Bank of Nova Scotia (BNS) 2006 Q3 法說會逐字稿

Good afternoon, and welcome to the presentation of Scotia Bank's third quarter results. I'm Luc Vanneste, Executive Vice President and Chief Financial Officer; Rick Waugh, our CEO will lead off with the highlights of our results. I will follow with the review of the financials. Then Brian Porter, our Chief Risk Officer will discuss credit quality. And finally, Rick will provide comments. We will then be glad to take your questions. We have our two Vice Chairman and our business line heads to participate in the Q&A. Before we start, I would like to refer you to slide number two of our presentation which contains Scotia Bank's caution regarding forward-looking statements. Rick, over to you.

Thanks very much, Luc. I'm very pleased to report record results again this quarter. Earnings per share $0.93, up a strong 21% from $0.77 a year ago and up 4% from the last quarter. Our return on equity, a very strong 22.8%. These results reflect strong revenue growth due to our key strategic priorities. All three business lines, domestic banking, international banking, and Scotia Capital contributed to these record results. Including our recent acquisitions of the Maple Financial Group in Canada and the two banks in Peru.

This quarter was also marked by significant asset growth, broad based growth, in the retail, commercial, and corporate portfolios. As well, favorable credit conditions continued in Canada, the United States, and the other regions where we have a significant presence. And finally, our capital position remains strong, which positions us very favorably to make strategic investments to continue to drive our growth.

Now looking at the business line performance, specifically, our domestic division generated net income of $319 million. This is unchanged year-over-year, but up 23 million 8% from our previous quarter. Year-over-year, we've seen significant volume increases in retail and in our commercial lending, business deposits, and higher transaction based revenues. And, as well, we continue to increase market share in a number of our key priorities.

International net income was a record $285 million, a substantial increase of 22% from last year. We had strong underlying growth led by Mexico, which had significant increases in both retail and commercial lending. The Caribbean and Central America also showed good asset growth and there are now solid contributions from Peru and our other recent acquisitions. Included in international banking results was the recovery of a value added tax of 51 million which added $0.05 a share. Scotia Capital recorded net income of $278 million, $78 million or 39% ahead of last year. These results were highlighted by continued growth now in our loan portfolios. As well, these results benefits from security gains and loan loss recoveries which more than offset a quarterly drop in our trading revenues.

Turning to slide 6, in terms of our 2006 financial performance objectives, we expect to be the -- at the upper end of our target range. Our return on equity of 22.5% for the first three quarters is ahead of our 8 to 22% target range. Our earnings per share growth of 13% in the first nine months exceeds our 5 to 10% objective. And finally, our productivity ratio was 54.7% or 55.3 adjusting for that back recovery I mentioned. Well ahead of our 58% target. And, of course, we continue to have strong capital ratios and good credit performance. Overall, a very solid quarter with good momentum for the future. So now I'll pass it off to Luc to go through in detail more of the numbers.

Thanks very much, Rick. Beginning on slide 8. This slide highlights our strong revenue growth, up 11% year-over-year with increases in both net interest income and other income. Net interest income was up 16% from the same period last year driven by very good asset growth across all our businesses. Average assets rose 15% year-over-year driven by both organic growth and acquisitions. As well, the all bank margin was up slightly.

The year-over-year increase of 45 million in other income was widespread with contributions from acquisitions as well as higher credit card and transaction based banking revenues up 26 million. And higher retail brokerage and mutual fund fees, which were up 24 million. Partly offsetting were lower trading results and lower securitization revenues. Compared to last quarter, total revenues were up 6%, with acquisitions driving most of the increase.

Looking at the asset growth in more detail on slide 9. Residential mortgages were up a significant $11 billion, or 16%. Securities increased $18 billion or 24% due to an increase in asset backed securities as well as an increase in trading securities to support customer driven activity. Business and government lending also continued to increase, up 12% in total. This significant asset growth is the best we have experienced in several years.

Turning to the margin on slide 10. As you can see, the all bank margin has remained stable over the past five quarters, although business line margins do vary, in part because our transfer pricing methodology. At the all bank level, which is where we manage interest rate risk, the margin base is up 1 basis point quarter over quarter despite the rapid rise in wholesale funding costs in Canada. In domestic, the reported margin is down 7 basis points on the quarter. However, the decrease is entirely due to the addition of the Maple Financial Group and the impact of accounting guideline 13. The good news is that the underlying margin is stable this quarter. In international, the margin is up with increases in several countries. In Scotia Capital, the margin also rolls, benefiting from interest recoveries. Going forward, we expect margin pressures in Canada to ease somewhat as the rapid rise in wholesale, or short-term wholesale deposit rates appear to be coming to an end.

Turning now to noninterest expenses on slide 11. Expenses increased 91 million, or 6% from the same period last year. Excluding the impact of foreign currency translation, recent acquisitions, and the VAT recovery, total expenses rose 7 %. The year-over-year growth in expenses in part reflects our investments for future growth. Salary and benefits rose mainly due to acquisitions and premises and technology costs were up due to acquisitions and new branch openings in Canada and in Mexico. Quarter-over-quarter expenses were up 3% mainly for the reasons I just mentioned as well as higher business and capital taxes and litigation costs.

Turning to slide 12, capital ratios. Our Tier 1 ratio was 10% and TCE was 8.4%, down slightly from last quarter due mainly to our very strong asset growth. Risk weighted assets were up 10 billion on the quarter driven mainly by strong loan growth across all our businesses, including our wholesale portfolios.

Turning now to the business line results. First domestic banking on slide 14. For the quarter, domestic banking had earnings of $319 million, up 23 million or 8% from last quarter as we continued to have strong retail asset growth with lower provisions in commercial banking. Net income was unchanged from the same quarter last year as strong retail asset growth and higher transaction based revenues were offset by higher expenses and margin compression. Looking at revenues in more detail, domestic banking revenues were up 4% year-over-year with increases in both net interest income and other income.

Personal banking revenues rose 3% year-over-year. Retail assets were up an impressive 12%, driven by organic growth in the acquisition of Maple Financial and National Bank of Greece. We also had good growth in personal deposits with GICs up nearly 15% and small business GICs were up a substantial 26%. As noted earlier, this asset growth was partly offset by margin compression. Transaction based revenues increased due in part to higher credit card interchase fees driven by higher customer loyalty and activity. As well, mutual fund fees rose 30% year-over-year. Commercial banking revenues increased 9% as net interest income rose driven in part by good loan growth and strong deposit growth. The income was also higher across several categories.

As you can see from the next slide, we have had excellent retail asset growth over the past two years from both organic growth and acquisitions. With an average annual growth rate of more than 12%. However, this growth has not come at the expense of asset quality. We continue to have a very high percentage of our loans secured at 90%. Retail loan losses also remain low at just 20 basis points of loans and acceptances, one of the lowest rates among our peer group.

Turning to expenses on slide 17, they're up 7% year-over-year. Acquisitions accounted for about 25% of the increase while the rest was due to higher staffing and compensation levels, technology projects, and small increases across a number of other categories as we continue to invest in a number of growth initiatives. For example, we are opening new branches and adding personal banking officers and trainees in existing branches. Quarter-over-quarter expenses rose 4% due primarily to the reasons I just outlined, as well as higher mortgage appraisal and acquisition costs.

Moving to international on slide 18. International banking had another good quarter with net income of 285 million. There were higher contributions from the acquisitions in Peru, and strong underlying asset growth in Mexico and the Caribbean and Central America. We also benefited from the $51 million of recovery of value-added taxes. We continued to earn through the effects of a stronger Canadian dollar which reduced earnings by 31 million compared to the same quarter last year at 9 million compared to Q2. Scotia Bank's Mexico's contribution this quarter was 160 million. Mexico continues to see strong underlying revenue growth driven by very good asset growth. Personal loans rose 34% year-over-year, at commercial lending was up 10%.

Revenues in international banking rose 13% year-over-year and 11% quarter-over-quarter. After adjusting for the impact of foreign currency translation, total revenues rose 25% year-over-year. In Mexico, revenues rose 10% or 23% after adjusting for foreign currency translation driven by strong volume increases in retail and commercial loans. In the Caribbean and Central America, revenues were up 10% or 23% after adjusting for FX translation. We continue to see robust underlying asset growth with assets up 18% year-over-year. Volumes were up across the region, including Jamaica, Trinidad, the Bahamas, and the Dominican Republic. In Latin America and Asia, total revenues rose 37 million or 22%. As the combination from new acquisitions was partly offset by lower securities gains.

Turning to international expenses on slide 20. Expenses rose 7% both year-over-year and on the quarter. Compared to last year, expenses rose due to the Peru acquisitions and higher technology, compensation, and premises expenses to support growth initiatives such as the 28 new branches opened to date this year in Mexico. These increases were partially offset by the VAT recovery and the favorable 4X impact. Quarter-over-quarter, expenses were higher due to Peru and the increases in a number of categories due to our growth initiatives and higher litigation costs.

Turning to slide 21, Scotia Capital had another record quarter with net income of 278 million, up 39% from last year. Return on equity was strong at 32%. This excellent performance was driven by corporate and investment banking, partly offset by lower trading results in global capital markets.

Turning to slide 22, Scotia Capital's total revenues were up 18% year-over-year and 6% quarter-over-quarter due primarily to strong results in corporate and investment banking where revenues rose 42% from last year. This increase was due to a number of factors, including record M&A revenues, increased lending volumes, particularly in the U.S., and interest recoveries and gains from the sale of securities in the U.S. and Europe. Global Capital market revenues were down 22% quarter-over-quarter due to declines in derivatives, institutional equities, and fixed income. Precious metals and foreign exchange revenues remained fairly stable. Expenses were up 9% year-over-year due to higher performance related compensation, as last year's results benefited from adjustments to the quarterly accrual. Salary and benefits were also higher in part reflecting the acquisition of Waterous and Co. Quarter-over-quarter, expenses were down 8% as performance related compensation decreased in line with lower trading results. I will now hand it over to Brian to talk about risk management.

Thank you, Luc. I'll be starting on slide 25. Credit quality was stable again this quarter as credit conditions remained favorable. So my comments will be brief. The specific provision for credit losses this quarter was 74 million. 11 million lower than the same quarter last year, but 39 million from the unusually -- up 39 million from the unusually low level last quarter. Net impaired loans were 479 million, down 100 million from Q2 '06 and down 94 million from the same quarter last year. The general allowance remained unchanged. As part of our risk mitigation strategy, we have purchased U.S. 1.2 billion in credit protection spread across a broad range of industries.

Slide 26 shows the break down of provision for credit losses by business line. Provisions in the domestic portfolio were 69 million, 19 million lower quarter-over-quarter and up slightly from the same period last year. The quarter-over-quarter decrease was primarily due to lower provisions in the commercial portfolio. As you remember, we provided against two accounts last quarter, credit quality in the retail portfolio remained stable. Provisions in international were 24 million, up 23 million from last quarter, following the unusually low level in Q2 '06. The increase was due to higher retail provisions in the Caribbean and Central America, compared to provision reversals last quarter. Scotia Capital had another quarter of loan loss recoveries, 19 million this quarter compared to a provision of 2 million last year and a 54 million recovery last quarter. This quarter's recoveries were primarily in the United States.

The next slide shows net impaired loan formations, which were minimal at 19 million this quarter. Net formations of 76 million in domestic retail were in line with the strong volume growth in our portfolio over the last number of quarters. Underlying credit trends remain stable. Net formations of 20 million in commercial were due to the classification of a number of small accounts this quarter. International net formations of 21 million were primarily in Mexico, in line with the growth of the portfolio. Partially offset by declassifications in Latin America and Asia. Scotia Capital had net declassifications totaling 98 million primarily due to the repayment of one large account in the U.S. Telecom sector.

Turning to trading revenue on the next slide. This quarter 85% of the days had positive results. There were 10 days of trading losses in the third quarter, compared to 8 days in the previous quarter. Overall, we continue to have low variability of trading revenue and we run this business with low risk.

On the next slide are the VAR trends. Our one day VAR averaged 9.2 million this quarter compared to 7.7 in Q3 '05. Compared to last quarter, the VAR increased by 1.2 million, as higher interest rate and equity exposures were partially offset by a decline in foreign exchange and commodity exposure. As you can see, there were no days when our trading losses exceeded the one day VAR. In summary, we had another quarter of favorable credit quality and low market risk. I'll now turn it over to Rick.

Great, Brian. So to recap, we have a strong and a sustainable growth in our assets and our earnings in this quarter. And as you can see in the slide we provided, we've continued to deliver strong growth of 13% in assets and income over the past two years. Domestically, our volumes and fee revenues are strong. We have good momentum. Margins are still challenging. But if, as expected, interest rate increases are over, or nearly over we should begin to see improvements in our Canadian margins due to a much improved funding position.

Our noninterest cost, they are higher than normal, but these are planned specific initiatives to generate future revenue and future growth. For example, international has a multitude of initiatives underway, which have a cost impact, but are and will produce significant revenue opportunities next year and beyond. We continually review these costs, but they are driven to produce higher revenues. But if they don't, we can and are prepared to make the necessary adjustments, that's always been the Scotia Bank strength.

I was pleased that Scotia Capital showed the benefit of our diversified revenue strategy, and despite lower trading revenues this quarter, corporate and investment banking had a great quarter. And it's nice to see the loan portfolios are showing good growth. More than 40% of the $10 billion growth we've showed this quarter in our risk weighted assets came of our longstanding U.S. and corporate relationships.

So, looking ahead. Our goal is to continue to drive sustainable growth, both organic growth and through acquisitions. Organic growth is being driven by a continued investment in our three main businesses. For example, we are expanding our branch network in Mexico and Canada where we expect to add 150 branches respectively by the end of 2007. We are continually investing more in training, marketing, sponsorships, and brand development. In Canada, we are currently adding over 300 sales staff in our new and existing branches. And we are delivering a number of new platforms to generate revenue, a new technology platform to enhance delivery of our investment products. A new platform for our retail loan portfolios and a new platform for commercial products and services as well as small business. All of this and still maintaining our leading productivity ratio. We have recognized the need to make investments to drive sustainable revenue growth. But with our cost control culture firmly in place, we will continue to maintain our productivity advantage.

We will also continue to make effective use of our capital through strategic acquisitions. Over the last 12 months we've made 6 acquisitions investing more than $1 billion. And there are a number of further acquisition possibilities. We have a strong pipeline and we are seriously looking at opportunities in all our major markets. So in summary, we've had a very good quarter, another record quarter, and we are well on our way to meeting and hopefully exceeding our 2006 key financial performance objectives. We are also building excellent momentum for the future to provide growth for 2007 and beyond. So with that, we'll pass it back to Luc for your questions. Luc?

Thanks very much, Rick. Jim?

Thanks, Luc. Just some questions on Scotia Capital. Just wanted to kind of decompose that asset growth. Because if you look back since Q1, we've actually had about a 20 billion increase in average assets, and obviously it's led to NIM growing, as well. It's kind of back to the old Scotia way in terms of lending and assets driving the story in Scotia Capital. Maybe, Steve, you can give me a sense of make breaking down that asset growth and what's sustainable going forth? It's a pretty big ramp up over two quarters?

Sure, as Rick indicated, and Luc before him, U.S. was the place of much of the growth. We had 11% growth quarter-over-quarter in the U.S. And 7% growth in Canada quarter-over-quarter. And that's in the core loan business. We had a substantial transaction with GMAC in addition to that. And that's been an event over the last two or three quarters. So that's substantially increased our drawings. It's principally being driven by heavy merger and acquisition activity across the -- North America. And so it's lumpy and some of this is bridge financing that will get taken out with bond economics or get refinanced into longer term deals. So it has a lumpy component to it and that's why I think you've seen such substantial growth in the last little while. And so the issue is how long are we going to see the M&A activity continue? But if it does continue at this pace, you should expect that our outstandings are going to continue to grow.

Okay. Is the GMAC facility used to its maximum level at this point?

Under the constraints of the agreement that we have, yes. It's certainly operating within those constraints, but it's at the top level. It's performing very well. We're very pleased with how that's going.

Luc, was there anything in NII that made it jump up as much as it has? About a 25% increase.

Are you talking about Scotia Capital? Yes, the one thing I want to point out, Jim, in terms of the asset, asset growth in Scotia Capital, the GMAC is securities. So the actual comparison on quarter-over-quarter, the growth is more in the securities line than it is in the -- in the loan line. Because of the GMAC. In terms of NII, it's good growth across the board. We did have -- did have that interest recovery in terms of -- in the neighborhood of 15 to 20 this quarter. We have had interest recoveries in the past, as well. So comparatives also do have interest recoveries, but not to the same extent.

Just the last question on Scotia Capital. Just looking at the trading revenues, the dropoff would seem to be more substantial relative to peers and didn't seem to be too bad of a quarter in terms of volatility and volumes. When I look at the number, it seems to be one of the weaker ones since 2004. Maybe john can you just give us a bit of reference on what's happened where should we get backed to?

I won't make any excuses about the quarter, it wasn't a good trading quarter. I'll say a couple of things about it. We've had really quite outstanding Q1 and Q2. And part of the story is positions which, I'll give you a little bit more detail, but positions which we've held since Q1, and reported earnings on in Q1 we still had in Q3. And because of the feds' decision to not signal holding rates, I think Bob and I were talking about whether it was May 11, or 13. That triggered an immediate loss in the order of 10 or 12% in the TSX, especially in the energy subindustries and we had positions in that area that we benefited from in Q1 and cost us in Q3. So didn't quite get the fed call right.

Having said that, in an overview sense, I point out that I don't track the pattern in the other banks. But our strong quarters in the trading businesses are Q1 and Q4. Q2 and Q3 are typically weaker. And it's because of the summer months and especially Q3 we lose a lot of client business, at least we experience that. So, you know, I won't call it a perfect storm because it wasn't a complete disaster disaster. It was not a good quarter and it was a result of lower client volumes and a bad call and keeping those positions that we had benefited from in Q1.

We are -- the good news is we're still ahead of plan and ahead of last year. So as you all know the trading business, ours are not very volatile. But they're not without some volatility and we expect to be ahead of plan and ahead of last year by the end of fiscal -- Q4 looks fine at this point. Just in case there's concern, there is nothing -- there are no toxic positions. There's nothing that we're worried about. There's no risk we're not comfortable with. Our books are very clean. Our VAR is still relatively low and we expect to have a good Q4.

And we're not letting John go on holidays next summer.

And I made the mistake of taking holidays this year.

Thank you, next question in the room?

Just some questions with respect to the domestic. I wonder if you could split out the ACG impact for us and the Maple? Because if you say that margins are essentially stable year-over-year, core excluding Maple, that still suggests a very strong margin 288 basis points. Is there any help you can give us on the ACG impact?

Yes, as part of the acquisition of Maple, we brought in $3.1 billion of mortgages, which had the lowest spread. They were not accompanied by any core deposits or anything. When you add that to the mix, that has a negative impact on the margin as well. As it relates to domestic, the quarter-over-quarter swing ACG 13 was $13 million. So the combination of those two items accounted for the entire basis point drop quarter-over-quarter in domestic.

Okay. And I guess, a question along the lines with Maple, spoke to some mortgage brokers during the quarter and they seem to suggest that Scotia typically is very aggressive with renewals. And I think this is also well supported by your annual report where you talk about a retention ratio, it's exceedingly high, 90% of all renewals. Couple of questions at the spur, come to mind with respect to that. First of all, is there any potential conflict here with Maple or any potential problems with the brokers who are servicing Maple with respect to that first? And I guess, second, I guess the prospect of further margin compression if rates come down. Do you have any comments on that? Chris, why don't you take the first one and then we'll take the second.

Let me cover the maple. First of all, the volumes on the Maple business have a very strong over the last few months and actually the closing of that was the end of March, so this has really been the first full quarter where we've had volume sort of come into the books. It's also impacted us more on the expense side as Luc and Rick indicated in terms of our expenses being up. It had an impact on our operating leverage. But that is -- we have one model through our Scotia express service and we have another model through Maple. We're working to develop a target operating model which we'll have in place in '07. We don't see any significant impact. There's a very strong relationship between John Webster and Maple and our whole domestic branch system. That is moving along well. In terms of the actual costs, we also had the staffing, which came into our expenses for the first full quarter and there's a couple of hundred additional people that have come on to the books. So it did have an impact on our operating leverage for this quarter. Very little in terms of revenue, but a large or significant 25% was what Luc and I think Rick had indicated earlier. Increases in expenses has come through the integration side of things. On retention, we don't see any issues there.

In terms of margin, it is a, it's a very competitive business. And we've been watching the whole margin side on the mortgage front. Our market share and mortgages has picked as you know significantly year-over-year mainly as a result of the Maple acquisition. But we are watching closely the whole pricing side. While we're being competitive we're not going to give the business away. We are watching that closely.

Bob, can I ask you to comment on the margins?

Sure, we are seeing some improvement in the domestic margin because of rates leveling out essentially. As rates were rising, there was compression because the cost side was getting ahead of the revenue side as the market anticipated the rising rates and pushed up short rates. That's reversed now or at least turned around. Even though the administered rates haven't actually come down. So that's helping. I think -- Chris is closer to this than I am, but my impression at least is there's a little more discipline in the pricing across the industry out there. I think people found that mortgage spreads were getting just too low. The third thing that should benefit us is as the Maple portfolio grows and mortgages roll, we'll be moving away from their policy of securitizing a greater percentage of that into putting them on our own books and that should widen the spreads, as well. We're fairly optimistic within a few basis points, I'm not talking huge leaps here that the margin will continue to improve.

Thanks and maybe just a follow up to that. It's been almost a year since your last investor day and we talked about the strategy that you had in place with respect for your domestic and one of them was grow your customer base. Do you have any metric you can give us? How many more customers do you have?

I can give you some specific numbers. We've added 43,000 on Maple Trust. We've added 37,000 on National Bank of Greece. And we've had 30,000 organic. In terms of the net of that, I'd have to go back and look at that. But there's been a very active customer acquisition side. As you heard at that conference a year ago, what we said is we're dealing with 20% of the marketplace versus two of our competitors dealing with about 30 to 31%. Therein lies our opportunity and our challenge to expand. That's where some of our expenses this quarter and looking a little further down the road will reflect the growth of our branch system and also adding as we indicated customer facing or salespeople into our branches so that we can balance our book of business and focus more on the investment side of our portfolio.

And so just a final bridge there, I guess is the cross sell.

Cross sell has worked very well on the mortgage side. And step is our product on that side as you're probably familiar with that. And that is a deliberate strategy on our part on the step side because it's a collection of a number of different products both credit and noncredit and the success of that product is that we actually -- the average customer in step has five Scotia Bank products versus a nonstep client that has two. So we are going to continue to focus on that particular product. On cross sell with Maple, that is really one of the biggest opportunities for us in the Maple transaction and it is still very early days -- our focus in the early running with Maple has been to focus more on the mortgage business and getting pieces of it integrated into Scotia and then look at cross sell opportunities there. Cross sell is occuring on our National Bank of Greece acquisition and we've got a number of things that we've got on the go on our deposit side too.

Our market share in the deposit market has picked up as you've seen. We're up about 42 basis points on deposits, which would lead the industry. And we've been very careful in terms of our pricing on that side. For example, our money master account, which, I believe, Ian, had a question the last quarter about -- we haven't raised the rate on that since the beginning of May, so we're sitting at about 3% and a number of our competitors are in the close to 4%, 4.25. So we're being very careful in terms of pricing on that we get a reasonable margin and we're not seeing a significant runoff. We're holding our balances there at about 12 billion.

Is it fair to say then that the cross sell is not necessarily working in the wealth management side?

No, I don't think that would be the case. I think that there is definitely some numbers that we could give you in terms of cross sell that is working on the wealth. It would be working more on the brokerage. The direct investing side, we had a very good quarter there, but I think the issue is on our mutual fund business. And in terms of the quarter there, we were up in terms of our fee revenue and the performance of the funds has been better, but we've been focusing on retooling as you're probably aware that whole business. And a couple of other things that I think are really important to reflect in our numbers, is that over the course of the last quarter and prior quarters we've made some significant investments in technology. One of those would be our term lending system, which is in our mortgage business, the second one that Rick referred to was the investment platform, which covers mutual funds and third party funds and GICs, so that is another big bucket. And the third one that will be coming out shortly, is a new broker workstation which is being developed and will be in the marketplace probably in the first quarter, first calendar quarter of '07. So those are significant investments and you think of mortgages, investments, and a broker workstation, all three of those basically will be into the market over the next 6 to 12 months.

Just two more questions. If I may, I'm sorry to hog the floor here.

Sure.

Is there a metric you can give me on wealth management in terms of year-over-year revenue growth? Would you be willing to share that?

I think that -- did we not reflect that in the numbers? I think that the overall number is, I want to say 8 to 9%, but I think we would have to go back and check that revenue growth. Quarter-over-quarter was slow in our retail brokerage business, our full service brokerage was slower.

And one last question finally, turning to the international division. You're looking to grow 100 branches next year, 9 per quarter, would you be willing to share, perhaps the earnings drag of the current expansion rate and what effectively that will do to international earnings and from a drag standpoint next year?

We'll probably put in about 50 branches this year, which is what we've articulated and we've said that we would like to put in 100 next year. That could be a drag of 30, $40 million over the course of the year.

Next year?

Yes.

But that's the capital expense?

It's combination of the two -- there will be an early drag as we staff up the training of people. You'll only get revenues the back half of the year if you open the branch right at the beginning of the year so it will ratchet down. The second year will be full income. But the numbers that you would be talking would be largely operational if you opened up the full 100. A lot of the capital expenses in terms of the real estate are leasing -- but we do have some capital expenditures in terms of computers, et cetera.

So 30 to 40 after tax earnings would be a good number for next year?

Pretax. Pretax, yes.

I think you can roughly assume it's 1 million a branch.

Okay, that's great, thanks.

Don't forget to add on the ones we were just putting on over the last 12 months, it's a rolling total. Don't put the debit in with a little bit of credit.

You done?

Yes.

A question for Steven, the -- in the narrative it talked about $8 billion of securities -- of purchase of these asset. I thought the cap under the GMAR field was 6 billion U.S.

There was some modification of our arrangement that allowed for some early increases, but it's the same overall cap over the 5 years. It was working well for both of us and so we decided to bump it up a bit. But again in the context of an overall 20 billion over 5 years.

So as you think about environment here with -- we've had a number of short-term numbers here which suggests the U.S. economy's not doing that well. You're picking up quasi consumer receivables at a pretty good clip. How do you get yourself comfortable with the fact that these receivables are going to perform the way you think?

Yes.

Are they just coming on to the books, are we going into a period of slightly slower U.S. growth?

We get very good data at least monthly on the portfolio, extremely detailed delinquency rates. We're able to model and analyze this portfolio extremely well. And there's nothing about the way that portfolio is performing that's got us concerned in a big way at all. Now, of course, there's these factors that we anticipate would happen at some point and that was all weighed into the original decision to do the deal. And GMAC was able to provide us with decades of data that dealt with all kinds of issues and events and performance levels against those events. It's that kind of data that gave us the comfort to proceed.

This portfolio was also, has quite a short effective duration in it's -- any individual receivable rolls quite quickly. So while, as Steve says, we've been accelerating the purchase compared to what we originally expected, the actual outstandings will not be net much higher.

Just point of reference -- we're not at the $20 billion range, we're in the 7 to $8 billion range in the quarter.

And the amortization of these assets is around 15 months, so it amortizes pretty fast.

Right, and do you have to put more on? I think the way it works, is you make and put them to you as long as they [Inaudible] model and stuff like that. So I mean I hear what you're saying that it's a 15-month duration, but for every one that goes away, you get another one.

No. They're done in tranches. They're not done day by day by day. They're separate tranches and we haven't had one for 6 months now. I think the next one's scheduled for December, if memory serves.

Ian, I would just make a point on the credit side of these instruments, as you know they're credit enhanced and 92% of them give or take 1 percentage point are AAA. As Steve said, this portfolio is performing exceedingly well. Beyond our mid case and of course before we did the transaction, we structured it to down case. So -- as Sabi said, it's burning off. The portfolio is amortizing extremely quickly. So candidly we're very pleased with the result today. It was a purchase of a structured transaction. So modeled as we said 90% of a percentage on AAA and structured with credit enhancement. We gave up a little bit on the upside yield which the residual risk was taken, so to me it's a very good risk/reward.

Questions on the phone, please.

Your next question comes from Steve Carly from TD Newcrest. Please go ahead.

Hi there, I think Darko may have asked this question. But I'll try it again. On the expense front, you mentioned right from the beginning, Rick, that there's a whole list of expenses. They almost sound as if you could turn the key off if you wanted to if you felt that some of the initiatives weren't exactly panning out. Scotia's been pretty up-front with the analysts and investors about various initiatives that you've been doing in keeping this constant update of what you guys are up to. I think you guys are better than most banks in letting us know what you're doing. Are you doing a lot more than you used to do? Obviously you've got more franchises, you're a bigger bank, are you incurring more of these potential turn on and off initiatives than you used to and can you quantify it?

Yes, well, I don't want to classify, turn it on and turn it off, that's not what we're about. It's sustainable revenue. I'm saying we've got to let these things mature, but we do review on a line item basis all of these initiatives and making sure that the metrics we set are starting to hit. We're going to let them run because so far everything we see, we're hitting our interim metrics on generating whether it be customers, or revenue or what have you. Everything we business case and we metric. And if one is -- they're all not going to work. And so we'll be prepared to touch.

What are we doing differently? Look at the Canadian branches. This is the first time since 1998 that we will open net new branches. These will be in new areas where we're not cannibalizing our, to any great degree our existing businesses. Because again, we've still got a long way to go in some of the demographics to cover the market. We've got a lot of that going on. You've seen our sponsorship programs which are not there just because we want our name on a building. It's because we want to get customer recognition. When customers change financial services, everybody wants options, but the facts are they go to 2 to 3. And where we've got great metrics on our existing customer base, high loyalty, high retention, what have you, those many Canadians who have not had the benefit of dealing with us, we have not been on their radar screen. So we're doing that, but we're data marketing our response rates and what have you in the Ottawa valley where we did the Scotia Bank place.

So there are a lot of them. The projects that Chris and I have mentioned, our term lending, these are 40 to $50 million projects that are going on in both investment program, personal lending program, got a huge on our commercial restructuring where we're actually taking all the administration of our commercial offices. Again those similar numbers in that. So there's a lot of things going on. Of course, once we get to international, there's a lot -- sales and services in some of our mature markets and what have you. That's what we've got to do and we're blessed with not only the people who can execute, but we've got the capital and we've got the multiple revenue streams that we can continue to invest and still produce, which I think is a very extraordinary high level of profitability and a continued growth rate which I think will meet and hopefully more than meet shareholders' expectations.

If I look at the domestic bank, for instance, 60.2%, hopefully my model is right, was the efficiency ratio in 2002. And since then, the ratio has gone up ever so slightly. And when I'm modeling forward now, it feels as if I can't go any lower than let's say what you just reported whereas some of your banking peers, TD, Royal, I know this calculation is not necessarily on apples to apples, but if you look at their trends, their trends are certainly to much better efficiency ratios. TD obviously has benefited from CT. There's a whole bunch of things in there, but your efficiency ratio hasn't improved according to my model since 2002 in the domestic bank. Which isn't exactly how Scotia would typify itself.

I think that's fair Steve, but as Chris said we've had two major projects in the domestic bank that were not cheap, being the term lending system and the investment platform. Those are in the numbers. If you also take a look at the numbers in terms of staffing in the supplementary package, we're increasing our manpower on the wealth management side of the equation, the training costs relating to that are also in there in addition to the compensation level. So what we are doing is investing for future growth and that's going to have in the short-term a negative impact on our productivity ratio within the domestic bank. Over a period of time, that will bear its fruit and we should see that go down. Chris, maybe, do you want to comment a little more on that?

Sure, one thing I'd like to -- your prior question, Steve, you asked about some of the investments we are making. And Rick mentioned about Ottawa and the sponsorship, but there's a good example of expanding our presence in a community that's important to us. There's a million people in the Ottawa area. We did a review of our awareness in Ottawa before we did the sponsorship and we had a 7% awareness in the marketplace and after we've done this sponsorship now, we've gone to 14%. Now the key issue is going to be how do we lever that into new accounts and new business, but we've got a very strong branch network there?

In terms of going forward, we are adding new branches. We've added nine this year. We'll go with a total of about 17 by the end of the year. And we are going to continue to add as Rick indicated in some of the higher-growth areas. At our fall investor conference a year ago we indicated that we believed we had an opportunity in our brokage side to add more advisers and we gave a number of adding 100 new advisors to go to 900 at this year. We will hit that number and we'll be at 1,000 within the next 2, 3 years at the most. We're continuing to add to our financial consult sales force. All of this, though, is designed to balance our book of business and to focus more on growing our investment and our deposits and our -- basically our liability side of the business.

So that, as Luc said will indicate a little bit of short-term, pain if you will, but we do not want to endure negative operating leverage for an extended period of time. And certainly when I look at the numbers for this quarter, we had higher expenses and I think we've given you the reasons for that. We do not want to continue to build that into our model going forward. That is not part of the plan.

One other thing on the productivity ratio. We have because of our wholesale funding and the fact of our transfer pricing where we charged -- we don't match funded for the business line, we hit it with the 30, 60, 90 wholesale rate, our rapid asset growth is there for finance with our highest cost of capital. And you can see in our interest margin, that obviously has a very fundamental effect on our productivity ratio, which is revenue divided by expenses. So, again, there is a funding issue in there that is structural in our bank. And when we had increases in wholesale rates, whatever, and they go up, and then your assets don't reprice until later on relatively quickly, that has a fundamental affect on the domestic bank. But I'll just back that up. Our net margin -- all bank margin has been flat for five quarters, but the Canadians are taking the hit not only in AIG13, but the fact of the matter is, the wholesale rates go up, and administered rates follow very shortly thereafter. And that's gone on for how many -- a lot of quarters.

Steve, this is Sabi, I just wanted to give you some color on some of these expenses. The four major programs that Rick and Chris alluded to, the term lending platform, the investment platform, the wealth management platform, the restructuring of the commercial bank. Those are all 40 to $60 million programs. I don't want you to assume that that money has yet to come. The vast, vast majority of those expenses have been incurred. So in terms of substance, we can choose not to incur the same level of investment going forward. In a sense we can't, so we have choices that we can still make, that money's been spent, which is in your expense already, so we can say all right 200 million for those four, for those four broke out. We don't have to sustain that level of spending. We can choose to carry it all, or we can choose to reduce it. That is the nature of the stop signs that you refer to. We do have choices to make that we can carry on that level or not.

I appreciate all the color, thank you.

Next question.

Your next question comes from Andre Hardy from Merrill Lynch.

This question is for Brian Porter. There was some disclosure on how much of the retail business is secured, but you're growing your corporate loan book pretty rapidly, can you tell us how much of the business is investment grade today versus when we went in the last credit cycle and how much of your new business is investment grade? And I have another question on the international side. If you back out the unusual item, it looks like the tax rate was close to 20% and that's higher than it's been, can you just remind us of where we are on the Mexican tax rate and whether there were unusual tax items which took the tax rate up?

Okay, maybe I'll deal with the tax and then pass it over to Brian. Andre, we've got a higher tax rate this quarter because of the earnings in Peru. They're taxed at a higher rate, tax rate there is 30%. There are also higher income earned in some places other than Mexico where the tax rate is higher. As it relates to Mexico, we expect that the unrecognized tax loss carry forwards will be substantially totally utilized in Q4 this year. We will have a smaller amount probably for a couple more quarters, but certainly not to the extent that we've had in the past. And we anticipate on a go forward basis starting with Q1, 2007 that the tax rate for Mexico will be in the 15 to 20% range.

Okay, thank you.

In terms of the Scotia Capital portfolio, today the portfolio is 85% investment grade. And as we commented on this call times a number of times, we haven't deviated from our strategy that we started four or five years ago. We've largely stayed out of the leverage loan market in the U.S. We have participated the odd time very selectively, but we just don't think we get paid for the tail end risk in that market. As Steve has commented before, our portfolio in the U.S. and Canada is largely investment grade, we haven't deviated from our strategy. The addition to risk weighted assets is largely driven by the M&A activity that we've seen in the marketplace. And some of that will be taken out with bridge financing in the equity or debt market over time.

But what would it have been in 2000 or 2001 ahead of the credit problems, Brian?

It would have been, I'm going off the top of my head, but the portfolio would have been probably 70-low 70% investment grade.

I would say 65 to 70. And a large much, when you go below the investment grade. Remember the old HLT LBO era, there was the heavy percentage of that in there. I don't know if we're going to go into -- I don't think we're going into any significant downturn but there's going to be a hard landing or a soft landing. But if we were to go into one, our portfolios now are in substantially better shape than they were say 2001 and 2002.

Back at that time, the positions would have been a lot lumpier than they are now in the leverage center. We have a lot more discipline about how much money we put at risk at the higher risk and of the spectrum. We don't think we can get in as much trouble as we did back in '01 and '02. We've basically worked hard to preclude ourselves that opportunity

That's very helpful. And maybe a last question if I may related to Maple. Is there anything you can do to accelerate an improvement in deposit? In funding costs there? Or it's just going to be a matter of mortgages getting renewed?

I think that's going to take time because the mortgage renewal side, that's about a 5-year term. I don't think -- in answer of your question, no, I think that's just going to take time.

But we have improved our market share in term personal deposits through our very aggressive GIC strategy. And the market share is 50, 60 basis points year-over-year.

42.

42 in the last metric of market share. So that is increasing our -- that's personal retail and GICs, so it's attractive in a rising rate environment which we had for the last year. That's starting to correct. But Chris is right, this is a long journey, but one we'll take.

Thank you very much.

Next question.

Your next question comes from Susan Cohen from Dundee Securities.

Thank you. With respect to acquisitions, you mentioned that the pipeline is strong. Could you update us with respect to your priority businesses and your priority countries with respect to acquisitions?

Yes, there's really no change, we're hopefully we'll -- we look at all our business lines, we did Waterous last year, which what a great time to buy an oil and gas company 18 months ago in M&A and that's there. So we're not -- there's a lot less, obviously, and we're not too acquisitive in buying companies in the wholesale. As we saw in the GMAC acquisition, we're always on the look for those kind of innovative deals. In domestic it's obviously going to be, see if we can do in wealth management, but not necessarily just wealth management. Maples was an example. We're looking, because -- we believe there's still potential there. But obviously international becomes the main one. We are essentially staying to those countries we're in. But we're in 45 to 50 of them. We're going to stay in acquisitions in the developing world or the emerging world. And again, you've heard me speak about the U.S. before, so that's not likely to be on. And the pipeline in these developing countries is -- is it continues to be strong. You cannot speculate as to timing or place. But it will be very consistent from everything we have said over the last several years.

Thank you.

We have time for one last question on the phone.

Your last question comes from Mario Mendonca from Genuity Capital Markets.

Good afternoon. Just when you sort of think you understand how NIM's move there's something else that happens that sort of invalidates your understanding. And I'd like to sort of maybe see if I could advance my understanding a little more. You've talked, particularly for Sabi, you've talked a fair bit about the GICs being an appropriate place to be, particularly as wholesale funding costs were moving materially higher. With wholesale funding costs slowing down here, possibly even reversing course, the whole idea that you've pushed more aggressively into the GICs, presumably longer to you than the 30, 60, 90 day wholesale funding. Does that constrain the capacity for the NIM's to improve the wholesale funding coming down?

Well, it's Bob, Mario. In theory it could if you were prepared to gap to that degree that you would fund a significant portion of your balance sheet with very short date funds and if they came down in a hurry, you would obviously benefit from that. The problem is life's not that simple. So you're always balancing off the extent to which you are prepared to take that kind of a structural rate bet. And in our case as has been pointed out, we have in relative terms such a large shortfall of retail deposits that we think it makes sense to aggressively go after those medium terms, these are not long dated GICs, these are medium term GICs.

A little over a year?

Yes. Typically a two-year area is where the concentration is. Secondly, right now, again, we happen to have an anomalous yield curve where you actually have an inverse curve. So you're not really paying away in the short run for the term funding as you would normally if you had an upward flow through yield curve. Now, you may be paying away 6 or 9 months from now if we get an aggressive lowering of short rates beyond what we've seen, but we don't think it's going to happen dramatically and quickly. We think there's lots of time for this portfolio to mature and the benefits that we talked about earlier to show through.

And -- this is more strategic than financial. But these are personal term. So there's a strategical region. This is not going out into the institutional one-year two-year market and putting a big $50 million term thing on there. This is very well distributed retail wise and has a core aspect to it.

So it's fair to say that you'll continue to pursue the GIC market?

Yes, we have a long-term goal. We've got to get more core deposits in Canada. And it's a very tough thing to do as we all know, but we are doing it and we will continue and that will reduce our -- the next time we get into a cycle like that we'll have more flexibility.

Sort of, not to sort of harp on the international expenses too much. But you can see from your supplement international expenses, noninterest expenses $477 million, reverse the 51 million that goes through that line, you get to 528. I was struck by that number because I immediately compared it to Q4, 2005. And Q4, 2005 was special, that was the quarter when the expenses were unusually high. So now we see another quarter where they're even higher than that. What I'm getting at is the additional expenses that came through this quarter, certainly there were some acquisitions that would have effected that, but was this across the board? Was it Mexico, South America, the Caribbean, just across the board expenses? Or was there a particular region where you focused?

No, it was really across the board, Mario, Peru contributed approximately 50 million to that increase. We had some increases in Mexico because of the branch openings. We also have higher profit sharing there because of the results we have locally. We had some additional litigation costs international this quarter in the 10 to $15 million range. We had less significant increases in the Caribbean, so that's a bit of a break down in the quarter-over-quarter. When you compare to Q4 last year, you didn't have acquisitions in there that you've got in there now.

Okay.

And one of the things, I quote those numbers for Peru, that doesn't include some of the additional expenses in terms of the integration. Those are the local costs, we've got a cost component here that relates to that as well.

I guess what I'm trying to wrap my mind around, is it would seem that Scotia -- if you're getting outsized growth in a particular area, that growth is used to fund -- sorry, outsized earnings in a particular area. Those outsized earnings are used to fund long-term growth initiatives elsewhere. What I'm trying to understand is for the next little while, is the goal, reap the benefits of wholesale earnings growth because of, for example, this wholesale loan growth, GMAC, for example and use that to fund growth elsewhere so that say the domestic and the international looks a little soft. Is that sort of a long-term or at least maybe for the next 12 months? Is that a way to think about this?

Our underlying priority is to produce sustainable revenue growth throughout the whole organization. Our one-team one goal. Sustainable revenue growth. And while we are very conscious of making sure we hit our yearly targets and our guidance and whatever and that, we are here to grow businesses and continually show sustainable revenue growth. And so that's what -- we have so many of these initiatives going. Some are front end and some are starting to reap, and we centralize our capital expenditure, our investments. Business cases from a very low level come up and have to justify themselves on sustainability of revenue and hopefully also reducing costs. I'm giving you a generic, or a very broad answer because it's 1,000 steps. There's nothing transformational. We make an acquisition in Peru, but hat's -- it's consistent and it's not huge. So, yes, we're always funding tomorrow's growth.

Thank you.

Thank you very much for participating in today's call. We'll see you next quarter. This conference call is terminated.