Bank of Nova Scotia (BNS) 2007 Q2 法說會逐字稿

I'm Luc Vanneste, CFO. Rick Waugh, our CEO will lead off with the highlights of our results. I will then follow with a review of the All Bank financials and each of the business line heads will review performance including an update on 2007 priorities. Brian Porter, our Chief Risk Officer will then discuss credit quality and market risk. And finally, Rick will provide some closing comments. We will then be glad to take your questions. We also have our two Vice Chairman and Steve McDonald, co-Head of Scotia Capital, are present 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.

Well, thanks very much, Luc. I'm very pleased to report record results, as net income exceeded $1 billion for the second consecutive quarter. Our earnings per share was $1.03, up 16% from a year ago and 2% higher than last quarter. Our return on equity remained very strong at 23.4%. Productivity came in at 53.8%. That's an improvement of 150 basis points year-over-year. So our strategy of diversification across our business line and geographies continued to produce consistent solid results with growth in revenues and cost efficiency gains.

Our capital position remains strong, and of course this allows us to make strategic investments for growth yet continue to reward our shareholders with dividend increases. So today, we're pleased to announce a further dividend increase of $0.03 a share to $0.45 per common. Dividends are now up 16% this year and have more than doubled in the past four years. Over the past ten years, dividends have increased by an average of almost 17%. We're very proud of this record of consistent dividend growth. It reflects earnings growth and our confidence in the future.

Taking a closer look at the performance of each of our businesses, what we call our growth platforms, all of them contributing to the strong year-over-year increase in earnings. Domestic banking continued to have very good performance with strong asset and customer growth along with improved Wealth Management results. We've had two excellent quarters in a row. In International Banking, the combination of organic growth and acquisitions fueled solid year-over-year results. Again, we have strong asset and customer growth in all regions as reflected by very strong revenues, and we continue to invest in business initiatives in this high growth area.

Scotia Capital achieved record results with improved contributions from most of its businesses. We also continue to benefit from a benign credit environment with excellent risk metrics in our credit and our market portfolios. So we've had a strong first half. We are on track to achieve and likely to exceed our 2007 financial objectives, so now we'll pass over to Luc to go through the numbers.

Thanks very much, Rick. As Rick mentioned, we had record earnings and a very strong ROE in the second quarter. Net income available to common shareholders was 1.028 billion, up 16% from the same quarter last year. Total revenues rose 13% year-over-year while expenses rose 10 %, resulting in positive operating leverage. We also benefited from higher interest recoveries and higher loan loss reversals. Quarter-over-quarter, net income rose 2%. The impact of the shorter quarter and lower securities gains was more than offset by the continued growth in our businesses as well as lower provisions for credit losses and higher interest recoveries.

Now turning to slide ten which highlights our very strong double digit asset growth. Average assets rose 18% year-over-year as all of the major balance sheet categories showed strong growth spread across all of our businesses.

Looking at revenues in more detail on slide 11, total revenues rose 13% year-over-year with net interest income up 16% and other income up 10%. The increase in net interest income was driven primarily by recent acquisitions in Peru and Costa Rica, higher interest recoveries in the U.S., and continued organic growth in retail lending assets. In Canada, strong retail lending growth was primarily in residential mortgages and personal lines of credit. Internationally, personal lending increased in Mexico and across the Caribbean. The increase in other income was also driven by good organic growth as well as the impact of recent international acquisitions. In Canada, Wealth Management revenues reached record levels. In Scotia Capital, Investment Banking revenues were strong, particularly M&A and advisory fees.

Now turning to non-interest expenses on slide 12. Expenses increased 10% from last year with acquisitions accounting for almost half of the increase. The remainder was mainly in salaries and other employee benefits as well as higher costs in premises and advertising and promotion to support ongoing business growth initiatives. We continue to invest in future growth through branch and salesforce expansion in Canada, Mexico, and the Caribbean. Quarter-over-quarter, expenses were flat.

Strong revenue growth and good expense control combined to produce positive year-to-date operating leverage. As you can see on the slide, the All Bank operating leverage was 3.2%. Each of the business lines had positive operating leverage. While operating leverage may vary from quarter to quarter, our goal is to maintain a positive ratio for the year. I will now turn it over to Chris Hodgson to discuss domestic banking's results.

Thank you, Luc. I'll be starting on slide 15. Domestic banking had another strong quarter. Year-over-year net income rose 23% and ROE was high at 32%. Revenues increased 8% reflecting continued volume growth of both assets and deposits, partly offset by some margin compression. As well, we achieved higher Wealth Management revenues. Expenses were up 3% due primarily to business growth including acquisitions and additions to the branch network and salesforces as well as normal salary increases. Year-over-year, operating leverage was strong. Quarter-over-quarter, net income was up slightly despite this quarter having three fewer days.

The next slide shows the strong volume growth we've experienced from cross selling to existing customers and adding new customers. We continue to have excellent performance in residential mortgages which are up 17% resulting in market share gains. Growth has come through all channels including Maple Trust, the Branch network, and our mobile salesforce. Reflecting Maple Trust's strong performance we're now number two in market share in the broker channel up from number three last year. We also had very good growth in business deposits up 14% and gained share in both personal term deposits and mutual funds. Mutual funds for the first time in a number of years.

Looking at the next slide and revenues in more detail, revenues were up 8% from last year. In retail and small business, revenues rose 9% as we benefited from strong mortgage and loan growth as well as higher personal and business deposits. This volume growth has enabled us to earn through some margin compression. As well, we had higher transaction and credit card revenues. We also had another record quarter in Wealth Management as revenues increased 12%, primarily in retail brokerage and mutual funds. Compared to the prior quarter, domestic revenues were essentially unchanged. Higher mutual fund and private client revenues and continued asset growth offset the impact of the shorter quarter.

Finally, I'd like to provide an update on some of our key priorities for 2007. In mutual funds, we're very encouraged by the continued strong sales performance, where we've set aggressive sales targets for the year. We had record net fund sales exceeding $1.5 billion for the first half of the year. In comparison that would have been 300 million in redemptions a year ago. As well we recently announced the hiring of several highly respected industry veterans to enhance our mutual fund product offering and drive sales growth through all of our distribution channels. We also continue to see strong growth in fee based products such as rap accounts which are nearly double the level they were three years ago. We've achieved record levels of assets under administration and management thanks to growth in a few areas in particular, mutual funds, brokerage, and private client assets.

In addition, we continue to look for ways to grow our customer base with new marketing and product initiatives such as the scene rewards program in partnership with Cinaplex Odeon, and finally, we continue to expand our distribution capacity, opening nine new branches to date this year with the balance of our planned openings which will take us up to 35 new branches scheduled to occur in the second half of the year. So overall, a strong first half, making solid progress in achieving our priorities which is good operating leverage and increasing our earnings momentum in the domestic business. I'll now turn it over to Rob Pitfield to talk about International Banking.

Thanks, Chris. Turning to International on slide 20, International Banking's net income was $293 million this quarter, an increase of 9% from last year. In the Caribbean and Central America, net income rose 8% reflecting strong organic growth of 25% and the positive impact of acquisitions in Costa Rica, Jamaica, and the Dominican Republic, partly offset by reversals of, benefits of reversals of loan losses last year.

In Latin America and Asia, earnings rose 52% primarily from the Peru acquisition as well as very good asset growth in Asia. In Mexico, earnings were 5% lower. We had very strong revenue growth up 16%. This was offset by higher expenses to support branch expansion and other business growth initiatives, higher retail loan losses reflecting portfolio growth and a higher tax rate, compared with Q1, international banking's net income was 7% lower. Mexico accounted for most of the decrease. Good revenue growth this quarter was offset by the positive impact last quarter of the reversal bonus accruals and loan losses. The underlying business trends in Mexico and other regions are very positive and we continue to invest in business initiatives to continue to drive revenue growth.

Looking at revenue growth in detail, Mexico's revenues continue to be robust, 16% year-over-year increase. This was driven by high levels of retail asset growth, 57% mortgages, 44% credit cards as well as a steady spread and higher retail and Capital Markets fees. Revenues in the Caribbean and Central America increased 25%. This is reflected in part by the acquisition in Costa Rica of Interfin, and the acquisition of Citibank's portfolios in the DR. As well, there was strong organic retail loan growth in several other countries particularly Bahamas and Trinidad and Tobago. Latin America and Asia revenues increased 62% primarily from acquisitions in Peru and good loan growth in Asia. Overall, you can see that we've got a very good balance of revenue streams throughout our various geographies.

Finally, talking about 2007 priorities, organic growth continues to be very strong. Our sales and service models that we instituted are driving good retail growth throughout the regions. Loans are up 3.5 billion, 30% from last year with about two-thirds of the increase coming from organic growth. We're expanding our distribution network 125 branches, 120 AVM's this year. We've added 14 this quarter on top of the 14 in the first quarter. We've included a private client unit that opened in the Bahamas and will rollout another seven over the course of the year.

We drove good customer acquisition. We've got a good credit card sales strategy in place in the Caribbean and Latin America. We're increasing our non-branch salesforces, expanding our telemarketing and direct mail programs. Our acquisition strategy continues to produce very good results for us. Acquisitions improve Costa Rica, DR, and Jamaica are all contributing well. Our retail loan volumes are growing at double digit rates in these markets. We'll complete the acquisition of our brokerage entity in Jamaica during Bunting and Golding this Summer as well as Interfin in Costa Rica. In line with our Asian strategy we announced the acquisition of nearly 25% of Thanachart Bank, the eighth largest bank in Thailand, the number one auto finance Company and in summary, for 2007, good first half. We should end up that way with a good Q3 and Q4 and I'll pass it over to John.

Thanks, Rob. Good afternoon, everyone. On my first slide, number 24, you can see that Scotia Capital had record results in the second quarter with net income of $318 million. That's up 15% from the same quarter last year. ROE was very high at 33.4%. Revenues rose 13% year-over-year driven mainly by strong growth in assets as well as higher interest recoveries. Expenses increased 3% due to higher salaries and technology cost partly offset by lower performance based compensation.

We also continue to benefit from very favorable credit conditions, as we realized a higher level of loan loss reversals and recoveries mainly in the U.S. with in fact no new loan loss provisions in the quarter. Quarter-over-quarter, earnings were up 8%.

Looking more closely at revenues on my next slide which is number 25, year-over-year revenue growth of 13% was mainly driven by higher revenues in global corporate and Investment Banking which rose 25%. The increase resulted from a significant 24% increase in lending volumes primarily investment grade business, as well as higher interest recoveries on impaired loans. These increases were partly offset by somewhat narrower spreads. In global Capital Markets, revenue rose 3% year-over-year with continued strong results in precious metals and solid results in fixed income. Compared to last quarter total revenue increased 4%. There were higher interest rate recoveries and strong results in Investment Banking particularly M&A and advisory fees partly offset by lower revenue Capital Markets revenue.

Looking briefly at our 2007 priorities, first we are continuing to build our NAFTA footprint by adding new product capabilities. For example, we're expanding securitization and derivatives capabilities in Mexico. We also continue to build global industry specializations. For example, we're broadening client and research coverage in the oil and gas sector to further leverage Scotia Waters. In mining we added expertise with several recent hires and are already seeing some benefits from that. In addition, we're growing our capabilities with alternative Asset Managers also known as hedge funds. The infrastructure for this business has been built and we're now stepping up our marketing efforts and we look to grow that client sector in a very selective fashion.

Finally, we will continue to grow our trading businesses in a disciplined fashion remaining well diversified and focused primarily on client driven transactions. Overall a very good half. I'll turn it over to Brian.

Thank you, John. I'll be starting on slide 28. Credit quality was once again stable this quarter as we continued to benefit from favorable credit conditions. The total provision for credit losses was $20 million compared to $35 million in the second quarter of 2006 and 63 million last quarter. This quarter's provision was composed of $45 million in specific provisions and a $25 million reduction in the general allowance. Net impaired loans were $579 million unchanged from last quarter and a year ago.

Looking at provisions by business line, on slide 29. Domestic provisions were $66 million, a decrease of $22 million from last year, and an $8 million lower from last quarter, due primarily to provision reversals in the commercial portfolio. Retail provisions were higher than a year ago due to the growth in the portfolios. International provisions of $30 million were up $29 million from last year, the second quarter of 2006 benefited from provision reversals in the Caribbean and Central America. The quarter-over-quarter increase of 11 million was due mainly to higher provisions in Mexico as the prior quarter benefited from reversals for provisions no longer required. Excluding these reversals, underlying provisions in Mexico on a Canadian GAAP basis were flat quarter-over-quarter. As well, there were higher provisions in the Caribbean and Peru due primarily to growth in the retail portfolios.

Scotia Capital had provision reversals and recoveries of 51 million compared to 54 million last year and 30 million last quarter. This quarter's reversals and recoveries were primarily in the U.S. portfolio. There were no new provisions in the quarter. Looking at the balance of 2007, we expect credit losses to rise somewhat as recoveries slow and our portfolios continue to grow.

The next slide shows the break down of net impaired loan formations this quarter. Domestic retail had net formations of 78 million, reflecting increasing portfolio size. Commercial had net declassifications of 20 million as a result of a payment received from one account. International net formations of 128 million were primarily in the retail portfolios across the division, largely reflecting portfolio growth. As well, two commercial accounts were classified in the Caribbean. Scotia Capital had net declassifications of 121 million mainly due to the repayment of two accounts in the U.S.

Turning to market risk, we had another good quarter on the trading side with only three lost days compared to one last quarter. The losses were well within the range predicted by VAR.

The next slide has the break down of VAR by risk factors. While the overall average daily VAR was 11.3 million, increased year-over-year on the quarter, the risk is well diversified and controlled, with most of the exposure in the interest rate and equity categories. Most of our commodity exposure is in our precious metals business within ScotiaMacotta.

Now, a few words on how we control and manage market risk. We operate within well defined, Board approved, trading policies and limits. We have risk management staff physically located on the trade floor who provide active, independent oversight of our trading activities. Our staff in GRM independently validate models and market data used for valuation. This includes obtaining multiple independent market quotes. We establish valuation reserves for factors such as risk concentrations and market illiquidity. We analyze and review trading results on a daily basis. While VAR measures potential trading losses in normal active markets, it does not estimate the severity of losses under abnormal market conditions so we regularly stress test our portfolios under various scenarios. All these measures and procedures help us to effectively manage the risks in our trading portfolios.

I will now turn it back to Rick. Okay, thank you very much, Brian. So, to recap, we had a strong second quarter and a first half of 2007. Each of our business lines delivered very good results, as did the combination of both organic growth and the positive impact of acquisitions. This performance reflects the progress we are making in our key priorities, both for the short-term and for the long term, driving sustainable revenue growth and effectively managing our capital. Year-to-date, we have solid revenue growth with increases in each business line. Domestic revenues grew 8% and we continue to experience strong asset and customer growth as well as improving the performance in our Wealth Management operations. Performance of the last few quarters and especially this one has been industry leading in many respects and we see that continuing.

International revenues increased an exceptional 29% reflecting both organic growth and the positive contributions from our acquisitions. Our unique emerging marketing strategy will continue to provide strong results over both the short run and the long run. Scotia Capital has also delivered good revenue growth of 13% driven by higher lending volumes. As well, it has produced very good Investment Banking revenues and a continued high level of diversified trading revenues.

Our second overlying priority, effective Capital Management, and we continue to invest for future growth in each of the business lines. Our capital deployed for acquisitions have produced excellent results to date with more growth to come. We're also growing our distribution networks in Canada and abroad. In the past 18 months, we've added to our salesforces, we've opened new branches in Canada and in international, particularly in Mexico. At the same time, we've upgraded our technology platform in retail lending, commercial banking, and Wealth Management, all of this to drive sales growth. We've also raised our brand awareness by investing in marketing initiatives and sponsorships. These are long term investments aimed at acquiring new customers for example, since we acquired the naming rights to Scotia Bank Place in Ottawa, we have become the most visible financial institution in the region and our timing couldn't have been better. Go, Sims, go.

At the same time of all of this, we've kept our capital strong. This allows us to prudently manage risk in an uncertain world, yet give us the ability to invest for the future and to grow significantly. So in summary we've had two consecutive quarters of record earnings. Each of our businesses is doing well in achieving its own key priorities to produce sustainable earnings growth for this year and beyond. Overall, I believe we are very well positioned to not only meet or exceed our 2007 performance objectives but to continue to achieve aggressive longer term goals and priorities. We'll get there with great people and a one team, one goal focus. That's to be the best Canadian based financial service company in the world. So with that, we'll now open up to questions and hand back to Luc.

Thank you very much, Rick. First question, Jim?

Jim Bantis, Credit Suisse. I just wanted to circle on the International Banking segment and it looks like we might be in a period where Latin America and Asia will be driving earnings growth for a number of quarters and I'm trying to just look at that 124 million coming from Mexico. Are we in a period, Rob, where loan loss provisions are normalizing or catching up to the portfolio growth, tax rate has gone to perhaps a more normalized level because the carry-forwards are gone, and obviously there's a number of expense initiatives with the branch distribution expansion. I mean, I'm just trying to think of Mexico being a muted factor maybe for a few quarters in terms of the international division and the other regions will kind of lead the way given the dynamics we just talked about. Is that fair?

Yes, I think that is fair. I think that you'll have (inaudible) carry forwards will be an issue, loan losses as being normalized will be an issue and the branch expenses will be an issue, but even on top of that which I think is worth noting that core run rate in Mexico is still very strong at 13%, so we're viewing that we'll be able to earn through the impact of these factors that you noted and that will be good and that will be strong, and then the rest of international will continue to grow and expand, so overall, our earnings should be strong on a go forward basis.

Were there, sorry, I may have missed it in the slides but market share with respect to Mexico in the key product areas?

Market share, and I'm very proud of the guys for doing it, market share has been -- consistently haven't lost any market share to any of our competitors. As a matter of fact we've grown in a couple areas and that's on top of the tremendous branch expansion and the people then to front end run the branch expansion and the size of the franchise, so all in all I think they're doing a great job.

Thank you. Just to finish off international, I did notice the ROE dipped to below 19% this quarter and that's unusual for this division, so--?

Well, I think that's just when you look at the expenses. As I said in the first quarter we had a $30 million benefit and that sort of caught up with us in Q2, we'll have that kind of thing where when you consider the taxes, the one-time expenses when they fall in, et cetera, But that should normalize back.

And tremendous asset growth in international land and Mexico.

Was there a result of acquisitions closing at all this quarter or not really?

No. Acquisitions did contribute more in Q2 than they did in Q1 as a group.

Got it. Okay, thank you.

Next question? Michael?

Michael Goldberg, Desjardins Securities. Question for John Schumacher. I think you mentioned that net interest margin was narrower. I'm just wondering, is that sequentially, leaving out interest for capture and with that in mind, if I was to estimate that interest per capture was about $35 million this quarter, would I be far off?

Maybe I could take the question on interest recoveries, Michael. In the current quarter, interest recoveries were about 25 more than they were in the previous quarter. That's a plus but we also have to take a look at, we had under the new financial instruments standard, we had mark-to-market on non-qualifying derivatives going the other way and that was in the neighborhood of 15, so the net impact of those two on the quarter was about ten on a pre-tax basis.

The other question that I'm wondering about is on risk weighted assets, the on balance sheet is roughly flat sequentially, but there's significant growth in the off balance sheet risk weighted assets. What's that all about?

Brian, do you want to take it?

Yes. I'll make a comment about it in terms of quarter by quarter. On the derivatives side on the equity derivatives side on a client driven, this is obviously a client driven business, we did some trades with high quality counterparts that were short-term dated over the quarter end, and on the credit derivatives side, again a client driven business. We've been growing that business and we had some growth in the book over the quarter. Some of it in our correlation trading book but that business as we've articulated here before continues to grow nicely.

One comment I could add on that. I manage the correlation book obviously. We do not have a specific risk model of proof for that book yet. We are planning on getting an Aussie approval within the year. We had that model approved, our risk assets would come down I think over $3 billion. That is going to explain most of what you're concerned about, most of the bump you see in risk assets.

Regulatory capital does not acknowledge the hedge is what John said.

Right. What I'm also wondering about is is this really just anomaly, the [$26 billion] increase in the quarter in the off balance sheet risk assets, should I look for that to be sustained or is that just an end of quarter anomaly?

I think 3 billion of it will be relieved once we get this model approved, but the answer is that we are increasing our risk asset usage by expanding our client businesses and so you can expect that to continue. I'm not sure what the safe number of relief we'll get for the specific risk model but it's very immaterial. Might be easier to talk about this next quarter when we get, Brian, I don't know if you'd know.

I don't know about the timing, John. I'd be happy to talk about it when we get it resolved.

Michael, it's Sabi. If you really look at the growth in risk dated assets and off balance sheet on Page 15 of the supplementary package you can see the gradual build up in risk weighted assets and off balance sheet gradually over the last two years so that's a gradual build up in the business overall as John said so you can expect some continuation build up in growth in the business.

Well,--?

It's larger Q2 over Q1 but there's a gradual build up over some period of time--.

It's really mostly in the past two quarters where it's up about $9 billion or so.

It's up Q1 to Q2, last year from 8.9 to 5.1 billion then dropped off so there's a gradual build up over time. It's not just in two quarters.

And as well Michael the other thing that I'd point out if you take a look at the on balance sheet, the securities, we had a deconsolidation of a BIE this quarter so that impacted that as well, took assets off the balance sheet.

And I have one other question. There's this big increase in the other other revenue line. It's up about $60 million year-over-year which is roughly 50% and 22 million of quarter-over-quarter and not as big a percentage but what are the factors that are driving that?

On the year-over-year Michael, the largest single component of that would be the acquisitions that we have done. You'll recall that most of our acquisitions only started kicking in in the back half of fiscal 2006 so that's the largest impact there. With respect to the current quarter Q2 versus Q1, it's about half of it correlates to securitizations.

And the other half?

The other half is just a, the other odds and sods it's about $10 million in various components through the various business lines, nothing individually significant at all.

And on the year-over-year, is it any particular revenue line that's contributing to it from the acquisitions?

No, not getting widespread different acquisitions, Peru, Travelers, Interfin, and Costa Rica.

Okay, thank you.

Ian?

The first question for Luc, just looking at the Mexico contribution, you give the break out in slide 39.

Yes.

But it looks as if when you bring it into the quarterly numbers, you actually get another bump of about $15 million. What's the difference between how you come up with it on Page 39 and how you come up with it on Page 20.

One is Scotia Group Mexico which ties into the local press release and the other we've got a rep office and some other Mexico revenues that are included in what we call our Mexico business line.

It seemed to be quite strong this quarter though.

There was some hedging activity that took place that came into that other category in a positive way.

The second question is more microquestion. Your credit performance is absolutely amazing, just stellar credit performance. Brian, when you think about this, your gross impairs and your net impairs on your allowances still remains very high, so the potential for recoveries and reversals you would see as still there. But you always worry that you're coming to the end. How do you think about that in terms of the bank in aggregate?

Good question. When we look across the portfolios of the bank, obviously Scotia Capital benefited from 51 million in recoveries this quarter. We're getting towards the end of the recovery in that business. I think that's fair to say it's hard to judge when they will come in but we're getting towards the end of the recoveries. If you'll look at the other portfolios, they continue to perform very well. The domestic commercial business has been very resilient in the face of higher energy prices and a strong Canadian dollar.

What we're focusing on is the international portfolios both commercial and retail. You've seen formations gradually rise which we talked about here before, but well within the risk tolerances of the business, so they're growing organically and by acquisition. The other comment I'd make is that just going back to the Scotia Capital portfolio for a sec, we've retained our discipline 76% of the portfolio is investment grade. We have done, we've been involved obviously in this M&A market in a number of bridge-type financings. We track bridges very closely in terms of risk rated, how they are going to be taken out, Capital Markets, asset sales, et cetera, So the portfolio continues to be, perform well and high grade.

Some of the commercial book in Canada had recoveries as well.

There was one recovery of an auto parts business which we classified last year at this time and we were able to sell the business.

Wouldn't you have thought, I mean, I would have thought manufacturing, you would have thought some of those by now would start to deteriorate. We're seeing it at some other banks and clearly, you guys are following better than your peers.

Well, and again, we've taken a hard look at these portfolios over a number of years. We've been vigilant in terms of our discipline and we've made some divisions with Scotia Capital and elsewhere to sell certain assets we didn't like. We hung on and you witness it through the recoveries where we thought there was value, we held the asset we realized on the value. So your question how long can it go on, there's the next couple quarters we view the outlook for Scotia Capital and the commercial portfolio as stable and you're going to see gradually rising formations in the international, retail, and commercial business commensurate with growth.

Let me add just a little bit more to that. I've been a lender, just say a long time. And through many many cycles including down in New York in 2001 and obviously, you always have to be concerned with now long this can go on. From a view right now, the portfolios have never been in as good shape as I've ever seen them in my career, Brian referred to the investment grade of the portfolio and the concentration risk, the average hold and what have you, so from where we are now, the portfolios are in very very good shape.

The question then becomes where are we going, how long the cycle? I spent a lot of time talking to people on the cycle and no one knows except we've been in it a long time but we said that last year and we said that the year before, but going in we're in good shape. You really look at where we are in our underwriting, because it's the stuff that you're putting on now that will create the habit going forward and again we're continuing with our disciplines, hold levels, and distribution. The syndication market has been fantastic to distribute risk, still is. That will probably come to a halt and everybody is saying well hopefully it's not the ones we're syndicating but the actual underwriting will determine what your loan loss is and while the underwriting is starting to show some signs, covenant light and the highly leveraged stuff, perhaps less equity, just looking at the equities let's say on an LBO or a deal, still much better than the prior cycles.

I mean, still to this day, maybe because there's so much private equity around and it's so liquid, there is still cash equity in most of these deals and these are generally public deals so you can look at yourself and much better than it was down in the time of junk bonds and all that, but again, so I don't see the deterioration. We grade our loans every time we do it and we're trying to keep the discipline on the grading and we don't see the degrading, even in our underwriting where we're approximately the same ratio of investment grade as we have on our books. But it's there.

I perhaps worry more about marketing and liquidity risks right now than I do the credit risk because the credit risk even when it does happen is going to be so well versed and you look at our portfolio, we will have higher loan losses, that's part of our business but on a relative basis, that part of it is the new technology and the market risks and the growth and the asset classes that we see and these other things, but again as we look at our book and as we look at it again, you worry about it because of the growth but the warning signs are there just because it grew so much but we don't see it happening. Now, that's why again we're going to keep the discipline on and give up a little growth on the earnings I guess, but you don't see an event happening soon. Having said that, what will next week bring, but we're in good shape.

Thanks, that's great.

Could we have the first question on the phone, please?

Your first question comes from Brad Smith of Blackmont Capital. Please go ahead.

Thanks very much. Question for Chris with respect to the retail brokerage, Chris, the assets under management seem to be growing and getting some real traction. I read them up 3.1% sequentially. I was just wondering if you could comment on your broker count and your plan there and where you stand relative to your year plan and perhaps put your retail brokerage AUA in context with respect to market share and the recent trend?

Okay. All right. Thank you. Actually, the full service brokerage revenues are up 7% year-over-year. We have just under 900 advisors by the end of this year, we will be close to 1000 which was what our target was. We're at about 66 billion in assets under management, and in terms of average assets per IE investment executive we're in the 70 million range give or take, so we are certainly growing that business. We've indicated that we wanted to continue to add advisors. We're doing that. We're also moving that business more to a fee based approach so we've got a very large fee based book in that business and the bottom line is in this business while we're somewhat smaller than a couple of our competitors, we're very productive in terms of the amount of business that this group does certainly in terms of new issue and other types of business.

One other comment on wealth overall, in terms of our revenue increase in the overall domestic business, wealth more broadly contributed about 30% of the revenue increase this quarter, so wealth is taking on a bigger piece of our revenue increase for the business overall and the full service side contributed to that.

And just in terms of market share, is that something that you have some clarity on? Do you feel like in your mortgage book, you feel confident that your market share is increasing? Are you seeing that in the retail brokerage side yet?

Well, the issue with market share and retail brokerage is you can look at it from one of two perspectives. One is the total number of advisors and the other is assets per advisor, and to be very specific and answer your question, I think we're far more focused on assets per advisor and in that respect, we do have a little ways to go in terms of a couple of other firms, but we think we are making up ground in terms of growing that part of our business but we're not entirely where we want that business to be yet.

Okay, terrific. Thanks very much and just a quick follow-up for Rob. I believe from what you were saying earlier, Rob, you've got a fairly big buildout in the second half of the year in terms of branch expansion in your portfolios to hit your '07 targets. Should we be expecting that to produce an incremental drag on operating leverage in the second half of the year in the international segment?

No. It will obviously have more of an impact, but we planned for it. It's entirely consistent with the cash flows of the business. We've said over the last while that typically when you put in 100 branches, you're on the 30 million mark. We'll be less than that, so we're just continuing on. If we don't hit the number 85 to 100 by the end of the fiscal year, we'll do it by the end of the calendar year. We're not positive if it leaks into another year. This has been something now we've been doing for about two, three years and we get better at it and more efficient and that's business as usual.

Another way of looking at it, we are funding this expansion with internal revenue growth and still having positive operating leverage. That's how good those numbers are. We gave a bunch in the presentation, the growth in mortgages and personal lending so you had dynamic growth there that can handle 85 branches and these branches are not quite as expensive as they are in Canada, but again, the revenue, this is self-funding and still having a positive leverage which is a great place to be because you're producing short-term performance but building for the long term at the same time without impairing your numbers.

And that's been our objective all the while to try and do this build and this build is not only in Mexico. It's really all over international and it sometimes makes it awkward to follow, but we've been able to maintain that positive leverage now for quite a few quarters and that's our goal going forward.

Okay, terrific and last question, Luc, you've given us some detail on the organic versus acquired break out on the expenses. Can you do the same on the consolidated revenues for us?

Half of the revenue growth is from acquisitions in international.

It is, okay, great. Thank you.

Your next question comes from Sumit Malhotra of Merrill Lynch. Please go ahead.

Good afternoon. The question is also for Chris. Chris, the operating leverage in domestic that you suggested we would see in 2007 seems to be taking place. So far revenue a big factor in that. When I look at your net interest margin over the last three quarters we are seeing some stabilization there. Looking ahead a little bit how concerned are you, if at all, about some of the competitive and macro factors we're starting to see, the Hawkish Bank of Canada upward movements the GAC rates, VA rates, funding has been an issue that we've talked about in the past, if we go back to the first half of last year, do you have some concern on where the margin is going to go in the back half of the year?

That's a great question and we spend a lot of time obviously looking at where we think rates are going to go, and the reality is that we believe that we're in a little more benign rate environment. We pay a lot of attention to it in our domestic business because of the gap but we've really focused on deposit growth over the last couple years and our deposit growth now, while it isn't exceeding our mortgage growth, is getting very very close so we've got quite a program on to grow our deposit side. The other comment is that we also look at the operating leverage over for the balance of the year and we're going to continue to invest in the growth platforms for the domestic business, so to Rob's comment a moment ago on new branches, we've got a number of new branches which we have planned for the balance of the year and that is going to contribute to our expenses in the second half, but having said that, we also have updated you in the past about technology projects and this past quarter, we launched investment platform which was something to consolidate third party funds so that's now in the market and that's contributing to our numbers in terms of funds and we're also launching for our brokerage side a new client committment platform over the next few weeks, so those investments that I've talked about in the past are being executed on now, but we obviously do continuously look at our book of business. We're continuing to get deposit growth actually in our high interest savings account and we've got some other products that we've been launching where we're attracting good deposits in that area and that's one of the reasons we've had market share growth. So we pay a lot of attention to it. We prefer to see rates come off a bit but they've certainly leveled out and Bob might even have a comment on that on the rate front.

Yes, I mean, I'm sure everyone saw the Bank of Canada's comments this morning, clearly more hawkish than the market expected, so it's entirely possible that we will have some rising rates in the latter part of the year here in Canada. If you look at our Canadian currency gap, you'll see that that actually benefits us in the very short-term. We're asset sensitive at the very short end of the curve so we'll actually get a little bit of a lift, should there be a rise in administered rates in the short run but as Chris says longer run, we would rather rates not be rising than if they are, but I don't think that it's an issue for the earnings for the last half of the year. If I could just add to that. The environment that hurts us is the environment we had when we had those rapid rise of short-term rates, about seven or eight policies and you look back in '05 and '06 you had a rapid rise of short rates.

At an All bank basis and even in domestic, rate stability, we would rather have a positive yield curve, rate stability ain't that all that bad, but we're not sensitive like we used to be in the old days on the interest rates, but if you get rapid rises, especially given the growth rate we've had in our mortgages and what have you, that created a lot of that compression you saw in our margin and in particularly affected the domestic bank where again with our transfer pricing and that. So again, we see the environment going forward and notwithstanding the hawkish outlook, the strong Canadian Dollar, we're not a bank that is calling for rapid increase in rates. There may be some rate increase but it's not going to be like it was in that '05, '06 environment and the strong Canadian dollar, which as we all know what's happened in that recently, that will have a mitigating effect presumably in the inflation so you don't see that environment. Having said that, we'll watch it closely, so we're not overly concerned on that issue, but we still like to see a positive yield curve.

Well Bob's been open about the fact in the past that to the extent you have to go to the wholesale market to make up some of the difference between the retail loan growth and the retail deposit growth. The wholesale market will price more quickly for the expectation of increases. We've certainly seen that over the last few weeks. On the same extent maybe this one is for Chris again. You've been very active on the GIC front so far in May in Q3 so far in Q3 and GIC has been that term deposit area where you have had the most growth. Your leadership in this regard, is that an attempt, if you will, to stem the use of the wholesale market having to go that channel to make up that differential? Is that why you've been so active on the GIC rates?

Yes. Mortgages continue to grow rapidly.

We've had excellent mortgage growths. We've seen that and we actually believe we will continue to see that so we've been accelerating our strategy on the deposit growth side so the short answer is yes.

We have also been pretty aggressive in the last while in putting hedges in place on our domestic liability recognizing that this risk was there. It's not to suggest that obviously you can see from the GAAP numbers there's still exposure but as I said earlier and as Rick said, it does not seem to be an environment that is going to be particularly problematic.

Okay, thanks a lot, guys.

Next question on the phone, please?

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

Just continuing on with that theme, currency, as we start moving towards VAR here, about 40% of your earnings are coming from outside of Canada. Any sort of comments in terms of your ability to hedge that risk and what kind of earnings headwinds that might create for you?

Well, you've seen it before. Obviously a rise in Canadian dollar for a bank that earns as much as we do, non-Canadian currency is a head wind, clearly, but we're expecting, even the increase we've seen is nothing compared to what we saw a couple of years ago is the first point I'd make and even if it does creep up to even a couple more cents which is far from clear I think as Rick indicated, there are a number of other things going on here that could see this currency level out a little bit. We hedge our foreign currency earnings to a degree. We are not able to get hedge accounting treatment on all of them. We are on some. Where we can, we run rolling hedges and we have done that so we have some protection in respect to this but it's certainly not enough to offset the full effect.

My second follow-up, Ian was talking about credit with both Rick and Brian and I thought the answers were actually pretty good there and I just wanted to--?

You sound surprised, Steve.

Well, you know what, Rick your credit experience in the past is helpful in cyphering out some of this stuff, but what I'm interested in is you've got that international book that's basically doubled since 200, so I guess my question is for Brian. Where do you think, Brian, let's say if we start to see the cycle turn, where do you think Scotia will first see it? What will be your leading indicator?

That's a good question, Steve. I think we'll see it on the retail side in the international operations would be the first place we would see it. And to a certain extent we would see it on the commercial side again in the same region through some of our Real Estate development hotel-type lending businesses.

Okay. So then my question is credit cards in some of these international markets. I think you've said, not you, Brian, but I think Rob has said that perhaps you haven't been aggressive enough in the credit card business in Mexico. Is it the time to be aggressive in Mexico right now on credit cards?

Well, I actually debate with Brian on that. His last answer I think is a fair answer but I think that when you look at our performance on our international portfolio, it's very good vis-a-vis the other banks, the write-offs, the loan loss level, being very steady. The increase that we have in credit cards, number one when you look at the ratio of secured to unsecured versus the other international banks, from my perspective, we are way under weight the unsecured. We have still, again from my perspective a long way to go to get to their kind of ratios, so we're still very very secured from that perspective number one.

Number two, the margins on these businesses, and this business are still, businesses from the perspective of lots of different geographies, are still very very wide, so you have lots of capability to earn through these, any downturn that you might experience and still have a very profitable franchise. So I know it's been a concern of yours, Steve, but we've got a very very experienced retail lending team who have been through many cycles on an international basis and this is far from open up the tops gusher of credit to near prime type entities. This is, these are growth markets, these are customers who warrant this kind of credit and we're doing it at a very judicious clip and with a proper focus on our lending models, we have a focus to enhance our credit risk management even further as I've articulated over a number of these sessions, so I'm very comfortable with it. To Brian's point, you could see a softening there if things turn, but it's not going to be anything material and it will be very manageable.

Just to add to that, Steve, in terms of you were asking the question particularly about international, our five year loan loss experience in the commercial bank internationally is something like 30 or 35 basis points.

What would it be on the credit card book?

On the credit card book, it depends, like Mexico would be around five or six. Overall Mexico would be about 1.8 down from 2.

We're talking a loan loss rate there, sorry?

Yes. And we have, you'd have very many players, Citibank, HSBC who would have larger numbers than that, so it's pretty well established and if you look at the trend lines, the trend lines are very solid, delinquency overall in Mexico is around 6, 6.5 and that's with the tremendous growth that we've had. Two, three years ago it was seven, so I think that we're just doing fine.

And the macro-economics in the markets we've chosen, we're still seeing growth so long as we don't lose our underwriting standards or the marketplace doesn't force us into which we hopefully wouldn't follow bad underwriting so if you look at Mexico, you look at Peru, again widespread because even with 2% losses, the spreads are average international spreads, 400 basis points.

Yes.

But the real issue is unlike the perhaps the debate that might go on in the states with subprime and the economy, that debate is not going on in a lot of these countries. We just came back from Peru and real GNP next year, regardless of copper prices or oil and gas, but based on domestic consumption is running around 7%. That's almost getting to be Asia kind of growth rates. Now, there's volatility in these predictions, but the emerging market thesis and particularly in Latin America where they are now and with what has been developing so we see the portfolios growing and as long as we don't lose the discipline of loan losses and if you look at the makeup of the markets we've chosen to be in, very competitive but disciplined players.

Thanks for being so thorough.

Next question on the phone?

Your next question comes from Mario Mendonca of Genuity Capital Markets.

Try to be quick, Chris Hodgson, 35 branches in the year, nine so far this -- year-to-date, nine, I've characterized that correctly, have i?

You do, Mario.

So we're looking at 26 in the second half, that's three times as many in the second half as in the first and I think you touched the subject a little but I didn't quite pick up on it entirely. What does that really mean from a cost perspective and I acknowledge that a good portion of that is capitalized and amortized over time but three times as many branches what does that mean from an expense perspective?

Well, first of all, you're absolutely right, it is, the majority of this is capitalized. Secondly, it's consistent with what we've done in the past. If you look at last year, we opened 20 branches and the majority of those came in the final quarter, two quarters and when we look at what our plans are for the balance of this year, a lot of these will actually come in, will probably open around ten in Q3 and then the balance will be coming into Q4. When we go back and we look at where we are from a competitive perspective, with the exception of one other institution we've opened the most number of new branches in the last couple of years so I commented that we could expect to see some increase in our expenses over the course of the balance of the year, but that's just investing in our growth platform, so Mario, I don't see a significant bump up.

Particularly because last year it wasn't all that different?

Correct.

From branch openings?

And if you look at the seasonality of it, the reality is and you'll see this likely out of one of our competitors is that a lot of their branches will be opened in Q4.

I see. There was reference to a pension recovery or something about the pension plan and good asset growth. Luc, maybe you can address that. Was there had anything material there from an expense perspective?

Certainly it was going in the right direction, Mario, and that we have had very strong returns on our funds there and that helped decrease the P&L hit in the quarter.

But nothing material like it didn't sound like it was a huge thing?

It wasn't a huge thing but any reduction in expenses I'm happy with.

It's just good management of expenses.

I got it and then finally on loan growth back in domestic, huge loan growth, good portion of that's Maple, from a mortgage perspective I think you disclosed that half of it was acquisitive, the other half was organic. Chris, from a total loan perspective, again, domestic, what proportion of that would be organic versus acquisitive?

Well, I'll give you, I don't know that I'll give you the exact answer on that, Mario. On the revenue growth for the business for domestic I mentioned 30% of it came from wealth, 20% has come from acquisitions and the majority of that came from Maple Trust because Maple has been integrated now and not only are we seeing good revenue growth there, we're seeing good NIAD growth and new account growth. We've opened up 12,000 new mortgage accounts through Maple and it has far exceeded our expectations as far as when we had bought the Company and what our plans were.

Thank you. And then just finally, going back to the rate question, short-term rates in Canada look like they could go higher as early as the next meeting. In the U.S., perhaps not. Does that dichotomy mean anything to Scotia?

It's Bob. It's does in that we've run the two books differently and as I mentioned, we have an asset gap which at the very short end in Canada so that actually benefits from rising rates, we have a liability gap in the United States at the short end of the curve so that would be hurt by rising rates or would benefit from falling rates. For what it's worth, our rate view in the states is still flat to falling. We do not anticipate rate increases in the United States at the short end in the next six months. So we think obviously we've positioned our book within pretty limited parameters because these are not times as we've said for several years in these meetings when it's taking big bets, but within that constraint we're positioned for the view we have. And the funding gap in Canada would be funded entirely in Canada. It's either funded in Canada or if it's funded elsewhere, it's fully hedged.

Swapped into Canadian dollars?

Yes, back into Canadian dollars.

Thanks very much.

Next question on the phone?

Your next question comes from Andre Hardy of RBC Capital Markets.

I'm on Page 13 of supplemental and the caller about operating leverage is you're hoping to be positive for the year. My hope is it's going to be much better than that because it's going to be an ugly second half but maybe some clarity here. On Scotia Capital, are we just seeing revenue mix changing here where you have capital intensive but low cost revenue coming on as the loan growth is growing or is there move than that? And on the domestic side, you've obviously invested a lot in technology in the last few years and Chris kind of alluded to that but from a spend standpoint, is that spend going to come off the books or will it be reinvested in other projects?

I'll start then. On the domestic front, there's been really three key areas we've invested in the last few years. One is our term lending system in mortgages and that was to the tune of $66 million. The other was the investment platform which is a consolidation platform for GIC's deposits and third party mutual funds and that one is about $33 million so there's $100 and there's the XI which is the client committment for brokerage business which is going to be launched in the next few weeks and that's $15 million. So those are large numbers, but once they're in and up and running, then aside from the operating cost, we won't be doing or we'll be doing very well else in those areas.

Our focus is on the expansion of our domestic branch footprints, so we're going to continue to invest in that area but we've also been very clear that there's a couple of product areas where we want to ramp up and one of those would be cards where we feel we've got a bigger opportunity and the other would be insurance. So to answer your question, we will redirect where possible. Some of our funding, if you will, into some of the growth platforms and that's how we will continue to accelerate the growth in the business.

So what we're seeing is probably a temporary widening of a gap in revenue and expense growth? It should come down to more sustainable levels?

Sorry, what should come down?

The gap between revenue growth and expense growth which was 5% in the quarter.

Oh, yes, no, no, I think what you'll see is we made a committment at the beginning of the year to generate significant positive operating leverage and we're still committed to that. I won't comment on quarter by quarter expense trends, but I think we've been pretty clear about the areas we're going to invest in and we're going to continue to do that to get the growth we need in the future.

Andre, I think it's fair to say that there will be some volatility in the operating leverage from the quarter to quarter basis but we're looking at it from a whole year perspective and our goal is, as we said to maintain a positive ratio for the year.

Okay, and on Scotia Capital?

Our operating leverage at Scotia Capital is quite impressive I think. It's certainly ranks well against the security dealers in Canada or elsewhere in the world.

How much of that is mix? You obviously have a much better efficiency ratio in lending and that's what's growing.

I think it's more than just the loan portfolio. I think this organization has had a history of managing expenses very carefully.

I don't think it's just the business, John Schumacher is making. It isn't just the lending side at all. It's my belief that we manage our salesforce related costs around the trading businesses much more tightly than others. I think our revenue per headcount I'm convinced especially with a couple of the other bigger players is much higher, so I think it's not just a mix issue in the sense of tilt towards the corporate loan book. I think we're efficient throughout Scotia Capital.

Okay, thanks.

We'll take a couple more questions.

Your next question goes from Darko Mihelic of CIBC World Markets.

Hi, good afternoon. I'll also be really quick here. Just two questions for Rob with respect to Mexico. The net interest margin there is down significantly year-over-year, quarter-over-quarter, seems to be a bit of a trend but when I look through the statements it looked as though there was a one-time item in the quarter with respect to net interest margin. Am I correct in that or should we continue to see the margin stabilize to go lower in Mexico for the next couple of quarters?

It will be stable, and I'm trying to think of the anomaly you're talking about, because really, what we've got here is a situation where we continue to add more retail to the portfolio, we continue to add more cards to the portfolio, even in a competitive environment. That margin should continue to trend well which it has, so we see the margin being able to hold.

Fair enough. What I'll do maybe is just follow-up with you after the call on some detail perspectives.

Darko, we've had the impact of the ACG 13 or and financial instruments come into play this quarter, so they are with Rob in terms of on a go forward basis, the margin should be solid.

Okay, great. Thank you very much.

Next question?

Mr. Vanneste, there are no further questions at this time.

Thank you very much. We'll take one last question from Michael Goldberg.

Okay, actually, if I could, two quick ones. Brian, you mentioned that you maintain a valuation reserve for market risk. Is Scotia unique in doing that and can you give us some ideas how big that valuation reserve is?

No. It depends on product, Michael and I don't think certainly we're unique at all. I think that it's just good conservative prudent risk management. It depends on the product. For instance, if we have, and there's, for instance, a, in the derivative business, we might have a deferral in some of the businesses in terms of accounting, but in terms of of where we get broker quotes and sources from, if we can only get one single broker quote, for instance, and that's an independent broker quote and I stress that, we have other mitigants around that in terms of valuing the business and one might very well be evaluation reserve.

I can help out with a couple of examples. We have present value accounting in some of our mark-to-market books. The common methodology is to mark the mid between bid and offer. You need a reserve to recognize the fact that you can't typically exit a position at mid market. You have to either go to the bid or the offer. There are credit deferrals, there are market risk deferrals, which relate to the wind down of the books should we decide to exit it we have deferrals related to that so they are very prevalent, everyone has them. I think it would be very rare to find a bank these days not to have them against, especially the mark-to-market books. It's less of an issue against the books where you defer and amortize so you're not realizing a bunch of front but it fits in over time so you sort of have a reserve building up as you go on, anything mark-to-market would have a reserve, at least one if not many reserves.

Finally if I could, just in terms of Maple and the mortgage originations from brokers, what percentage of your mortgage originations are coming from brokers now? And how is cross-selling doing on this, as well, there really seems to be a difference of views between some of the banks. Some are prepared to do business with brokers and some don't want to do business with brokers and you're one of them that is doing business with brokers and growing that business. Do you want to give us your experience and what you think it means for you in the future?

Was that one question?

Thanks, Rick, I counted about a dozen.

Okay, let me start with Maple and originations. In terms of originations, as we are currently without giving you specific numbers, it would be in about the 20% range in terms of originations that we have coming on to our books today. Our average assets within Maple right now is 7.1 billion and as I mentioned our NIAD and our revenue were growing and we're getting a lot of new accounts. In answer to your question about where is the market going from a broker perspective, clearly we're getting more of our business in Canada through, well, we're growing our broker channel and we continue to see that growth building over the course of the next number of years, and we've increased our market share, Michael, which I had mentioned before. We're now number two in that market.

The cross selling component is really just starting and it's really just starting right now, so I can't give you any specifics other than to say that we've got 12,000 new mortgage customers that have come out of Maple and our cross-selling will be starting right now along with some technology project which we, I've commented on previously which will be in place for '08. I can't comment on the strategies of other banks but I will suggest that with the numbers of brokers that are out in the marketplace and the consumer aptitude to actually go through a mortgage broker it fits very nicely with our strategy so we see it as another alternative and we see that market growing and being actually larger than what we were generating through our proprietary channels over time.

Just to be clear, Maple is not our first foray into mortgage brokers. We used mortgage brokers long before we purchased Maple so Maple has been an increment to the broker channel, it is not the only broker channel so that 20% number Chris referred to was Maple. There's broker business over and above that, right?

Yes. Thank you, very much, for joining us today. We'll see you next quarter. The call is terminated.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating, and please disconnect your lines.