Bank of Nova Scotia (BNS) 2011 Q2 法說會逐字稿

Good afternoon and welcome to the presentation of Scotiabank's second quarter results. I'm Luc Vanneste, Chief Financial Officer. Rick Waugh, our CEO, will lead off with the highlights of the second quarter. Next, I will go over the financial results including a review of business line performance. Bob Pitfield, our Chief Risk Officer will then discuss credit quality and market risk. Bob will be followed by our business line heads who will provide an outlook for their respective businesses for the remainder of 2011. Anatol Von Hahn will discuss Canadian Banking; Brian Porter will cover International Banking; Chris will discuss Global Wealth Management; and Steve McDonald will discuss Scotia Capital.

We will then be glad to take your questions. Before we start, I would like to refer you to slide number 2 of our presentation which contains Scotiabank's caution regarding forward-looking statements. Over to you.

Thanks, Luc. We are pleased to report a solid quarter, indeed, a record quarter, with good performance across all 4 of our business lines. Scotiabank generated net income of more than CAD1.5 billion this quarter. This number includes gains related to recent acquisitions, which Luc will discuss in detail in his financial review.

Earnings per share were CAD1.36 for the quarter, this included CAD0.26 of one-time gains related to recent acquisitions. As well as the negative impact of foreign currency translations of CAD0.03. This result compares well with CAD1.02 we earned in the second quarter of last year. Top-line revenue grew by 9%, compared to the same period a year ago, even after we exclude the one-time gains and notwithstanding the foreign exchange headwinds. Return on equity at 22.9% remains strong, and industry-leading.

The credit environment continued to be benign, and performance continued to improve as evidenced by our lower loan loss provisions again this quarter. Our performance this quarter is a result of our diversified business model and strong contributions from each platform. In Canadian Banking, margin compression from a highly competitive environment was largely offset by a growth in market share of deposits, small business, and residential mortgages. Results were also assisted by strong expense control and lower loan loss provision.

International Banking had a record quarter, led by growth in commercial banking and wider margins in certain of our key markets. This quarter marks a milestone for Global Wealth Management which also had a record quarter. We completed the acquisition of DundeeWealth and surpassed CAD100 billion in assets under Management for the first time and improved our market share significantly. The business also reported strong performance across all our Wealth Management and insurance platforms.

And finally, results in Scotia Capital were strengthened by the diversification across product lines and geographies. We saw particular strength in investment banking where we were ranked number 1 in equity underwriting by Bloomberg so far this year. As well, strength in our fixed income business. From a capital standpoint, we continued to benefit from high quality capital and the strong ability to generate internal capital due to our strong profitability.

So in summary, this was a solid quarter of sustainable quality. While the results we are reporting today -- with the results we are reporting today, we remain well on track to achieve our goals for the full year. With that, I'll turn it back to Luc.

Thanks, Rick. Slide 6 shows our key financial performance metrics as reported.

Q2 was a record quarter for Scotiabank with revenue of over CAD4.5 billion, up 16% from a year earlier. As Rick mentioned, even excluding the one-time gains, revenues were up 9% year-over-year. Net income for the quarter exceeded CAD1.5 billion. On a per share basis this translates to earnings of CAD1.36. Return on equity this quarter, 22.9%.

Slide 7 shows the impact of 2 recent acquisitions which resulted in non-recurring gains for us this quarter. A gain arose from the Bank's acquisition of DundeeWealth. The investment to acquire the remainder of DundeeWealth was considered a step acquisition and was accounted for on a fair value basis. A gain of CAD260 million was recognized to account for the significant increase in value since we made our original 18% investment in DundeeWealth. The remaining CAD26 million was related to a smaller acquisition in International Banking which was purchased at a price lower than fair value. With this acquisition, we recognized CAD26 million in negative goodwill for the acquisition.

As a result of our adoption of the new Canadian accounting standards on business combinations, we also recognized an additional CAD26 million in negative goodwill, bringing the total negative goodwill on this acquisition to CAD52 million. The new accounting standards align with International Financial Reporting Standards or IFRS and require acquisitions to be measured at fair value. I should also mention that independent of these gains, we also incurred CAD27 million in one-time transaction and integration expenses relating to the DundeeWealth acquisition.

Slide 8 shows Scotiabank's results excluding the one-time gains related to the adoption of the new accounting standards I just mentioned. Earnings per share for the quarter were CAD1.10, an increase of 8% from last year and 3% from last quarter. Looking at the year-over-year changes, solid growth in assets drove net interest income while the net interest margin narrowed. Asset growth was primarily in residential mortgages in Canada and commercial lending in International.

Earnings also benefited from higher Wealth Management revenues, driven by the DundeeWealth acquisition, higher mutual fund fees, and higher performance in wholesale banking, particularly in fixed income and investment banking. The provision for credit losses was CAD262 million this quarter, down CAD76 million from last year, due primarily to lower provisions in both International Banking and Canadian Banking. Offsetting these items were higher operating expenses, the majority of which were due to acquisitions, but also reflected investments to support business growth. We also experienced lower trading results primarily in institutional equity, and had lower net gains on investment securities. Return on equity for the quarter at 18.5% remains strong.

Moving to revenues on slide 9. Revenues during the quarter were CAD4.3 billion, excluding the one-time gains described earlier, an increase of 9% from last year, and 2% from last quarter. Looking at year-over-year changes, growth in asset levels offset a lower margin and drove net interest income higher. Asset levels were driven by acquisitions, growth in residential mortgages, primarily in Canada, growth in commercial loans in International Banking, and increases in securities reflecting the expansion of our fixed income business. This was partly offset by lower corporate lending volumes in Scotia Capital. The margin was down as a result of a higher level of low spread assets and a continued consumer preference for lower yielding variable rate mortgages.

Other income at a record CAD2 billion increased 11% from last year, excluding the non-recurring gains. Recent acquisitions and higher mutual fund revenues resulting from record assets under Management were the primary drivers of this growth. Quarter-over-quarter, net interest income declined CAD88 million. The decrease was primarily due to margin compression and the impact of 3 fewer days in the quarter, partly offset by asset growth. Other income increased 11%, excluding the one-time gains, reflecting higher net gains on securities and increased Wealth Management revenues. Partly offsetting were lower trading revenues.

Turning to slide 10, non-interest expenses were up 21% year-over-year. Acquisitions accounted for CAD226 million of the increase, and excluding this, expenses were up 10%. Expenses were up primarily from higher staffing levels for new initiatives, as well as salary increases, higher pension and benefit costs, and higher premises costs. In addition, there was an increase in technology, advertising and business development, and professional expenses, again, due to growth initiatives. Comparing to the prior quarter, expenses increased 4% or CAD92 million.

Excluding acquisitions, expenses were down CAD105 million. Expenses were down mainly due to the lower stock-based compensation, largely reflecting the seasonal impact of new grants awarded in the previous quarter as well as lower salaries. This was partly offset by a gain in the previous quarter on the final windup and settlement of the subsidiary pension plan. Turning to Capital, you can see that the Bank continues to maintain a strong capital position.

The Tier 1 capital ratio increased to 12%, due to internally generated capital and the issuance of common and preferred shares for the acquisition of DundeeWealth. These capital increases more than offset the negative impact of increases in goodwill and intangibles from the acquisition and the growth in respirated assets. The tangible common equity ratio decreased modestly to 9.3% due to the impact of the DundeeWealth acquisition but it is up over Q2 2010. Our capital ratios remain well above regulatory minimums and continue to be very strong by international standards.

Now turning to the business line results, beginning on slide 12. Canadian Banking had net income for the quarter of CAD440 million, down slightly from last year. On a year-over-year basis, total revenue was down 4%. Asset levels increased 6%, primarily from growth in residential mortgages. Deposits also grew 4%, reflecting a number of deposit and payments initiatives. Net interest income was down, however, as solid asset growth was offset by a lower margin due primarily to higher funding costs. Other income was also down, due entirely to -- due entirely to a gain on sale of securities in the same quarter last year.

Provisions for credit losses were down CAD44 million to CAD145 million, due to lower provisions in both the retail and commercial portfolios. Quarter-over-quarter, we also saw growth in assets. Margin was negatively affected by a consumer preference for lower yielding variable rate mortgages, and older, higher yielding fixed rate mortgages which reached maturity. The lower margin combined with the shorter quarter resulted in lower net interest income. Other income was also lower, due to lower gains on securities. The provision for credit losses was down CAD20 million from the previous quarter. Expenses were flat. However, the prior quarter included a gain on the windup of the subsidiary pension plan. Excluding this gain, expenses were lower due to the shorter quarter and lower stock-based compensation.

Moving to International Banking on slide 13. International Banking's net income in the quarter was a record CAD376 million, excluding the acquisition related gains as a result of adopting the new accounting standards. This represents an increase of CAD119 million or 46% from Q2 of last year. Acquisitions continued to provide strong growth and earnings and contributed approximately one-third of the year-over-year increase.

Average assets were up from last year, due in part to acquisitions. As well, there was strong organic growth in commercial lending, particularly in Asia and Peru, and retail lending in Peru, Chile and the Caribbean. The broad-based growth in lending volumes contributed to the increase in net interest income. The CAD67 million decline in loan loss provisions was primarily attributable to improvements in commercial portfolios in the Caribbean and Chile, and to a lesser extent lower retail provisions in Chile and Peru.

Expenses were up partly due to acquisitions, but also from investments in growth initiatives. Quarter-over-quarter, we saw growth in commercial loans across most regions, and in retail loans in Peru. Low cost deposits grew in the Caribbean and Peru. However, overall, revenue was flat as a result of the negative impact of foreign currency translation. Non-interest expenses were down mainly due to lower stock-based compensation, and lower business and capital taxes.

On slide 14, you can see the Global Wealth Management generated net income of CAD229 million for the quarter, excluding the gain from the revaluation of our original 18% stake in DundeeWealth. The full impact of DundeeWealth was partially offset by CAD27 million of one-time acquisition and integration costs. If we exclude both the non-recurring gain and the one-time costs, Global Wealth's net income would have been CAD256 million. Year-over-year we saw total revenues increase 52% excluding the gain. The increase was due to the DundeeWealth acquisition and the continued strong sales in our existing Wealth Management platform.

As well, there was growth in our insurance businesses, primarily from international sales. This quarter the Wealth Management businesses accounted for about 86% of the business line's revenue and our insurance businesses accounted for the other 14% of revenue, excluding the one-time gain. This is up from 80% for Wealth in the same time last year and the change in revenue mix reflects the DundeeWealth purchase. Quarter-over-quarter, revenues were up 39% excluding the gain. Revenues were up due to the acquisition, as well as higher mutual fund fees, full service brokerage revenues, and insurance income. Excluding DundeeWealth, AUA and AUM each saw organic growth of 2%. Expenses increased principally from the consolidation of DundeeWealth but were partly offset by lower stock-based compensation.

Looking at slide 15, Scotia Capital recorded net income of CAD357 million. Year-over-year, the CAD29 billion or 19% growth in average assets was primarily due to increases in securities purchased under resale agreements and higher levels of trading securities resulting from the expansion of our fixed income businesses. Partially offsetting this growth was a CAD5 billion or 15% decline in corporate loans and acceptances. Lower revenues in the institutional equity business, which were down from the high levels achieved last year contributed to the year-over-year decline in net income. Loan loss provisions were modest at CAD10 million in the quarter, primarily in Canada and Europe, up from a net recovery of CAD24 million in the same period last year. Expenses were up 20%, reflecting higher remuneration and benefits expenses, technology and other support costs for growth initiatives in the trading businesses, as well as higher legal provision.

Quarter-over-quarter, revenues were down slightly, mainly due to modest decrease in the trading businesses as reductions in institutional equities and precious metals were largely offset by stronger fixed income revenues. Net interest income declined due to lower spreads in Canada and the US, lower origination fees, and marginally lower lending assets. Other income was up due to higher net gains on non-trading securities, and higher investment banking revenues. Expenses declined 7% from last quarter, primarily as a result of lower stock-based compensation, which is cyclically higher in the first quarter.

I'll now turn to the Other segment which incorporates the results of Group Treasury, smaller operating units, and certain corporate adjustments. The Other segment reported a net loss of CAD149 million in Q2, compared to a loss of CAD183 million last year. Year-over-year, the Other segment benefited from an increase in wholesale rates used for transfer pricing, and a favorable change in the fair value of financial instruments used for asset and liability management. Offsetting this were lower gains on available for sale securities and slightly higher expenses.

Quarter-over-quarter, net income was aided by a favorable change in the fair value of financial instruments used for asset and liability management purposes, and a lower net cost of term funding. Offsetting this were lower securitization revenues. Expenses were down from last quarter, due to lower legal provisions, and a decrease in technology project costs. This concludes my review of our financial results. I'll now turn it over to Rob who will discuss risk.

Thanks, Luc. The risk in our credit portfolio continues to be well-managed. We're seeing a steady improving trend in the quality of our loan portfolio that's measured by a number of key credit metrics, including provisions for loan losses. We saw significant decline of CAD95 million in specific provisions year-over-year, to CAD262 million. On the quarter, the decrease was CAD7 million.

Our market risk remains well-controlled and within our risk tolerances. Our average one-day VaR was CAD12.1 million compared to CAD11.7 million in Q1. There were trading losses in the quarter of 2, down from the 6 in the previous quarter. The losses were within the range predicted by VaR.

Slide 19 shows the trend in specific provisions over the past 5 quarters. As you can see, specific provisions have come down meaningfully in the retail and commercial portfolios in Canada, and International from a year ago. As a result, our all-bank PCL ratio of 38 basis points improved considerably from the 55 basis points a year ago but remained unchanged from the prior quarter.

To summarize, our asset quality remains strong with the retail and commercial portfolios performing well. And our corporate portfolios continuing to show remarkable strength. Looking ahead, we expect provisions for the remainder of the year to remain in line with first half of 2011 as a modest decline in retail provisions should offset a modest increase in corporate and commercial provisions. And that concludes my comments and I'll turn it over to Anatol.

Thank you Rob. We had a strong quarter in Canadian Banking with success in all of our key areas of focus. In Q2, we grew our deposits by CAD1 billion, with growth in each of retail, small business, and commercial. One result is that our retail deposit market share increased for the fifth consecutive quarter, with a good portion of that coming in core deposits. This strong growth reflects the success of our Let the Savings Begin and Bank the Rest campaigns. And we expect to be able to continue to grow as we continue to roll out our campaigns and introduce new products in the coming months.

Our focus on meeting the payments needs of our retail customer continues to show positive results. Customer use of our credit cards for purchases is growing at a rate materially higher than the market, and we are seeing strong growth in checking accounts. Q2 was also a record quarter for mutual fund sales through our branch network, helping Chris and the Global Wealth team to achieve number 1 status in net sales.

Turning briefly to retail asset growth, we have seen some moderating of consumer demand, and intensifying competition in the first 2 quarters of 2011. And we expect this environment to persist for the remainder of the year. The effects of an increasingly competitive market, as well as consumer preferences for lower yield, variable rate loans has put pressure on our margin and we expect this pressure to be sustained for the rest of fiscal 2011 as well.

Turning to commercial banking, we see continued growth opportunities. In our consumer and commercial auto businesses, which have been performing very well, in leasing and asset-backed lending as well as in our core commercial lending and deposit-gathering businesses. Personal and non-personal PCLs were both down quarter-over-quarter, and year-over-year. We expect to see further improvements in personal provisions while commercial provisions will likely stay relatively steady.

Finally, we expect expenses to follow their normal pattern and increase for the final 2 quarters of the year, due to seasonality, continued investment in revenue generating activities, and also as we expect somewhat lower expense recoveries from Wealth Management, following this quarter's record mutual fund sales level. In summary, we continue to see opportunities going forward, although tempered by a slowing retail asset market and margin pressures. With that, I'll turn it over to Brian.

Thanks, Anatol. This quarter International Banking benefited from a combination of improving conditions, progress on our growth initiatives, and favorable one-time pick-up in a recent acquisition. In total, we produced a record quarter of well-diversified earnings. Excluding the FX impact of CAD11 million, and the acquisition adjustment, we achieved solid underlying growth in our commercial business, with strong results in Mexico, Peru and Asia. And in our retail business, mainly in Peru.

As we look ahead, our commercial business has a strong and growing pipeline. On the retail side, our focus on growth initiatives is starting to produce the desired results, particularly in our non-branch distribution channels and more generally, we expect asset and revenue growth to continue as economic conditions improve. Margins remained relatively stable this quarter, which we expect to continue for the balance of the year. As for our cost components, PCLs were stable this quarter and we expect this trend to continue. And expenses were lower this quarter, but going forward will reflect our continuing investments in our long-term organic growth initiatives.

Finally, on the M&A front, we were pleased to close the acquisition of Pronto in Uruguay this quarter and Nuevo Banco Comercial is on track to close in the third quarter. And our ongoing integrations in Puerto Rico and Thailand are proceeding as planned. We continue to be interested in acquisitions, particularly in our existing markets. Overall, we are pleased with the first half of 2011 and the elements are in place for a promising second half. Now I will pass it over to Chris.

Thank you, Brian. The outlook for Global Wealth Management is strong.

First, we closed our acquisition of DundeeWealth in the quarter, and have made very good progress in supporting its momentum and growth. We have put plans in place to retain the key people and are working diligently to identify areas of opportunity to drive value. We're very pleased that both Dundee's assets under Management and net sales are ahead of our expectations for the business. The underlying business performance is very strong. Our approach to integration has been thoughtful and deliberate. We've combined some areas all ready, and are currently developing detailed plans to capture value in other areas.

Second, strong markets, increasing sales, and the acquisition of DundeeWealth have positioned all of our Wealth businesses very favorably. This quarter we were ranked number 2 in mutual funds, our assets under Management among Canadian banks, and number 1 in the industry in mutual fund total net sales in Canada. Currently the all-bank Asset Under Management AUM exceeds CAD107 billion, a milestone achievement for us. AUA is also very strong, at CAD280 billion. These AUM and AUA bases are expected to drive solid earnings in the coming quarters.

Third, the outlook for our global insurance businesses is positive. In Canada, we're making steady progress in increasing the cross-sell of insurance products, and we've been successful in rolling out insurance products, both creditor products and direct insurance products. Internationally, we continue to enjoy increases in sales of insurance, as a result of our investment in contact centers, particularly in Mexico. We're also pleased to have completed the integration of our insurance operations in Puerto Rico, and those of R-G Premier Bank.

And fourth, we are pursuing and will continue to pursue M&A opportunities in international markets. Finally, our investment in CI continues to be an important investment for us. And we will continue to maintain all of our options as we move forward. We will vote on items presented to shareholders that we are allowed to vote on and will continue to look for ways to enhance shareholder value. And with that I'll pass it over to Steve.

Thanks, Chris. We continue to focus on the execution of several initiatives we have under way in our core businesses and industry sectors. We posted strong results in the second quarter, despite somewhat more challenging market conditions in the trading businesses. Combined with the prior quarter our year-to-date results have been very positive, especially considering the normalized trading levels compared to the prior year. We are benefiting from diversification of our products and geographies.

Growth initiatives continue to positively impact our performance. This includes our fixed income investments in London and New York. Although this has led to higher average assets, we've been careful to maintain our discipline on risk exposures. In Global Corporate Investment Banking, we remain cautious on loan growth even though the declining trend in volumes has reduced. Modest growth in the US was masked by the strengthening of the Canadian dollar. During the quarter, spreads were decreased somewhat in the US and Canada. We expect fairly stable corporate loan margins despite some competitive pressures. We expect to see modest M&A activity going forward. Recent activity has been centered more on equity or public debt issues than on bank debt. The credit quality of our loan portfolio remains strong and PCLs are expected to remain modest.

In the second quarter, we reported higher investment banking revenues including a record quarter by Scotia Waterous. The pipeline for new equity issues and M&A is reasonably strong. We continue to see healthy activity in energy and mining, 2 of our focus sectors. Expenses continue to be closely managed. We saw quarter-over-quarter reduction this quarter, due to the cyclical nature of stock-based compensation which is highest in the first quarter. However, this was partially offset by higher technology costs and legal provisions. We have substantially completed our investments in people and technology for our key growth initiatives and expect the growth in expenses to level off as we leverage these investments. With that, let me turn it back to Luc.

Thanks, Steve. That concludes our prepared remarks. We would now be pleased to take your questions. Please limit yourself to 1 question and re-queue if you have additional questions. Operator, can we have the first question on the phone, please.

Steve Theriault, Bank of America.

Last quarter Brian, you talked about changes in risk appetite that could create some acceleration of growth in the commercial book. We don't really see that coming through the segment this quarter but maybe that has -- I suspect that has something to do with currency. Maybe you could update us on your expectations there and how maybe they've changed since 3 months ago. And then as a follow-up last quarter you provided us with some helpful numbers with respect to loan growth in some your key geographies so maybe you could provide an update there on some numbers on Mexico, Peru, and maybe some of the other areas.

Sure Steve. Well FX does have a muting effect on the asset growth. But this quarter assets on a commercial basis grew 4%, as I said, primarily driven out of Mexico. Peru and Asia, the retail growth was a little less muted. We have a number of initiatives in place to grow both types of business.

From a commercial standpoint, we're looking at reengineering a number of our processes in terms of turnaround time for clients. And if you do that, obviously you get the loan on your books and earn interest a lot faster. From an international perspective we have roughly 8,900 different commercial clients around the globe. We think with tweaking with our risk appetite that we can grow that book significantly. It has a nice margin in it. Something that we know how to do and execute very well. Our loss rates on the business are certainly manageable from a risk appetite standpoint.

From a retail standpoint, we've got a number of initiatives underway to increase sales force productivity. We're growing our external sales force, both -- and expanding our non-branch channel through our contact centers. We're revitalizing our auto business in some markets. Chile and Mexico would be two very good examples. So we've got a number of initiatives underway to grow revenue. But we would call our bread and butter businesses in international. But if you look at the asset growth across the divisions, the Spanish Caribbean, for instance, commercial volumes -- and this is just adjusted for FX -- grew 3% last quarter. Retail volumes were relatively flat.

In Mexico, retail volumes were up 1% last quarter, commercial volumes were up 8% quarter-over-quarter. Peru, we're seeing very good growth as I've commented on a couple of quarters, retail volumes, up 8% quarter-over-quarter, commercial volumes up over 5%. Asia, which is a commercial business, is up over 4%. So that gives you some look at -- and transparency in terms of the numbers and they're definitely trending in the right direction.

Thanks for that.

Robert Sedran, CIBC World Markets.

Just wanted to come back to the DundeeWealth acquisition, please. Luc, I guess your comment on slide 7 was that this is a one-time integration and transaction expense and I just wanted to confirm that there won't be any more notable I guess charges going forward as an integration continues and that this really is a one-time charge. And then on a related note, are there any ongoing retention payments that might bleed through the compensation line in subsequent quarters as well? And then just finally, on a related note, perhaps I know Chris you gave some high level thoughts on the integration. I'm just wondering if we should think about this more as the businesses are going to cooperate and work very closely together but not fully integrate or how much -- how fully integrated they'll be when all this is done?

Okay, Rob. It is Chris. I'll deal with all of those. In terms of the one-time items, they are one-time items and they primarily related to severance, some compensation costs, some legal advisory fees, et cetera. So we don't expect any notable increase over time in that category.

In terms of retention, we don't disclose publicly what our retention plans are, but in reality, I think we've -- through Management, have done a good job ensuring that the leadership and the key portfolio managers and people will be retained for the considerable period of time. It's important. We spent a considerable amount on this new partnership and we want to ensure that the intellectual capacity is there to continue to build the business and we're confident that we'll be able to do that.

Finally, in terms of integration plans, we have been active since the last quarterly call. There's a number of things that we've done. We are and have been combining the investment management teams, all of those are in the process of and in some cases have already moved but all will be moving under David Goodman's leadership, so Scotia Asset Management, Investment Management will be under David Goodman. We've combined the advisory channel wholesale teams and we've moved that out of Scotia Asset Management and also put that into Dynamic and Dundee. We're aligning the private client investment council groups and we're also aligning the Institutional Asset Management teams. So you're going to have more of a pure platform, Rob, to answer your question which is where we think we can get the full value.

Thanks, Chris. That's helpful.

Gabriel Dechaine, Credit Suisse.

Just a question for Anatol and also for Luc. I guess if you can touch upon the margin a bit, Luc, I'd appreciate a reconciliation of the items that contributed to the 10 basis point sequential decline. And Anatol, you touched upon or I believe it was you, anyway, the movement towards lower yielding variable rate loans and a runoff of higher yielding fixed rate mortgages. Wondering if on the latter point, that should be something we expect to continue and contribute to depressed margins for a while here. Is that correct?

Gabriel. It's Luc. Let me start with talking about the margin, the 10 basis points quarter-over-quarter. The two items that you just had mentioned, the decline in fixed rate mortgage spread and the movement out of the fixed rate mortgages is about half of the 10 points. As well, we've got a narrower spread on the floating rate portfolio. As you know, it's a competitive market out there and there's downward pressure on the spread. And that really accounts for very much the lion's share on a quarter-over-quarter basis.

Let me Gabriel, take the second question, which is the variable rate and fixed rate. In short, what we're seeing is both our existing customers, as their mortgages come due, are opting to go in large part into variable rate mortgages. They've got a much lower interest rate or yield. And new customers are opting into the same product, the variable rate product. What we expect is and what we see our customers doing is they're looking and waiting until interest rates go up before they'll lock into the 5 year fixed.

So that's what we're seeing. And towards your question, do we expect that in the future? Yes, we expect that to occur whilst the rates are this low. Once the Bank of Canada increases the rates I think we'll see the behavior switching. At the same time what this provides us, though, is the opportunity to cross-sell into other products and services with these customers, which we do.

Maybe more important to know -- let's say they were moving to fixed rate mortgages today or given the competitive environment, how would you compare the spreads today simply on a --

Talking about -- you're talking about 200 basis points.

How would that have compared to the stuff that's rolling off?

Well, it depends. But if you're looking at 5 year mortgages that are rolling off, it could be anywhere between 200 and 300 basis points.

And then just on the International, sorry to switch, also on margins, was a big 15 basis point increase. How sustainable is that?

Well, Gabriel, it's Brian. We saw some increase in margin in a couple of our countries, particularly Peru and Mexico. Peru is running into elections so we saw better pricing on loans in the last little while. I'm not going to predict margin for you. It varies from time to time. But I would categorize a margin that we saw in Q1 as predictable throughout the balance of the year.

Thank you.

John Reucassel, BMO Capital Markets.

Follow-up with Anatol. Anatol, you talked about the outlook for the next half of the year. And I just want to make sure I got it right. Was moderating consumer loan demand, continued shifting in preferences, still pressure on margins and expenses are going to be higher in the second half than the first half. Do I have that right? And does that effectively mean that the earnings this quarter, it's going to be tough to achieve those in the back half of the year on a quarterly basis?

No. At the same time, we also have a number of fee initiatives that have gone in, so as we look forward into Q3 and into Q4, we expect earnings to be similar or somewhat higher and it's going to be in large part also dependent on volumes.

Okay. So you're still finding -- so what happened the first quarter was some of the spread offset was market share gains, so you still think that's something that's going to continue?

Yes, if you look at in terms of deposits, we believe that the initiatives that we started, I talked about Let the Savings Begin and Bank the Rest as an example, we expect to continue to have market share growth on the deposit side. In the terms of the lending side, what we're doing is we're not chasing rates or products that are not profitable. But what we are doing is cross-selling where we can.

So as we look forward, we do expect to continue to have the earnings, both in the terms of the retail and the commercial. On the commercial, the spreads are not tightening as much as what we've seen on the retail side. We continue to have a very strong pipeline in the commercial side.

Okay. Thank you very much.

Brad Smith, Stonecap Securities.

Question for Brian. Now that you've been in the Chair for a number of months, Brian, I note that you've all ready had an impact in terms of the return that's being generated by the International Banking group. I think it came on your defined basis of economic equity.

Thanks, Brad.

15.9.

(laughter)

Yes, that was up handily. I was just wondering if you could give us some sense for where you think you can take that return? Is that a sustainable number? Or is it -- are you on a journey to a higher number?

Look, I think this ties into the first question I was asked by Steve. In the International division, we're not trying to boil the ocean. We're not going to be all things to all people. We're really focused on bread and butter banking. We think that there's a huge lift for us over time to expand our commercial business in the footprint that we're in. The retail business in some countries we think there's significant lift as well.

But you know, some of these countries as we've discussed before have -- there's varying degrees of impact of the financial downturn. The English Caribbean is stabilizing. The last quarter or 2 have been better but it's going to be a long road back. But we like where we are in our footprint. We'll continue to be selective in terms of acquisitions within our footprint, but we're really as a Management team spending our time on growing the business organically.

Right. If I could just have one follow-up. With respect to Peru I think I heard you say that in the lead up to the election it's actually been sort of a positive to your margins. What are the -- I mean, what are the things that you think about when you think about how that election might go and how that might impact on the Bank's growth strategy?

Well, look, Peru is an important country for us but we have a history of operating in a bunch of different political environments over time. Peru is somewhat unique there, in that you can see it throughout the system, the system is more liquid today than it was 6 months ago. We built up liquidity in our bank. A lot of our commercial lines there would be uncommitted lines. 90% of our lines are uncommitted. So if there is a nervous reaction to the outcome early next week, we're prepared for that.

Terrific. Thanks very much, Brian.

Sumit Malhotra, Macquarie Capital Markets.

A couple numbers questions coming up. Maybe just to follow-up on those last comments from Brian. With all the press that's been around with the Peru election, have you seen any impact, economically or business-wise, in the last couple of months as certainly there have been some somewhat scary headlines that have been in the press. Any near term impact that you've seen in the business?

No, I would describe it as business as usual. We've seen a number of significant credits from Peru come up for power generation facilities, energy transactions, E&P type transactions. So it's business as usual, other than the system as I said earlier to the last question tends to be more liquid. What you see is a run-up in these situations.

All right. Just a couple of numbers questions to wrap up here. First for Luc, I think compensation was touched on. I'm not sure if you look at it the same way, but if we were to look at a ratio of, say your salaries and employee benefits expense as a percentage of revenue, so a compensation ratio. Last quarter you were up at a higher level than we usually see and it was talked about there was some Scotia Capital vesting issues there. Even with that normalizing so-to-speak you're still pretty much flat quarter-over-quarter at that elevated level. I realize DundeeWealth would have certainly pushed that number up.

I guess my direct question is, is there anything extraordinary in the compensation ratio that you see this quarter or are we probably at a new run rate, just given the shifting business mix, maybe with more Wealth Management in Scotiabank?

Certainly the latter aspect that you just mentioned is going to have an impact. But I also want to point out, Sumit, that we are continuing to expand our businesses, other than via acquisition and that has a salary cost component to it. So as those businesses expand, you will see on a quarter-over-quarter or year-over-year basis, that there might be an increase there but I will suggest that on a go-forward basis, in the next couple of quarters when we look at year-over-year, I don't think that we'll see major increases like we have in the last couple of quarters.

Lastly for Luc or perhaps Rob Pitfield, if I just look at your risk weighted assets this quarter, you seem to be one of the few banks that didn't get -- probably had some benefit, but it didn't lead to an all-bank decline in risk weighted assets. The two numbers that jumped out to me in your on-balance sheet assets, the all other category up about CAD4 billion, and then your operational risk, one of the larger increases we've seen. Anything you can point me to there that pushed up risk weighted assets in those categories this quarter?

The other category is -- it's Mike Durland -- is coming from the gold loan books as the appreciation of the underlying volume price that drives that.

As well, we have an increase from goodwill and intangibles on the acquisition of DundeeWealth.

So that would run through the other line as well?

Yes.

Thanks for your time.

Brian Clark, KBW.

Quick question for you, Luc. Within the business segment, the Other or Treasury segment, there was a significant increase in deposits. Maybe you can just talk about the strategy and since most of that was stored in cash at the end of the quarter, maybe you could talk about the plan for deployment for that excess liquidity.

Okay Brian, I'm going to turn that question over to Jeff Heath, our Treasurer.

Yes, I guess what we've been doing is recognizing there's a lot of liquidity in the short-term dollar market. We've basically been making very short-term, low risk deposits and earning a spread over the cost of funds. That's what's driven that up.

Okay. And I guess a follow-up question for Rob. It does look like on a gross GIL formation basis, there's still a growth, sequentially, looks like Canadian retail was up again a little bit more in International retail, International commercial. Now, the resolutions have been up too but it does seem like the formation, growth formation numbers keep ticking up. Do you think we're getting somewhere that we might see that start to trail off, at least looking at the Canadian retail and International retail, should there be an inflection point here where we start to see the formation numbers decline?

I think what you've got, in our NILs, is a certain amount of choppiness. I think that's based on the commercial corporate side, because of heavy real estate asset oriented loans such as our Caribbean portfolio. So that's going to take a little while to work off. On the retail side, it's the same kind of thing. So you've got mortgages in Central America. You've got mortgages in Chile. You've got the working off of the Peru portfolio, or sorry, the Puerto Rico portfolio.

So you'll see a choppiness to it. I don't think that it will trend down significantly. It will be somewhat volatile and we'll just work that part of the portfolio off. There's no fundamental issues that are causing that portfolio to rise.

Okay. Maybe just one last follow-up. On the International retail, the new classifications, I'd imagine some of that's from R-G Premier. Do you know how much of that was R-G Premier related? And obviously those are indemnified by the FDIC.

Those would be about CAD65 million.

Okay, great. Thanks for taking my questions.

Michael Goldberg, Desjardins Securities.

First, I'd just like to go back to a question about expenses. You said that growth and performance based comp was in line with revenue growth. But when I look at performance based comp just as a percent of brokerage underwriting and trading revenues is up from the low 40s range in several recent quarters to 56% this quarter. I'm just wondering if you can explain why? Was there any kind of accrual true-up this quarter? And also, variable comp overall was up year-over-year and quarter-over-quarter. So I just wonder if you can explain what's happening there. And I have another question that I'll come to after this one.

Okay. In terms of your latter quarter, the year-over-year we have additional staffing levels which would account for that. In terms of whether there was anything unusual in the current quarter, Michael, I don't recall anything unusual.

So why would it increase, then, as a percent of brokerage underwriting and trading revenue?

Investment banking, institutional equity. IE's, Wealth Management.

So let me take that one offline, Michael and I'll get back to you.

Sure. You can do that. And secondly, given the turmoil in Europe, you discussed briefly your exposure to European banks. Is there anything that you can add? And also, do you see any possibility of any businesses owned by these banks possibly being put up for sale, businesses that you might be interested in?

Mike, it's Rick. Let me just take -- obviously the concern on a macro basis is what's happening over in Europe and as you see in our disclosures, our exposures in Europe, whether we're talking sovereign risks in those countries, or any of the European countries, or even banking risk is very, very low, both on an absolute and a relative basis.

However, we see opportunity. And this is because of, again, the government funding that's going to have to be done in the bond market or whatever. So Scotia Capital, we just opened our very expensive but very high tech state-of-the-art trading floor in London, just a few weeks ago, Mike went over. So we have initiative on in the rates business. We've gone out and have got dealer status and Mike can give more details on this, in several of those countries and we're just waiting for the US add.

So we see this as a window of opportunity for us. We've got great acceptance of our counter-party, most of the counter-parties have low exposure to us and yet we're a high quality name. So we see that adversity, if we can call it that, that we can do some very high quality client-driven, government-driven business and our portfolios, other than some corporate portfolios out of London, are very, very small. So we're in I think very good shape to -- which of course is a little bit different than what's happening in Europe with the banks, but we're in pretty good shape there.

And any possibility of assets owned by European banks in Latin America for example being put up for sale that you might be interested in?

Well of course that is -- our first quarter, when you saw that negative goodwill was a prime example. That was a very opportunistic purchase from us because we're well established in Chile and our people did a great job and when you can buy something for negative goodwill, this was from RBS, as you know, and that was one example. Similarly in Colombia, we've now got a full service operation in Colombia. That was from a full -- from a European bank. Thirdly, in Brazil, we did the same thing with another European bank for our full service operation there.

So -- and there's a fair activity in the M&A pipeline. But I also go back to Brian's statement about generic growth. We were very comfortable with our footprint. Having said that, we can be opportunistic as we were. I mentioned at Chile in one. There will be opportunities. But I think executing on our footprint generically and then augmenting when we get a deal that makes sense for us will give us some opportunity in the Americas.

Thanks very much.

Mario Mendonca, Canaccord Genuity.

I have a few follow-up questions. Hopefully they can be quick. Brian, you referred to quarter-over-quarter organic or quarter-over-quarter loan growth in International. You refer to a number of regions, a number of numbers. Does it work out to about 3% to 4% quarter-over-quarter constant currency loan growth, is that essentially what we're seeing?

Yes. We're seeing 4% on the commercial side and just under 2% on the retail side.

How does that compare to what you've seen in the last few quarters? Is that an up-tick or --

It's picking up. As said earlier, we have a good pipeline developing on the commercial side and we're comfortable with that business. You're not going to see -- I guess I've been asked this question a couple times today. You're not going to see a blockbuster quarter where asset growth goes significantly up. This is an incremental game. It takes time to put accounts on the books. It takes time to execute these transactions. Having said that, the underlying fundamentals of the business are very good and we think we've got a lot of opportunity to execute on the commercial business.

Quarter-over-quarter, there's nothing wrong with 4%. I just wanted to clarify that.

Exactly.

It's flat in the supplement. I guess that's all currency then.

That's all currency.

Another quick follow-up on retail margin, up, I'm sorry, down 10 basis points quarter-over-quarter. Was any of that 10 -- can we attribute any of the 10 basis points to the transfer pricing mechanism charging the wholesale funding rates, or is that all just competition?

It's really all competition. In the quarter-over-quarter, Mario, on a year-over-year basis, a good chunk of it is our transfer pricing mechanism. So the hurt that you have in Canadian Banking on that year-over-year basis is offset in the other segment.

Right. So the 25 basis points year-over-year is essentially -- that is the transfer pricing but the quarter-over-quarter you think is competition.

Well, it's not -- yes, year-over-year, I'd say about two-thirds of it relates to the offset in Other. But we still got the same issue in terms of the mix that the customers are going after and the older, higher yield mortgages that are maturing and being rebooked at a lower rate, or on the variable side.

The final thing, this is probably for Mike Durland. Opening up a big trading floor in the UK is not unique to Scotia. One of your peers, we all know has done that. And while it certainly can lead to some big numbers quarter-to-quarter, it can also lead to some serious volatility. Is there anything you're doing that would suggest the volatility isn't going to play out in the same way it has, say, for one of your larger peers?

Firstly, I think Rick overstated the size and scope --

Small trading desk.

It was expensive but small. (laughter)

Certainly, in the context of what we have for premises in the past, it's a nice upgrade. Our investment in London has been modest. It's been focused on our fixed income platform. We've hired somewhere around 25 people. They're up and running.

The nice thing about our business there, is firstly we go into a market powder dry. We have reasonably modest expectations, so we're not trying to be everything to everybody. We're linking it to our domestic platform. We're also going to link it to our broader international platform. So we're -- and they've had a very good start. We've been up and running in that business for about 9 months. It's a very strong team.

So even though it is to us something that we like to talk about, in the context of our broader results and if you're looking at value at risk and that type of thing, it's not going to be moving the dial on the risk side. The expansion that we're contemplating in both London and New York is being done within the context of our historic VaR limits.

Okay. When you said 25 people instead of 250 people I think that was kind of the answer to the question.

Exactly.

Thank you.

Okay. We have time for one more question.

Peter Rutledge, National Bank Financial.

Quick one, just on Capital. In your report to shareholders the way I read it was the bank will meet the 2019 Basel III Capital requirements early in the transition period. What do you infer from that, that Scotiabank won't be at 7% on the Basel III tangible common equity ratio by the start of 2013? And are there any regulatory implications if this were to come to pass?

We're quite confident we can meet the Basel III or whatever regulatory requirements we are required to meet. And we feel that capital planning, we spend a lot of time on it. My concern is we maintain a level playing field. You've seen in a number of other jurisdictions outside of Canada, in Europe and elsewhere, where there's still a lot of uncertainty as to how local regulators will implement. And so either the absolute or relative levels of capital and the timings we'll be able to meet. But I just want us to make sure that we're not disadvantages. Because others are giving -- their regulators tend to be -- could be more lax.

We don't know. This is an evolving issue. You saw the news about Europe on this issue over the weekend. We just have to watch it. We're comfortable on our capital position.

You're comfortable with the 7% if [Basel III] sort of makes that more formal.

Certainly.

Okay. Thank you.

Thank you for joining us. Have a great day. We'll see you next quarter.