see out there from (inaudible), we are still surplus.

One final one, on page 5, the international banking. This is pulling from the supplementary. For the international bank and the 212 in net income, you got me confused on the various gains and what-not from sale of the Brady and PDI. Can you say to me 12 - if there weren't gains on sale there, what would have been the profit number and with the provision for credit loss that looks like it was recovery of 16 million, can you again clarify that for me?

Comment on the recovery?

In the normal court, we will have occasions when we have recoveries greater than our - provisions we put up in lost accounts. That was the case in the international bank for this quarter. It was a range of a whole series of smaller accounts.

Whole range. Is that the only thing in there I should view as being unsustainable? I don't think we should be modeling 212 per quarter from this moving forward?

As Sabi said, gross gain of 25 million.

20 million after-tax.

Okay.

In terms of (inaudible), you should be marketing 212. We have gains occasionally, last quarter we had the (inaudible) and you don't have write-down. These numbers, you know, you say you want to pick one item out, other things that go the other way.

Thanks.

That 212 is a high number. I wouldn't annualize it at all. I don't know, again, as Sabi says, it is a lot to do with foreign exchange. 180 would be a reasonable number.

Thanks, Rick.

Ian.

(inaudible) a lot of questions here on the growth in net impaired, some competitors are going to (inaudible) sectoral. What is sort of your sense on that providing for particular blocks of loans where it looks as if there could be sustained period of higher provisioning going forward, what is your view on that?

It is (inaudible). It is interesting initiative. As you know, we have generals. Generals in the U.S., as most of the European system would be fluctuated and in effect, playing the part of sectorals. The sectoral is putting up reserve against it that keep it from being impaired where the interest income can go through earnings. Back to that question, we didn't have the number. Once we are impaired, interest earnings disappear and the reserve pool starts to build up.

So, I think it is an interesting initiative. It moves us closer to U.S. style, where the difference between nonaccrual and accrual is great because under the classification, you can keep part of a loan performing and your earnings per share stay up. So, I welcome that. We are not thinking of going there. Frankly, it is our classic style, we have had tunnel vision right now. Get the impaireds down and make sure we have reserves properly sized and that our existing businesses which are doing so well keep managing the way they should and keep taking share and keep producing good earnings for our shareholders. Sectorals might become a way of life up here. I personally think we will converge more with a SFAS 142 style and get out of the ciba, because so much of the rest is moving that way. Maybe that will be two or three years.

Any questions on the phone?

We have a question from Trevor Bateman from CIBC World Markets.

Thank you. Just a question with regard to supplemental page 11 (inaudible) assets with respect to the indirect credit instruments, notable increase in the quarter?

Could you speak up a little bit?

Notable increase in credit instruments on supplemental page 11. I am wondering what is the driver of that and how should I expect that number to perform in the future as you reduce your corporate credit relationship?

Couple of components in there, as David mentioned, we sold credit and that goes into that number. With the reduction in direct lending commitments or lending the offset comes in indirect. There is trade-up between lending and going into indirect credit commitments. Those are the two items.

Thank you.

Any other questions?

Yes, on the balance sheet, market valuation in the quarter, is there anything -

Function of (inaudible) on the balance sheet.

If there are no further questions. Thank you for coming. We look forward to seeing you in three months.