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- EVP, CFO
Good afternoon and welcome to the presentation of Scotiabank's second 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. Next, I will go over the financials. This will be followed by a review of business line performance and priorities by each of the business line heads. Then Brian Porter, our Chief Risk Officer, will discuss credit quality and market risk. Finally, Rick will close with some brief comments on the outlook for the rest of 2008. We will then be glad to take your questions. We also have our two Vice Chairmen available to participate in the Q&A. Before we start, I would like to refer you to slide number two of our presentation, which contains Scotiabank's caution regarding forward-looking statements. Rick, over to you.
- CEO
Thanks very much, Luc. As you will see, we rebounded quite nicely with a solid performance this quarter. Our net income was up 9 -- was $980 million, up 18% from last quarter, although down 6% from the same quarter a year ago. Our earnings per share were $0.97, with a return on equity of 21.4%. Our productivity ratio is 54.8%, better than our target of 57%.
This improved performance resulted from continued growth in all of our businesses. As well, we had minimal security write-downs this quarter, reflecting our strong risk management and our very modest exposure to troubled markets. While the conditions in global financial markets continue to impact asset values, our trading and credit portfolios are in good shape. Brian will provide more detail on our credit quality in a few minutes.
This quarter, we benefited from continued solid performance in our personal and commercial businesses, in both domestic and international. We've also benefited from our recent acquisitions. As well, the stability of the Canadian dollar helped us this quarter, although year-over-year our comparisons were affected. Overall, it was a much improved quarter with very little noise. Actually, I was somewhat disappointed that our rebound could not have even been better. However, refinancing activity in our wholesale lending businesses has been slower than we anticipated, and this has delayed an expected improvement in our margins in this business.
Looking at the three businesses, they are performing well. Earnings in each of these growth platforms are up compared to the last quarter. Domestic banking had a very good quarter of solid volume growth and market share gains, also benefiting from higher margins. International banking had good organic growth and benefited from recent acquisitions and investments, particularly in Peru, Chile, and Thailand. Scotia Capital continues to see high quality loan growth and significant margin increases on new business, as well, trading results have rebounded from last quarter. Our credit portfolios are in good shape and we have a strong capital base.
We feel confident that our strategy of diversification and of growth is working well. It's allowing us to capitalize on growth opportunities, deliver solid results and maintain a strong balance sheet. It's also allowing us to maintain our record of dividend increases. We are pleased to announce an increase of $0.02 per share to $0.49 in the third quarter. Dividends are an important part of our balanced capital management strategy to ensure consistent growth in our shareholders' returns. So with that I'll now turn it over to Luc who will go through the numbers in more detail.
- EVP, CFO
Thank you, Rick. Earnings rose 18% quarter-over-quarter. As Rick mentioned, we had minimal securities write-downs this quarter. These items had a net negative impact of approximately $20 million or $0.02 per share versus net write-downs of $0.17 last quarter. We also benefited from higher net interest income and trading revenues. These were partially offset by higher but well contained provisions for credit losses and higher performance based compensation. Year-over-year earnings were down 6%. This was due mainly to higher loan loss provisions as well as lower trading revenues and the negative effect of foreign currency translation. On the positive side, we had higher net interest income from strong asset growth as well as contributions from our recent acquisitions.
Looking at revenues in more detail on slide eight, year-over-year net interest income was up 4% driven by solid asset growth in our core P&C and corporate lending businesses as well as the impact of acquisitions. This growth was partly offset by a lower net interest margin and the $100 million negative impact of foreign currency translation. Other income was down marginally year-over-year. This was due mainly to lower capital markets related revenues, lower trading, investment banking and retail brokerage. We also had lower gains on non-trading securities. However, there were increases in credit fees and mutual fund fees as well as higher securitization and insurance revenues. Quarter-over-quarter, total revenues rose 11%, due primarily to write-downs on structured credit instruments in Q1. As well, trading revenues were higher with record results in precious metals. Partly offsetting were lower Foreign Exchange revenues which were down slightly from record levels in Q1.
Now turning to slide nine, we continue to see very solid asset growth. Assets were up 13% year-over-year, with double-digit increases in most of the major balance sheet categories. Residential mortgages were up 14%, personal loans up 11%, and business and government loans rose a substantial 25%. These broad-based increases were driven by both strong organic growth and acquisitions.
Now turning to expenses on slide 10. Expenses increased 4% compared to the same quarter last year, due mainly to spending on growth initiatives. Particularly for new branches in Canada and Latin America, as well as the impact of our acquisitions. These were partly offset by lower performance based compensation and the favorable impact of foreign exchange translation. Quarter-over-quarter, expenses rose 7%, mostly due to higher performance based compensation in line with improved trading results. We also had a full quarter of expenses for Banco del Desarrollo in Chile, compared with just one month in our Q1 '08 results. Our operating leverage was a positive 4% quarter-over-quarter. We continued to target positive operating leverage on a full-year basis.
Looking at capital on slide 11, capital management is one of our three key strategic priorities. We continue to have a very strong capital base. So far this year, we have generated capital of nearly $1 billion. We have raised $575 million of preferred shares and raised $2.2 billion of subordinated debentures. This additional capital as well as the impact of moving to the 90% floor under Basel II has resulted in higher capital ratios. Total capital increased 153 basis points. Tier 1 capital rose 62 basis points and tangible common equity increased 34 basis points. We will continue to use a strong capital base to pursue growth opportunities. Both organic and by acquisition. Our strong capital also allows us to maintain our record of dividend increases. Our dividend policy is a key component of overall capital management and takes into account our long-term payout range and earnings growth. With that, I will now turn it over to Chris Hodgson to talk about domestic banking.
- EVP, Head of Domestic Personal Banking
Thank you, Luc. Domestic banking had a very strong quarter with year-over-year net income growth of 14%, operating leverage of 6%. Revenues rose 8% as strong asset and deposit growth was partly offset by margin compression. Expenses were well-managed, rising only 2%. Spending on key strategic growth initiatives were partly offset by lower performance driven compensation as a result of slower capital markets. Compared to Q1, net income grew 13%. Revenues were 5% higher as we benefited from strong asset growth and a 14 basis point increase in the margin due to lower funding costs. We're optimistic that the margin will continue to rise during the second half.
Expenses were flat versus Q1. Higher growth spending and seasonal expenses were offset by the effect of the shorter quarter and lower stock-based compensation. We continue to invest in revenue growth initiatives and as a result we expect expenses to rise somewhat in the second half, but we remain focused on managing our costs, particularly in today's environment.
Looking at revenues in more detail on the next slide, total revenues increased 8% year-over-year. Retail and small business volume growth was driven by mortgages, which were up $15 billion or 16%. Deposit growth was also strong, up $10 billion or 12%. Commercial banking had very strong revenue growth driven by 16% asset growth and a higher margin. Wealth management revenues were down slightly from Q2 '07. Despite a tougher environment, we continued to have success in mutual funds, increasing revenues 12%. Due to weaker market conditions, our full service brokerage saw 11% decline in revenues. However, in key areas of focus, fee-based business and insurance, our revenues grew 3% and 27% respectively.
The next slide shows the impact of our growth initiatives in terms of market share. Year-over-year, we've increased market share in residential mortgages by 17 basis points. Quarter-over-quarter, our mortgage market share is down 6 basis points. As competition is very intense and we are maintaining our discipline on pricing.
Moving to the liability side of the balance sheet, we continue to have success in deposit market share, reflecting new product initiatives, selectives and target programs in our acquisition and continued growth of Dundee Bank. Our share in total personal deposits is up 63 basis points year over year, the highest amongst the banks. We've also grown our mutual fund market share by 26 basis points, entirely in the more profitable long-term funds. Finally, looking at our progress in achieving our priorities, we remain focused on driving sustainable revenue growth in several ways.
First, we are continuing to take actions to grow our customer base. We opened four branches in Q2 and plan to open a total of 15 branches in 2008. We've expanded our sales capacity in key growth markets by hiring more than 100 personal and small business sales officers in the first half of 2008. We are also continuing to develop our innovative Scene partnership with Cineplex, and we're pleased with the results so far. Both the number of Scene members which is nearing 1 million the number of new day-to-day banking customers that have signed up has exceeded our original projections.
As part of our multi-cultural focus, we established an innovative collaboration with Western Union. This enables Canadian customers to transfer money to more than 200 countries worldwide online or from a domestic branch. We've also been active on the product front where we recently launched a Bank the Rest savings program, the first of its kind in Canada. And we are in the process of upgrading our branch technology platform, which will provide additional capacity to enable us to more readily implement technologies such as chip and electronic signatures. Lastly, we continue to focus on building our wealth management business. We launched an advisory series of funds and the Scotia Global Climate Change Fund, the first of its kind in Canada. In addition, we have grown and are developing our mutual fund wholesaler team, focusing on select third party advisors. We've also added front line sales in ScotiaMcLeod and Scotia Private Client Group.
In summary, we are confident that our domestic banking business will maintain good earnings momentum and positive operating leverage through the balance of '08. I'll now turn it over to Rob Pitfield to talk about international banking.
- EVP, International Banking
Thanks, Chris. International banking's net income was $326 million this quarter, up $33 million or 11% from Q2 '07, despite the $42 million negative impact of foreign currency translation. Revenue growth was a strong 18% with key drivers with volume growth, acquisitions, Banco del Desarrollo in Chile and our investment in Thailand. And higher gains on non-trading securities. Expenses increased 7%, far below revenue growth. The growth in expenses reflect the impact of acquisitions, ongoing growth initiatives, including new branch openings.
International tax rate increased 22% from 12% in Q2 '07, mostly due to more normal tax rate in Mexico. Compared to last quarter, net income was up 16%, reflecting strong loan and deposit growth and acquisitions. Partly offsetting were higher provisions for credit losses and lower expense recoveries versus Q1.
Year-over-year regional revenues more detail, in Mexico we benefit from good underlying retail loan and deposit growth and higher insurance and mutual fund revenues offset in part by 4X. In the Caribbean and Central America, underlying loan growth was also strong, both retail and commercial and the margins improved. In Latin America, Asia and other, revenues increase a very strong 78% and this increase was driven by acquisitions in Chile, Thailand, strong net interest income growth in Asia, Peru, and Chile and higher gains on non-trading securities. Quarter-over-quarter revenues were up 11%, due largely to acquisitions and loan growth across the region.
Looking against priorities for the year 2008, revenue growth continues to be a top priority, obviously and it's coming through diversification and acquisitions in different geographies, as well as diversification across business lines, customer segments and delivery capabilities. As an example, Chile represented 11% of our revenue this quarter compared to just 3% in the same quarter last year, reflecting the acquisition of Banco del Desarrollo. Our segmentation strategy is also starting to work well. We're leveraging our expertise in consumer finance in Peru to drive growth in Chile and other Latin American countries. We recently launched a joint venture aimed at this segment in Mexico. We started with 15,000 credit card applications in very short order and we think that this will be a very good initiative for us.
The wealth management segment is also important for us. We've opened up four private client centers to date and plan to open another seven plus through the course of the year. We're also growing our delivery capabilities. We've already opened 50 new branches year-to-date and will plan to open about 90 to 100 over the course of the year. Acquisitions will continue to grow. This month we reached agreements to add to our presence in Peru reflecting our confidence in this fast-growing market and to further solidify our leadership position there. We're increasing our ownership in Scotiabank Peru. The country's third largest bank by 20% to 98% of the cost of 230 U.S. 30 million, that is. As well as we're acquiring Banco del Trabajo, a niche bank which will allow us to accelerate growth in the consumer finance market. Moving us to number one in this important segment with more than 130 locations.
Finally, we're focused on initiatives to improve operating efficiency. We're continuing to roll out a series of really world class platforms and call centers, Internet, credit risk management, and financial MIS. So all in all, a good quarter. Our earns through 4X run us some tax loss carry forwards, doing this systemically through diversifying revenues, and geographies, business lines and delivery points. I now turn it over to Mike.
- EVP, Head of Global Capital Markets
Thanks, Rob. Scotia Capital's net income for the quarter was $251 million. Up 34% from Q1, but down from our record quarter last year. Revenues were down 18% versus Q2 '07, which was the highest level since 2002. Expenses decreased 7% from last year, driven by lower performance based compensation. Loan loss recoveries were lower from a very high level in Q2 '07. Quarter-over-quarter, revenue was up 33% as we rebounded from a weak Q1. Expenses rose 27%, due to higher performance based compensation, consistent with the higher revenues. Other operating expenses were well-controlled.
Looking more closely at revenues on slide 23. Year-over-year, the decline in revenue was largely from interest recoveries in Q2 '07, and the loss on non-trading securities this quarter. In addition, tough market conditions led to lower fixed income and derivative trading results. And lower investment banking revenues. These declines were partly offset by a record quarter in our precious metals business, and continued strength in foreign exchange trading. Corporate lending volumes and spreads were also higher than last year. Quarter-over-quarter, revenues rose an impressive 33%. This increase reflected the strong product diversification in Scotia Capital with excellent trading results in precious metals, foreign exchange trading was also very strong but down from the record quarter in Q1.
On the lending side, we benefited from an increase in corporate loan volumes. Predominantly in investment grade credits and wider spreads in Canada and the United States. Looking at our priorities for the year, our number one priority is sustainable revenue growth. We are focusing on a number of initiatives. We are continuing to leverage our NAFTA capabilities, a significant competitive advantage. We are very pleased with the performance of Scotia Capital Mexico where we are leading in underwritings and have strong syndications, cash management and derivative businesses. In addition, we are doing more cross border transactions, not only across the NAFTA region, but also in other geographies, partnering with international banking.
We are further expanding our client coverage globally in selected industries, particularly in energy and mining. These selected sectors represent significant opportunities, which are important to the overall franchise. They operate on a global basis and we are managing them across all product lines. In energy, for example, approximately two-thirds of Scotia Watrous' business is now outside Canada. Its pipeline for the year is strong. Through Scotia Mocatta, we are leveraging our leading position in precious metals, to grow the mining business. Also, we are increasing the breadth and scope of our institutional buy side client base by expanding across geographies and sectors. As well, we continue to capitalize on market opportunities and conditions. For example, our lending business is benefiting from better terms and wider pricing on new transactions. But above all, we will continue to be disciplined about risk management. I will now pass it over to Brian to talk about risk management in more detail.
- EVP, Chief Risk Officer
Thanks, Mike. Credit quality was relatively stable this quarter. Market risk remained well-controlled. In fact, VAR decreased this quarter. As we have said previously, with respect to areas of current focus, the underlying assets are of high quality, our exposures are not significant relative to our overall portfolio, and we reduced exposures during the quarter.
Looking at provisions in more detail, the specific provisions were $153 million this quarter. Compared to $111 million last quarter and $45 million a year ago. The increase over the prior quarter, as you can see, was primarily due to lower commercial recoveries and reversals in international. The increase in domestic commercial provisions was a result of the classification of two accounts. The modest increase in domestic and international retail provisions, primarily reflects growth in these portfolios. In Scotia Capital, we again benefited from recoveries and reversals. There are no new provisions this quarter in Scotia Capital.
Turning to net impaired loans, on the next slide, impaired loans increased $156 million quarter-over-quarter, of which $97 million was due to additional reporting of impaired loans by our recent acquisitions in international. The underlying trend in impaired loans continues to be relatively stable. Looking at impaired loans by business line, the increase in domestic mainly reflects the classification of two commercial accounts that I just mentioned. As well, there were some modest increase in retail, which include higher provisions in the auto leasing portfolio from the Travelers acquisition. The increase in international primarily reflects the classification of a couple of commercial accounts in the Caribbean. The decrease in Scotia Capital was due to the sale of two accounts, one in Canada, the other in the U.S.
The next slide shows the VAR in our trading portfolios. The average one-day VAR has come down from $16.6 million last quarter, to $14.6 million. The decrease was mainly in interest rate and equities, partially offset by an increase in commodities. Looking at our trading results, this quarter continued to be challenging. With positive results on 67% of trading days, compared to 79% last quarter. We saw a higher level of volatility this quarter, particularly in credit markets. As high grade credit spreads nearly doubled before coming back in line with prior quarter levels. In terms of VAR, we do not have any lost days exceeding with one-day VAR this quarter. Overall, we remain comfortable with our market risk.
Turning to areas of current focus, this slide gives you an update on our exposures. Third party asset backed commercial paper was unchanged from last quarter. Our CDO and CLO holdings of $1.2 billion decreased by $200 million. Our investments are virtually all investment grade with underlying reference assets being corporate and sovereign exposures. This quarter, we took a $51 million pretax markdown on our CDO portfolio, reflecting changes in fair value. We are comfortable with our CDO and CLO exposures.
During the quarter, we replaced credit default protection previously provided by a mono line. The bank purchased the protection from a newly-formed entity, rated AAA by S&P. From a risk perspective, we are comfortable with the default protection purchased. Our indirect mono line exposure of $3.2 billion has declined by U.S. $1.2 billion from the previous quarter. Exposure to subprime mortgages is nominal. With respect to our GMAC secured auto loans, as a result of a recent modification to the GMAC agreement, we will be able to diversify a portion of the U.S. exposures to the Canadian market. The GMAC portfolio is performing to our expectations. Finally, we have no exposure to auction rated securities.
Looking forward, we expect credit quality to remain fairly stable for the remainder of 2008. At this time, we do not foresee significant changes in credit losses from current levels. Beyond 2008, given our current outlook for the North American and international economies, we would expect credit losses to increase gradually, reflecting the impact of acquisitions, organic growth and the change in the mix of loan portfolios. As well as lower levels of reversals and recoveries. I'll now turn it back to Rick.
- CEO
Okay. Thanks, Brian. So in summary, as you have seen, it's been a much improved quarter. We see no need to change our long-term strategies. We will continue to invest in our three growth platforms to support both our organic expansion and future acquisitions which will drive our sustainable revenue and earnings growth. The same time, we have strengthened our balance sheet and improved all of our capital ratios.
In terms of our financial objectives, we're on track to meet three of our four key targets. However, the uncertainty in global financial markets has impacted earnings so far this year. And as a result, it is unlikely that we will meet our original earnings per share growth objective set last year. The good news is that as we look to the rest of the year, and beyond, we expect the improvements that we achieved this quarter to continue. Our personal and commercial businesses in Canada and the emerging markets will continue to grow assets and customers at good margins and with acceptable risks.
Capital market conditions should further stabilize and show improvement helping our global trading and our corporate and investment banking business to continue to improve, provide improving results. Canadian dollar is expected to remain stable, reducing the headwinds we experienced from 4X translation in the first six months of this year. And our funding costs should continue to improve. Finally, as Brian and I mentioned, we expect credit quality to remain stable thanks to our well-diversified, well-controlled exposures and strong risk management capabilities. So with that now I'll pass it on to Luc who will open it up to questions.
- EVP, CFO
Thank you very much, Rick. Could we have the first question on the phone, please.
Operator
Your first question comes from Robert Sedran from National Bank Financial. Please go ahead.
- Analyst
Hello. Good afternoon. I guess I just want to start with the dividend. If I look at the new dividend and the $0.97 you reported today. It would imply a payout ratio that's well in excess of the target range. Is it your expectation that you'll be within the 35 to 45% target range for this year if we exclude the write-downs in Q1.
- CEO
The payout ratio is one of the things we look at. But we don't look at it at a quarterly basis and it can get variability on the quarter. So we take a longer term view at the payout ratio. But given the improvement in our earnings, given our very strong balance sheet, and our capital management policy and that we feel comfortable with the dividend increase and our long-term outlook on the payout ratios.
- Analyst
It remains 35 to 45 longer term, I assume?
- CEO
We have not changed our governance on that.
- Analyst
Okay. And just the second question, revolves around credit quality. Brian, I guess it's a bit of a longer term question. It would seem even with the higher provisions this quarter you're still probably the furthest bank from your 10 year average provision ratio. I'm not necessarily looking for near term guidance, although I'd be happy to take it. How should we think about a mid-cycle average provision ratio for this bank, especially with Scotia Capital still looking for net recoveries?
- EVP, Chief Risk Officer
It's a good question. It's a question I get asked quite often. I look at our watch list on a regular basis, as you'd expect. And the gross amount, dollar amount of loans in our watch list category is actually down quarter-over-quarter. The number is actually up slightly, very slightly, at 2 or 3%. But when you look across the different buckets of business fraud, Scotia Capital, we had one provision last quarter. We worked that out. Portfolio continues to perform at our expectations.
If you look at the composition of that portfolio, which I think is very important, if you look at the four biggest industry groups or components to that portfolio, our financial services would be one, energy and pipelines would be number two, power would be number three and real estate would be number four. And real estate largely the domestic commercial business and investment grade lending in the U.S. and Canada. So if you look at asset quality in the portfolio, we view it as extremely strong in Scotia Capital.
If you look across the other business lines, the domestic retail business is growing organically well. The provisioning there, again, we're 90% secured in the portfolio. The provisioning is relatively formulaic. The domestic commercial portfolio we've talked about at this time, given higher energy costs, a stronger currency, et cetera, the portfolio has been fairly resilient. But we would expect the odd non-accrual and we've seen two in the last quarter but we don't see anything systemic in the portfolio. You turn to the international business, and clearly those businesses are growing well. The retail business, we talked a little bit about this before, Mexico primarily we've been watching very closely. Credit to consumers is a relatively new thing in Mexico. So we've seen delinquencies over the past year, 18 months, grow generally in all product segments. In the last two quarters in credit cards, they've come down. We took corrective action. We were concerned about some of the trends generally in the Mexican marketplace. So Mexico, we've put corrective action in place, delinquencies have come down and we would expect loan losses to lag and follow that. The Caribbean market is steady and we see -- we don't see anything there.
In the international commercial portfolio, which I haven't commented on, we had two non-accrual loans, one in Puerto Rico, one in the Bahamas the last quarter. We're concerned about knock-on effects from the U.S. economy. But again, loan to values are less than you'd see in a more developed marketplace. So we've got lots of coverage. We've been there a long time. We know how to work these things out. As Rick said and I said in our comments, for the next couple quarters our view is it's going to be relatively what you've seen this quarter.
- Analyst
Okay. Thanks.
- EVP, Chief Risk Officer
Long-winded answer.
- Analyst
I'll requeue. Thanks.
- EVP, CFO
Next question on the phone, please.
Operator
Your next question comes from Brad Smith from Blackmont Capital. Please go ahead.
- Analyst
Yes, thank you. Rick, I was just wondering if you could maybe make some passing comments about what you're seeing in the U.S., there was some chatter number of weeks ago with respect to possibly making an entry into that retail banking market. I know the table is set with a strong currency and a low relative valuation south of the border. Are you warming up to that as an idea?
- CEO
Well, Brad, it's springtime. But -- we -- we're very comfortable with our current strategies and I've said before, the U.S. retail has not been our strategy and our strategies are working so we're certainly feel no compulsion at this time. Having said that, and you brought it up, the valuations are obviously intriguing when we've seen the great decline in number of U.S. stock prices and of course the relative improvement in ours and with currency, but so we've also been opportunistic but it is not on our strategy. We will watch that market and others to see -- we've always said -- we always look for value and we also look to see what value we can provide. We'll keep our eyes and ears open but I feel very comfortable in our strategies. We got that great advantage that we don't have to do a deal in a market that we're not there. So we're going to very much keep the discipline. The discipline that we've done dozens of acquisitions now over the last several years. We'll keep that discipline, but we feel obviously very comfortable with our balance sheet and our currency and so we'll keep our eyes and ears open. But it's steady as she goes for now.
- Analyst
Great. Thank you and maybe just one other question for Brian. Just looking at the sort of consolidated loan portfolio, looking at the net impaired loans after your specific allowances, that's been climbing couple of hundred million, 266 million, it's up over the last year. Could you just maybe provide me with a little bit of insight into why this is the right time to be letting that net impaired loan balance rise like that with an uncertain economic scenario facing us -- facing the bank in its international segment, particularly and also in the domestic segment?
- EVP, Chief Risk Officer
Sure. Well, good question. If you look at the net impaired loans. You can see on your slide, the bulk of the recent increase in the last quarter is from our acquisition in Chile. And subsequent add-ons in Guatemala and the Dominican Republic. So again, it's a combination of three things, really. One is acquisitions. Two it's organic growth in the domestic retail portfolio and the other portfolios as well. And it's a change of business mix. Peru and Chile have a consumer finance and a micro finance business which we're comfortable with, clearly. And so you're seeing a bit of a change in mix, business mix, so you're going to see in some of these portfolios, again, well-contained, our net impaired loans are going to grow but it's going to grow commensurate with the growth and the profitability of those business lines.
- Analyst
Terrific. Thanks, Brian.
- EVP, CFO
Thank you. Next question, please.
Operator
Your next question comes from John Aiken from Dundee Capital Markets. Please go ahead.
- Analyst
Good afternoon. I guess this question is for Luc. Luc, in terms of the international banking reporting, we've got fairly significant increase in earnings, yet a decline in ROE and now I have to assume that the bulk of that is related to the increase in equity allocated to international banking because of acquisitions. But it does seem like a fairly significant increase in the denominator in the ROE. Was there any change in the capital allocated to international during the quarter?
- EVP, CFO
No, you've hit it on -- the nail on the head, John. It's the acquisition that's have the impact. If you take a look at the note to the quarterly financial statements, the allocation of the purchase price relating to Desarrollo in Chile has got a fairly big number there, in terms of $800 million on goodwill as an example, that gets allocated to the business line so that has a significant impact on the ROE for that business line.
- Analyst
Great. Thanks, Luc. And Rick, I guess wanted to take a look at acquisitions from another perspective, Brad touched on the U.S. But what we saw this quarter was international represented about 34% of the total earnings and I know you stated in the past that you liked the one-third, one-third, one-third split but with the bulk of the acquisitions being on the international front, are you still essentially being restricted by that classification or are you willing to let international, the proportion of earnings from international grow in conjunction with even just the organic growth that we're seeing in that segment?
- CEO
Well, diversification is very important to us. And I like that split. It's about 40, 30, 30, 40 for Canada but close to a third, a third, a third. Acquisitions do become lumpy and you can only do what you can do. We're going to keep our discipline but we're going to keep diversifying. I think one important part of it, while the acquisitions have taken place in international, the diversification of our international earnings is quite significant. Of course we had the great success in Mexico and that continues but now we're much more diversified with Chile and Peru and Central America. But in terms of the big pie and that one-third, we want to keep an eye on that. Although I say we're more diversified in international but diversification in these three businesses is very fundamental to how we look to the future.
- EVP, CFO
Next question.
Operator
Your next question comes from Andre Hardy from RBC Capital Markets. Please go ahead.
- Analyst
Thanks. Two related questions on Canada and one on GMAC. Start with the easy one on GMAC. Are you willing to tell us how high delinquencies need to rise before you incur losses? And on Canada, was there any change in either retail loan growth or provisions for credit loss or delinquencies as the quarter evolved, i.e. was the year-over-year loan growth the same in April as February and was the year-over-year increase in provisions the same?
- EVP, Chief Risk Officer
I'll start off on GMAC, if I can and Steve McDonald may have a comment. But the portfolio continues to perform within our expectation. Net charge-offs reported at the end of the quarter are well within our projections. What we look like, and again we're bound by confidentiality agreement, so I can't say a whole lot, but as a credit person what you're looking for in a portfolio like this is spikes in delinquencies or spikes in defaults or actual losses and we haven't seen that. They've gone up a little bit but again, we structured this. We didn't have a rating agency or a third party structure this. We've got a lot of experience internally in terms of how to structure these types of securitizations. We're comfortable with how we structured it. We've been able to add some Canadian assets into the mix which makes us feel comfortable, provides some flexibility and diversification into the portfolio so again, performing within our expectations.
- Analyst
But just to clarify, were your expectations not to lose money or?
- EVP, Chief Risk Officer
We gave up revenue on the upside to protect the down side. We obviously had a hurdle rate here. We wanted to make money but the -- it's overcollateralized, it's what you would expect in a strong securitization and, obviously we know the business can be cyclical and we planned for that eventuality and we are again comfortable with the performance of the portfolio.
- CEO
Andre, we went into it to make money. Our expectations are we will make money. On that business.
- Co-Chairman, Co-CEO
Andre, just in terms of your question on retail loan growth, no, there has been no significant uptick in provisions, it is purely related to volume and as our volume has risen there has been a slight increase in our PCLs but that is normal and we don't see anything of any significance there at this point.
- Analyst
So the loss rates weren't higher going into Q3 as they would have been during the quarter.
- Co-Chairman, Co-CEO
No.
- Analyst
Thank you.
- EVP, CFO
Next question, please.
Operator
Your next question comes from Ian de Verteuil from BMO Capital Markets. Please go ahead.
- Analyst
Hi. Brian, I think it's beat up on you day. When I think about the GMAC, obviously you guys very pleased with how it's performing but when I look across the bank it does seem as if the auto exposure is high. So you've got GMAC of 6 billion, you've provided some insight into the conduits. You've got another 4 billion in the U.S. conduit. That's auto loans. You've got another 4 billion in the Canadian conduit that's auto loans. You've got the stuff you acquired from Travelers. It's not hard to see that you've got 20 billion of auto lending business, whether it's dealer floor plans, or whatever it is. I mean, shouldn't you think of that in aggregate to the extent we're seeing some deterioration in the auto business in North America?
- EVP, Chief Risk Officer
Yes, that's a good question and it's one we talk about Ian and, in terms of the composition of the auto portfolio has changed significantly in the last three or four years. We de-emphasized the manufacturing base. We've got out of a lot of names in the auto parts sector that we were concerned about so we avoided when a lot of those companies tipped over, we weren't there. We had protection or we had actually made loan sales and we high graded the portfolio, we took the capital elsewhere.
As I was saying when somebody else asked me a question, I think it was Rob, in terms of the Scotia Capital portfolio, when you look at the concentrations by portfolio, or by industry group, which we do on a regular basis, the biggest ones in this bank which we feel comfortable with are financial services, energy and pipelines, which is an investment grade portfolio, power which is investment grade portfolio, real estate which is well-structured and we've had success in that portfolio, and auto would be fifth or sixth. The aggregate amount has not gone up. We've been mindful of that. And when we've seen opportunities to, we have taken our exposures down. We'll continue to do so.
- Analyst
But I mean, it's a reasonable guess that across all auto lending you've got about $20 billion in there, including the off balance sheet conduits?
- EVP, Chief Risk Officer
That's fair.
- Analyst
Okay. Thanks.
- EVP, CFO
Next question.
Operator
Your next question comes from Jim Bantis from Credit Suisse. Please go ahead.
- Analyst
Hi, good afternoon. Looking at slide 11 and the strong capital, and I'm just thinking of Rick's comments virtually ruling out U.S. retail banking acquisition. And I think of Brian's comfort with respect to the credit quality as Ian had just talked about auto and we've gone through other sectors. So why was the bank felt so compelled to raise almost $3 billion in capital over the last quarter? I mean your Tier 1 ratio and capital ratios had already been strong and obviously a beacon of light relative to global banks but what was the thought process in terms of expanding it as much as you did this quarter?
- CEO
Well, -- it's Rick Waugh. Capital is -- we have three overriding strategies, sustainable revenue, build up our management and leadership and manage our capital and keep it strong. We all know the challenges in this environment and so capital gives you a buffer. But quite frankly, capital gives you opportunity. And the cost of that capital and I think it's important for you to note and I'm not sure you have, is how we raised it. It is regulatory capital, subordinated notes and preferred shares. It isn't common. So we keep our shareholders very much in mind and at the cost of that capital and the leverage it does provide us, I think quite frankly at the real cost of that capital is very attractive and if, based upon our track record we can use it as wisely as we have in the past, it creates opportunities for the future and if those opportunities don't exist, A, it gives us a buffer in case we don't do this and the market turns the wrong way on us, the global markets, it's good to have that as a buffer. And then gets the questions if we've got strong capital and we don't see the opportunities, then we obviously believe in dividends and the question on our dividend increase. It's just the right place to be at this time and gives us all sorts of flexibilities so I think it's a real strength.
- Analyst
Got it. I certainly agree. Thank you. My second question is I just wanted to follow-up with Chris on domestic banking. Chris, when I -- you've got your mojo back in terms of earnings momentum.
- EVP, Head of Domestic Personal Banking
I don't think it ever left.
- Analyst
Well, when I think of domestic banking most people think of wealth management as the big growth engine but commercial banking pretty strong growth numbers there and maybe you could shed some light in terms of what's driving that revenue growth and as well as is there any market share gains that you can talk about as well?
- EVP, Head of Domestic Personal Banking
Okay. Well, what I'm going to do, Jim, I've got the head of our commercial business here, Dieter Jentsch and he's the one that's really driving that. So I'm going to turn that to him.
- EVP, Domestic Commercial Banking
Over a number of years we've invested both operationally and some capital enhancements over commercial platform and we're in year four of our build-out and it's coming together so we've had some modest capital market share gains and just enhancements in terms of our customers from how they borrow and the various facilities and services they use from us. So just a very broad-based growth.
- Analyst
Okay. Thank you. Just it seemed that the revenue growth, the numbers are pretty staggering relative to what we've seen other players do in that market.
- EVP, Domestic Commercial Banking
Been a good quarter. It's been a good two quarters.
- Analyst
Got it. Thank you. Just a very quick question for Brian. Brian, general allowance ticked up 25 billion.
- EVP, Chief Risk Officer
That's a balance sheet item related to the purchase in Chile of Desarrollo.
- Analyst
Got it. That's perfect. Thank you.
- EVP, CFO
Next question, please.
Operator
Next question comes from Sumit Malhotra from Merrill Lynch. Please go ahead.
- Analyst
Good afternoon. Start with a couple for Brian Porter, please. First one on GMAC, the $6 billion in securities that you hold right now and the ability to diversify some of the U.S. exposure into Canada. Can you tell us of the $6 billion you hold how much is Canadian right now and how much you have the option to diversify additionally?
- EVP, Chief Risk Officer
I'm going to ask Steve McDonald to handle that if you don't mind.
- Co-Chairman, Co-CEO
My answer is going to be short, I'm afraid. I really don't think, given the confidentiality agreement we can disclose that kind of detail. I thought Brian gave a pretty complete answer to the question about our GMAC position. We are very comfortable with it. It continues to operate as expected. We have gotten improvements, modifications, that do make us feel even better about this position. But I think that confidentiality agreement does really preclude us from adding to that.
- CEO
It's Rick Waugh. I know everybody knows this, but just in case some people don't, it is a retail. We are -- individual Americans and Canadians are primarily sourced to repayment. GMAC is the sponsor. But it is broadly diversified by individuals and geographical and adding the Canadian consumer to that portfolio was an assistance to GMAC on its ongoing funding because of the capital markets and so we used that opportunity to actually improve the position on a diversified basis.
- Analyst
Let's move on to something else for Brian as well, probably. There's an item deep in the press release about a $62 million loss relating to a CDO asset acquired under a liquidity asset purchase agreement. Can you give us a little bit more color on what we're looking at here?
- EVP, Chief Risk Officer
Sure. This is a one-off, I want to stress that. We had one CDO in Liberty Street in our conduit in the U.S. that was a mezzanine piece. It was downgraded this quarter and given the way that Liberty Street is structured and the first loss note, et cetera, we took it on the bank's balance sheet, given the asset quality and the nature of the security, we wrote it down. And I do want to stress this is a one-off. We don't have any other securities of this nature.
- Analyst
This is the conduit that you brought back back onto the balance sheet in Q4, I believe?
- EVP, Chief Risk Officer
No, it's not.
- CEO
This is off-balance sheet.
- EVP, Chief Risk Officer
This is Liberty Street in New York.
- Analyst
That was a European one story that you brought back in Q4?
- EVP, Chief Risk Officer
Yes, we're mixing apples and oranges. We did bring back in Q4, you're correct. This asset did not come from there.
- Analyst
Okay. I just want to make sure we're on the same page here because when I look at Scotia Capital's loans and acceptances this quarter, up to 454 billion in your segmented disclosure, it's a pretty sizable jump, something like 30% plus year-over-year. How much of this is some of your corporate clients maybe finding the bond market a little bit dicier to access and coming back to the bank for loans? How much is you having to provide liquidity for some of the conduits you're exposed to?
- EVP, Chief Risk Officer
I'd answer it this way. First of all, we have not been -- I can tell you it's a small handful of names that have backed into their lines. So it's not that. In terms of we've seen good asset growth, primarily in Q1 and Q4 last year. That has moderated in the last quarter. There are some clients that have bridges to capital markets or debt markets that might not like current spreads or think they might get more advantageous pricing, that type of thing. Again, we're comfortable with the quality of the asset. And what was the last part of your question?
- CEO
It is not a consolidation of conduits. It is not.
- Analyst
Our conduits, the two in Canada, King and Bay Street, the paper is rolling very well as it is in Liberty Street in New York. Last one for me. This is probably for Rob Pitfield. Rob just looking at your Mexico disclosure, looks like past due loans on the mortgage side in Mexico have been increasing at a pretty good clip over the last year. Could you talk about the state of the Mexico housing market, how comfortable you are with that since that's been the biggest part of your loan book? It looks like you were able to do a securitization for the first time in that business in Mexico, maybe just some of the trends you're seeing in relation to housing and your ability to move some of these loans if it's attractive from a capital perspective.
- EVP, Chief Risk Officer
As far as Mexico and housing, the housing has stood up relatively well. If there's been a weakness in Mexico, it's been in credit cards generally. That was the part of the portfolio that was impacted back in Q1. It continues to be soft. We've taken corrective action on it and it's trending very well. As far as housing and our own portfolio, the trends are good. The delinquency is well-managed. The provisions have been stabilized. So it's -- the trends are fine that way. As far as securitization, our ability to move that, it was three times oversubscribed. It was very good. We did it to help our funding and so it's very positive for us.
- Analyst
Okay. Thanks very much.
- EVP, CFO
Next question, please.
Operator
Your next question comes from Mario Mendonca from Genuity Capital Markets.
- Analyst
There was reference made to -- might have been you, Luc -- about generating positive operating leverage for the year. Maybe you can clarify if you're referring to the domestic business or the bank in total and if you could discuss it in the context of operating leverage this quarter of negative 2 on a total bank basis?
- EVP, CFO
The negative 2 is relative to last year. The number that I quoted was relative to the previous quarter. We look for zero to 3 positive operating leverage on a total bank basis and some of the business lines are going to be higher than others. They each have their individual targets. But overall, we look at delivering on a consolidated basis a positive operating leverage.
- Analyst
For the year?
- EVP, CFO
For the year, yes.
- Analyst
Seems difficult, though, given -- I think last quarter it was negative 5.5, this quarter, 2. How do you get there for the year?
- EVP, CFO
Well, it's always a challenge. But when you take a look at our revenue growth in the current quarter and you know about our cost culture and the cost cull sure in Scotiabank is alive and well, not suggesting it's going to be easy, Mario, but we're going to give it our best shot.
- Analyst
The reason why it seems implausible, is the comments from Chris Hodgson about spending a little more aggressive in the domestic business in the second half. When you sort of wrap it all up, it just doesn't seem like a plausible perspective. Is there anything the bank is planning in any other segment that you could refer to now that would help us understand how the second half of the year can drive positive operating leverage for full year?
- EVP, CFO
Mario, let me deal with your comment about the domestic side. The expenses for this quarter were basically flat. We're up 2% year-over-year and as we demonstrated in the past, our operating leverage is going to fluctuate from quarter-to-quarter. But as we look out over the balance of the year, we are expecting to continue to see positive operating leverage and we don't give a specific amount. At the same time, we are also -- we're being very cost conscious and we're slowing down some expense growth in non-essential areas and that's having a positive impact on the business and redirecting those expenses to other areas. The long and short of it is we expect a reasonable positive operating leverage for our domestic business for '08.
- CEO
Mario, it's Rick Waugh. We initiated several months ago a complete review of our '08 operating plans, including our expenses, of course. And as we said, we have accelerated over the last few years our expenses for revenue generating initiatives. What we did in all three business lines and the support groups did this, and recommitted to, A, we reprioritized everything. Still continuing to grow in revenue generating enterprises but we have prioritized and cut back the rate of growth that we originally anticipated to invest in the business. But still is investing. And part of our process as we set ourselves some internal targets and that's one of them and I've got the commitment of all the business lines that they believe is achievable. We're not there but we believe it's achievable and we actually committed to our shareholders.
- Analyst
Is there anything in the second half of the year can you point to in other segments, other than domestic retail business, where there are plans in place today to cut costs?
- CEO
Not so much to -- the plans that we committed to are of course taking place in the full year. There's the rate of expansion on branches will not be at the initial rate, both in international and domestic, that we had counted on. We still see some more leverage on some of the revenue lines. In my comments, I mentioned that the repricing on the wholesale portfolio, the new business we're doing is very -- the spreads are very, very good. But it's sticky because our clients are hanging on to that low cost debt and the financial activity has been very slow. Having said that, the natural repricing that takes place in the wholesale portfolios will continue. The spreads, while they've tightened a little bit, are still very, very good. So we still see the revenue line giving us help in all of our businesses. And the expenses will be lumpy but as we planned them out, they look reasonable. I don't think I can give you -- if anybody else around the table can give more granularity, please feel free.
- EVP, CFO
I think that's about it.
- Analyst
Final question. There was reference was made to improving margins. This is you, I think, Chris. Improving margins domestic retail going forward. Given what we saw this quarter with your margin which was obviously a huge jump, and I understand the sensitivity to the prime BA spread, what are you presupposing in sort of guiding to a higher margin going forward?
- EVP, Head of Domestic Personal Banking
Well, Mario, as you know, I'm not going to give you a number but the reality is, with our rate forecast, let me go back a little bit. At the end of Q1 our margin started to improve. The last month of the quarter we were up 2 basis points and then this quarter we're up 14 basis points. Based on our projections for rates, we will continue to see the margins widen. But I'm reluctant to give any particular number at this particular point but it will be a reasonable number. What do you presuppose for the overall environment, interest rates, prime BA spread, what are you suggesting the environment will feel like to drive that kind of margin improvement? Well, we do see rates coming off. If you're talking about interest rates?
- Analyst
Yes.
- EVP, Head of Domestic Personal Banking
We see rates coming off. Some of that is in the marketplace right now and -- but the other side of it is, while we talk about a margin increase, there's also a very competitive market out there in terms of product and we're seeing that in some of our competitors. So we're being very disciplined in terms of our pricing, particularly in the mortgage side which is one of the reasons why our market share in mortgages came off on the quarter. And we're also being very careful in our deposit business where we had the largest increase in deposit market share of all of our bank competitors, we're probably paying the lowest amount in terms of our high interest savings accounts. So we're being very, very disciplined in our pricing. But we do expect rates to come off a bit further. That is going to help us on the margin. Part of that does getter eroded in that whole competitive product side of things and we're seeing that in some of our competitors but we're being careful not to be drawn into that game.
- EVP, CFO
Mario, we will also get it, particularly on the domestic side, on the funding side, both what we view as lower funding costs both in terms of a lowering of rates, secondly a more helpful yield curve will help us and also, and you saw it in our market share numbers that we gave you on how much funding now we're doing retail. And so the domestic bank is now more than funding itself in terms of its growth and that's, retail is of course at a less of a rate than the wholesale. So our mix is improving. So there's those three factors that offset what are still some very aggressive on the mortgage margins in terms of the competitiveness. But those three are going our way.
- Analyst
Thank you.
- EVP, CFO
One last question, please.
Operator
Your next question comes from Darko Mihelic from CIBC World Markets. Please go ahead.
- Analyst
Hi. Thank you. I just have a couple of points of clarification, if I may. Luc, you mentioned in your remarks that you had about $0.02 impact in the quarter with respect to some write-downs. Were you referring to the write-downs of the CLOs or what precisely were you referring to?
- EVP, CFO
Referring to what Brian referred to, the CDO write-down and then in the quarterly report, I think it's on page 12, we refer to a modest gain, it's the net of those transactions were $0.02, $20 million after tax.
- Analyst
Okay. So it's the net of the -- okay. And is that -- I guess the question for Brian, then, you mentioned the file that came back to you from Liberty as a one-off. Why do you refer to it as a one-off. Are you suggesting that it cannot happen in the future?
- EVP, Chief Risk Officer
Well it was an asset quality that was downgraded below investment grade and if you take the mark-to-market loss on that security it would have triggered our first loss note in Liberty Street, not to get too complicated. But we felt the best thing to do, if we want to keep high quality assets in Liberty Street was to take the thing back on the banks' books, take the hit, the mark-to-market and drive on.
- Analyst
What you're suggesting is there's no possibility of that occurring again in the future or?
- EVP, Chief Risk Officer
We've given you a break down of asset quality by asset class in Liberty Street. We're comfortable with asset quality there. It's high. And I view this as a one-off.
- Analyst
Okay.
- Co-Chairman, Co-CEO
It's Steve McDonald. The only comment I'd add to that, we had 66 transactions in Liberty Street. The only one we had that was mezzanine in nature was this one. And it's the mezzanine nature and structure that really is the hard lesson learned here. So that's why we feel comfortable that in that portfolio, we have no other mezzanine positions of the 66 -- the 65 remaining. Because that was a write-off as opposed to a write-down.
- Analyst
I see. Okay. That's helpful. Thank you. Maybe just one last question, again for Brian, with respect to the formations in the quarter. You mentioned there was a couple of commercial files in the Caribbean, looked like formations there were around 77 million versus last quarter's 10. You mentioned in the one-offs again or is there any level of deterioration that we're seeing in the Caribbean that we should be looking for in the future here?
- EVP, Chief Risk Officer
The one concern we have, Darko, we're concerned about contagion from a slowing U.S. economy. Let's keep in mind and I think we've mentioned this is in the past, the island of Puerto Rico particularly has been in recession or a slow environment for probably three years. And so we've got one real estate project there that went non-accrual. But again, when you look at these things, you have to look at loan to value in terms of -- loan to value is 50, 60% most of these things. We'll work our way out in time. So I don't see anything systemic there but we are coming off in the international commercial portfolio a great performance. We would suspect that we're going to continue to see recoveries, although at a modest rate, out of Peru and possibly Mexico. But they're going to be the slower rate than we've seen in the past but there's nothing systemic in the portfolio.
- Analyst
Okay. Great. Thank you very much.
- EVP, CFO
Thank you very much. That terminates our conference call. Thank you for joining us and we'll see you next quarter. Thank you.
Operator
Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.