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Industry Report - Banking - November 2008

A Company and Industry Analysis November 2008

CONTENTS

Current Environment US Sector Overview Sector Performance Leading Players Mergers and Acquisitions

Current Environment Canada Sector Overview Sector Performance Leading Banks Mergers and Acquisitions

Industry Prole US Industry Size and Value Industry Focus Policy and Regulatory

EnvironmentIndustry Prole Canada Industry Size and Value

Industry Highlights Policy and Regulatory

EnvironmentMarket Trends and Outlook US Electronic Bank Crime on the

Rise Foreclosures and Delinquencies

Still Building Mortgage Applications Slow Market Outlook

Market Trends and Outlook Canada Canada Leads Online Banking

Adoption Rates Ination in Canada Remains

High Market Outlook

Currency Conversion TableThe Scope of This ReportKey ReferencesComparative DataReports Coverage

Current Environment Key Points

The credit turmoil continued to depress the US banking sector over the last six months and left

banks in worsening state.

Over the last six months, worse news about the sector sent worldwide banking stocks downward.

Faced with the most challenging operating environment seen in decades, ongoing concerns about

the health of bank balance sheets hampered M&A activity in the US banking industry. Although there was collateral damage to the Canadian economy from a slowdown in the US,

nancial trauma in the Canadian banking system was more subdued compared to its US and

European counterparts.

Over the six-month period ending September 2008, the S&P/TSX Composite Index tumbled

1,072.13 points to 12,064.57. Canadian banking stocks lost their shine and showed depressed

performances.

Losses from bad loans and slowing revenue from equity markets caused Canadian major banks to

register steep prot declines.

Industry Prole Key Points

As of March 2008, Federal Deposit Insurance Corporation (FDIC) gures put assets held by the

US banking industry at US$13.37 trillion, an increase from US$13.03 trillion in the rst quarter of

2007.

Banks have been forced to boost their capital levels to ensure sufcient funds to repay depositors

and investors and to continue making loans to consumers and businesses.

A new mortgage lending rule aimed at facilitating more responsible lending and protect consumers

from shady lending practices was approved on July 14. The new rule will take effect on October 1,

2009.

Canadian banks manage over C$2.6 trillion (US$2.45 trillion) in assets, accounting for over 70%

of the total assets of the countrys nancial services market.

Canadian banks are touting their commitment to become more customer-centric and more service-

oriented in the hope that this approach will differentiate them from the rest.

Market Trends and Outlook Key Points

Banking crimes in the US, particularly check fraud and identity theft, are growing at a fast rate.

A combination of factors, including tighter lending criteria, a slowing US economy and weak

housing sales, have left more US homeowners facing foreclosure and bankruptcy.

With loan rates hovering near one-year highs exacerbating the housing markets woes, application

volumes for US home mortgages tumbled to their slowest pace in July since December 2000.

Canadians lead most countries in embracing online banking. According to comScore, a global

internet information provider, 67.1% of Canadian did their banking online in April alone.

Ination in Canada is expected to peak at 4.3% early next year, rising beyond the BOCs 1% to 3%

target range.

1

North America

Banking Sectors

Adding Value to Information Since 1900


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The North America Industry Reports are

published by Mergent, Inc., headquartered in

Fort Mill, South Carolina, USA. Each

industry sector report is updated every six

months. Mergent, Inc., a leading provider of

global business and financial information on

publicly traded companies, operates sales

offices in key North American cities as well as

London, Tokyo and Sydney.

Publisher

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Director

John Pedernales

Managing Editor

Peter OShea

Research Analyst

Angelina Ho Li Na

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3

Current EnvironmentUnited States

Even after a year since the credit crisis erupted, the health

of the US banking system continued to deteriorate and

its banks remained in a miserable state. Headlines went

from bad to bleak and the torrent of troubles caused the

sector to be confronted with an uninspiring six months.

Alan Greenspan, who retired two years ago after serving

18 years as Federal Reserve Chairman, even said that the

current credit turmoil was the most wrenching in at least

50 years and possibly more. The horrifying credit distress

continued to depress the sector where it downed evenresilient banks which used to yield juicy prots but started

to report stunning losses.

The nations economy continued to slow over the last six

months, exacerbated by higher energy prices and the pain

in the housing market that seemed to deteriorate. More

worrisome, the weakening economy made investors,

especially bond traders, harder to invest with condence

because even areas such as auto loans, commercial

mortgages and credit cards that previously looked secure

seemed vulnerable to losses. Concerns about the status of

the nations banks, which were dogged by double fears of

capital shortages and worsening credit, were heightenedwith further loan losses not ruled out. The past six months

saw non-performing assets and net charge-offs continue to

rise, while shares of banks sagged and many banks in the

US reported massive write-downs. Once again, they had to

beef up their loan loss reserves as the economy sputtered

and the housing market softened. Globally, US housing

deterioration sparked about US$500 billion in credit market

losses and markdowns for banks since the start of 2007,

according to the International Monetary Fund (IMF).

Grappling with panic, the meltdown has morphed into a

full-blown crisis and saw growing lists of bank failures. The

enormous breadth and depth of the troubles has squeezedthousands of small lenders, local builders and businesses

that rely on those banks for nancing. Data revealed by

the Federal Deposit Insurance Corp (FDIC), the US federal

agency which guarantees bank deposits, showed that the

number of ailing US banks jumped to 117 during the

second quarter of 2008, the highest level in ve years.

By the end of March, there were only 90 on the list that

exhibited nancial, operational or managerial weaknesses.

A turn of events shocked many and forever changed the US

banking sector when investment bank Lehman Brothers

and Washington Mutual (WaMu) (NYSE: WM), the largest

US savings and loans, collapsed in September under the

weight of their huge bad bets on the mortgage market.

Merrill Lynch (NYSE: MER), on the other hand, was lucky

to be saved after being snapped up by the Bank of America

(BofA) (NYSE: BAC) for a mere US$50 billion.

The 158-year-old Lehman Brothers came to an ugly

end after ling for bankruptcy and after failing to attract

investors to shore up its capital position. The company that

began in the boom in US cotton trade before the Civil War

was weakened by its large exposure to commercial real

estate and wrote down its assets by US$5.6 billion in the

third quarter, initiating a second straight quarterly loss of

US43.9 billion. Lehman faded into history after efforts to

hash out an orderly sale for the company faltered.

With debts of more than US$8 billion and insufcient

liquidity to meet its obligation, Seattle-based WaMu, which

had about US$307 billion of assets and US$188 billion of

deposits, was seized and shut down by the federal Ofce

of Thrift Supervision (OTS) and the FDIC on September26. Hit hard by the nations housing and credit crisis and

already suffering from soaring mortgage losses, the lender

by far was the biggest US bank to fail in history, eclipsing

the US$40 billion failure of Continental Illinois National

Bank, which failed in 1984, and the US$32 billion failure

of IndyMac, which the Government closed down on July

11. A chunk of the thrifts banking assets were later sold to

JPMorgan Chase & Co (NYSE: JPM) for US$1.9 billion,

six months after bailing out Bear Stearns.

The consequent panic on Wall Street prompted investors

and clients to abandon even the most secure investment

banks and made large, independent investment banks anendangered species. It forced Goldman Sachs (NYSE:

GS) and Morgan Stanley (NYSE: MS) to convert to

traditional bank holding companies. By transforming

into bank holding companies, the two of Wall Streets

last remaining investment bank came under the scrutiny

of national banking regulators and will be subject to new

capital requirements. The Fed and Treasury in the US were

keen to treat the situation abruptly and were prepared to

go to great lengths to defend the nations nancial system.

Sector Overview


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Current Environment - United States

On September 20, they swung into action to pacify themarkets and avert an even worse meltdown. The Bush

Administration announced a gargantuan US$700 billion

bailout plan to keep credit owing and to rescue fragile

banks from bad loans that could derail the nation and

global economies.

Sector Performance

After experiencing a great run for many years, US banks

did not seem to be protable in the current situation.

Stubborn woes in the real estate market, the economic

slump and stricter credit conditions continued to trim prots

at the nations banks and added pressure on the banking

industry in the second quarter of 2008. As the mortgage

crisis unfolded, the earnings of many of the largest banks

and thrifts remained weak and volatile and fewer banking

institutions improved their earnings. By any yardstick, it

was clearly another tough quarter for bank earnings. While

the rising trend in troubled loans showed no sign of abating,

loan losses rose much more sharply at the major banks.

Higher loan loss provisions were the main cause of the

drop in industry earnings, hampered also by market-related

charges such as write-downs on asset-backed securities

(ABS) and collateralized debt obligations (CDOs).

The industry performance for the second quarter displayed

dim results and data from FDIC disclosed that net incomecame at only US$5.0 billion. It was the second lowest

quarterly total since 1991 and was US$31.8 billion or 86.5%less than what was earned in the second quarter of 2007.

For the rst half of 2008, prots of US commercial banks

and thrifts were down by 66%. Quarterly loss provisions

where banks have to add more money to reserves to cover

potential loan losses eclipsed US$50 billion more than

four times the US$11.4 billion quarterly total of a year

ago.

Stocks on Wall Street nished the six months ended

September 3, 2008, with a downward plunge on worries

that the rot of the credit crisis was spreading and the

growing evidence of danger times ahead for the US

economy. After the technology bubble burst in 2000 and

the September 11 attacks, stocks were hurled lower but

many on Wall Street feared that the effects of the nations

current problems could end up being just as destructive, or

more so. Disturbing news about the banking sector piled

up during the period and banks that were poised to reveal

that they remain on shaky footing sent stocks to steep

losses. During the six-month period, the DJ Banks Titan 30

Index staggered and dropped 9.1% to reach 91.46 points on

September 3. Its lowest level was at 72.88 points on July

15, with many banks looking the cheapest they had been in

a decade. Banking stocks led the decliners and among the

heaviest fallers were troubled mortgage nanciers Fannie

Mae and Freddie Mac whose share prices plummeted by

72.3% and 77.3% respectively after reporting larger-than-expected second quarter losses.

Table 1: Quarterly Earnings of the US Banking Industry from 2004 to Q2 2008

Source: Federal Deposit Insurance Corporation, August 2008

(US$ billions)

40.0

30.0

15.0

35.0

20.0

25.0

10.0

5.0

0.0Q1

31.8 31.232.5

31.0

34.0 33.234.7

32.6

36.9 38.0 38.1

35.3 35.636.8

28.7

0.6

19.3

5.0

Q1 Q1 Q1 Q1

2004 2005 2006 2007 2008

Q3 Q3 Q3 Q3Q2 Q2 Q2 Q2 Q2Q4 Q4 Q4 Q4


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Although many believed that Wachovia Corp (NYSE:

WB) would be able to survive on its own and was unlikely

to suffer the same fate as WaMu, investors were concerned

about its large troubled mortgage portfolio. Shares of the

Charlotte, North Carolina-based bank plunged 43.5%to US$17.18. With the exception of Wells Fargo & Co

(NYSE: WFC) and Goldman Sachs, shares of Citigroup

Inc (NYSE: C), BofA and JPMorgan Chase & Co all

registered their cheapest trades in at least a year, declining

by 15.1%, 15.9% and 0.3% respectively. Unlike previous

bad times, there was no swift rebound in banking stocks,

with many analysts saying it would be a year until the

market recovered in a more stable manner.

Leading Players

Tension in the nancial markets was not eased and the

mortgage meltdown that started last year continued tosaddle the US major banks while losses that started

with CDOs spread from one asset type to another. The

leading banks were forced to make further write-downs

in addition to the billions that had already been recorded.

In April, Citigroup, which has topped the ranking with

the most write-downs and credit losses at US$55.1 billion

since the third quarter of 2007, and Merrill Lynch that

followed with US$51.8 billion of write-downs, disclosed

fresh subprime write-downs totaling US$15 billion or

more. In another sign of the intense pressure on leading

banks, a string of them were forced to slash dividends

or raise new capital in response to losses deriving from

falling values of securities related to all types of home

loans and commercial mortgages as well as leveraged-loan commitments.

As the credit crunch continued to wreck havoc, the six

leading banks Citigroup, BofA, JPMorgan Chase, Wells

Fargo, Wachovia Corp and US Bancorp (NYSE: USB)

reported a slew of disappointing earnings. Wachovias

operations were hit by billions of dollars in losses related

to the mortgage and credit markets. A major player in retail

banking and mortgages, things were from bad to worse for

Wachovia over the past year. In the rst quarter of 2008,

the fourth largest US bank, which registered its rst trip

into the red since 2001, plunged into losses once again

in the second quarter. This time it was about 12 timesas large. It lost US$8.86 billion, which was more than it

had ever earned in a full year. Since acquiring Oakland-

based Golden West Financial Corp in 2006, it has been

suffering massive mortgage losses from its so-called Pick-

a-Payment loans inherited from Golden West.

More misfortunes hit the US largest banks. JPMorgan

Chase, the third largest US bank, also lagged behind and

reported dipped earnings although it largely dodged the

Table 2: Share Performance of Key Players in the Industry (US$)

BanksClosing Price

Total Return (%)March 3, 2008 September 3, 2008

Decliners

Freddie Mac $23.72 $5.38 -77.3%

Fannie Mae $26.44 $7.32 -72.3%

Washington Mutual $13.65 $4.40 -67.8%

Wachovia Corp $30.41 $17.18 -43.5%

Merrill Lynch $48.64 $28.33 -41.8%

Bank of America $39.18 $32.96 -15.9%

Citigroup Inc $23.09 $19.61 -15.1%

JPMorgan Chase & Co $39.82 $39.71 -0.3%

Gainers

Wells Fargo $28.87 $31.01 7.4%

Goldman Sachs $165.08 $167.61 1.5%

Source: Mergent Analysis & Respective Companies

Note: Returns are calculated using the price of stock from March to September 2008


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subprime bullet by shunning CDOs. JPMorgan was hurt byturmoil in the credit and mortgage markets, lower levels

of liquidity and the cost of crippled rival Bear Stearns

US$2.3 billion acquisition in March. Its net income of

US$2.0 billion for the second quarter was down from its

rst quarter earnings of US$2.37 billion and less than half

of the US$4.2 billion it earned in the second quarter of

2007. As more customers failed to pay back their loans,

Wells Fargo, the nations fth largest bank and the biggest

US bank on the West Coast, dwindled and posted a drop in

prot. For the April to June period, its prot fell by 22% to

US$1.75 billion, down from US$2.28 billion for the same

timeframe last year. A number of poor results were also

displayed from a group of regional nancial institutions,

such as Cincinnati-based Fifth Third Bank (NYSE: FITB),

Regions Financial (NYSE: RF), SunTrust Banks (NYSE:

STI), National City (NYSE: NCC) and KeyCorp (NYSE:

KEY).

Citigroup (NYSE:C)

After having to weather hard times brought on by the

subprime crisis, Citigroup was keen to get its house in

order and continue to focus on strengthening its business.

After months of intense review, new Chief Executive

Vikram Pandit had plans in mind to shrink the company

by about one fth and shed between US$400 billion and

US$500 billion of its US$2.2 trillion in assets. The three-year plan also includes cutting new loans to be held in

portfolio mostly within its consumer and securities banking

sectors by half and growing its revenue by 9% as it strivesto rebound from the massive credit markets losses. Apart

from closing 32 sales distribution outlets and 540 ATMs

in Japan, Citigroup also sold several businesses including

CitiStreet, CitiCapital and Diners Club. Despite US$11.7

billion in write-downs and credit losses, its second quarter

loss of US$2.5 billion was smaller than the market

expected.

Bank of America (NYSE: BAC)

News grew tougher for BofA earnings as credit quality

continued to weaken during the second quarter, particularly

in markets that suffered the most signicant drops in home

prices. While its chairman and CEO, Ken Lewis warned

that credit losses would remain an issue and would spread

from residential customers to commercial borrowers,

BofA was exposed to the struggling auto industry in the

Midwest due to its purchase of LaSalle Bank late 2007

for US$21 billion. Prot for the nations second largest

bank, which was also the largest retail bank, dived by

41% to US$3.41 billion during the April-June period as it

more than tripled its reserve for loan losses due to a weak

economy and declining home prices. This was the fourth

straight quarterly decline but, was less than expected on

record revenue. However, Ken Lewis remained optimistic

and hoped that its high-prole acquisition of the troubled

once largest mortgage lender, Countrywide Financial Corpon July 1, would add to prot by the end of the year and

result in US$900 million of cost savings.

Table 3: Ten Largest US Banks Ranked by Assets

Rank BankReported Assets

(US$ billion)as of June 30, 2008

Reported Assets(US$ billion)

as of June 30, 2007% Change

1 Citigroup Inc 2,100.54 2,220.87 -5.4

2 JPMorgan Chase & Co 1,775.67 1,458.04 21.8

3 Bank of America 1,716.88 1,534,36 11.9

4 Wachovia Corp 796.44 704.77 13.05 Wells Fargo & Co 609.07 539.86 12.8

6 US Bancorp 246.54 222.53 10.8

7 Bank of New York Mellon 195.99 114.32 71.4

8 SunTrust Banks Inc 176.23 180.75 -2.5

9 National City Corp 153.67 140.64 9.3

10 BB&T Corp 136.46 127.58 6.9

Source: Mergent Analysis, September 2008


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Mergers and Acquisitions

Facing the most challenging operating environment ever

seen, mergers and acquisitions (M&As) within the US

banking industry went through a quiet spell. Downward

pressure on banking stocks was a dampener on M&A

activity, with acquiring companies not ush when their

stock prices are depressed. Likewise, targeted companies

cannot argue for healthy acquisition prices if their shares

are sinking. Many will not sell because they wont get

a good price and those that have high levels of lending

portfolios tied-up with residential housing will further

hamper M&A activity.

Ongoing concerns about the strength of many banks

balance sheets reduced the likelihood of M&As in the

banking industry. Buyers tend to feel apprehensive about

a target banks viability or attractiveness when capital is

in short supply and prots are damaged. It is difcult to

ascertain how much bad debt a bank might have when

real estate loans have been securitized, bought and sold

many times. This further compounded a difcult M&A

landscape. During the tough credit conditions, most

deals that came were likely related to banks that were

underperforming and needed a partner soon to survive

or worse. Larger banks with stronger capital positions

acquired several troubled institutions over the past months

for example. JPMorgan Chase purchased Bear Stearns inMarch and BofA acquired Countrywide Financial in July.

It is uncertain whether these giants still have room to

acquire others.

After failing in the talks to buy Lehman, BofA turned its

head to Merrill, which is considered a better t for the

retail giant. The 94-year-old Merrill, the worlds largest

brokerage rm, agreed on September 14 to be taken over

by BofA in a rushed bid to ride out the storm. The US$50

billion deal would create a global nancial giant to rival

Citigroup in terms of assets. Merrill, which had reported

four straight quarterly losses, was struggling with tight

credit markets and attempting to sell off toxic debt thatcaused the company to bleed capital. The transaction,

which was expected to close in the rst quarter of 2009,

represented a perfect t for BofA because by adding

Merrills more than 16,000 nancial advisers, BofA would

have the largest brokerage in the world with more than

22,000 advisers and US$2.5 trillion in client assets. The

combination would add give strength BofA in emerging

markets such as India as well as strength in global debt

underwriting, global equities and global M&A advice.

Renowned for large acquisitions, BofA has spent over

US$100 billion since 2004 buying other companies.


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Current EnvironmentCanada

The past six months were clearly a bad season for the

entire banking sector. The gigantic nancial meltdown left

Canadian banks bruised and some beaten. In the month of

September alone, a nancial bomb exploded and the end

result in the US saw three Lehman Brothers, Merrill

Lynch and giant insurer American International Group

(AIG) (NYSE: AIG) cave in within a day. Fears of a

total breakdown of the global nancial system took over

and the values of shares worth billions of dollars around

the globe were wiped off.

In an effort to ensure sufcient cash and revived a system

that has virtually ground to a halt, the worlds major

central banks injected US$180 billion into global nancial

markets. This amount included US$10 billion pumped by

the Bank of Canada (BOC) to ward off a total freeze-up of

global capital markets. The massive US$180 billion rescue

packages involved loans, sales of assets and company

restructuring, all served to prop up condence and stabilize

the situation for the time being. However, the Canadian

nancial system was neither in the same shape as its US

counterpart, nor suffered the same damage.

Although there was collateral damage to the Canadian

economy from a slowdown in the US, Canadas nancial

institutions were in a stronger position to weather the crisis.

Big nancials not only in the US, but also in Asia and

Europe, were damaged with problem of risky mortgages

packaged into bad securities but the number of Canadian

banks that jumped on this risky bandwagon appeared to

be much lesser. Compared with more than 30% in the US,

the Canadian market for subprime mortgages accounted

for only about 5% of residential mortgages, data from

Toronto-Dominion Bank (TD) (TSX: TD) indicates.

As for the nations own mortgage market, due to its banks

more conservative nature, it contained very few risky

mortgages and was less dependent on securitization for

nancing and on capital markets for revenues. Furthermore,

there were fewer traumas on the housing market since

prices were not in freefall as experienced in the US.

Apart from having healthy balance sheets with good core

funding and absolute leverage that was signicantly lower

than many of their international peers, Canadian banks

tend to be more diverse across investment, mortgage and

general retail operations. They hardly concentrate on one

particularly area as US banks tend to practice and more

importantly, the major banks were not involved largely in

the subprime business. Another upside was that Canadian

banks had better capitalizations and their write-downs

paled in comparison to those of American and European

banks, although the banks endured weaker results and

lower earnings.

Sector Performance

Last year, despite an overall positive earnings growth,

Canadian banking stocks lost their shine and put in a

depressed performance. Canadian banking stocks were

battered as dark stormy clouds spread over their US

counterparts and, as a result, saw banks loose a tenth of

their stock value in 2007. However, it was not as bad

compared to American banks which were down by a third.

Worries about the US nancial system, the aftershocks of

the implosion on Wall Street and signs of deteriorating

loans at some of the regional banks in the US continued

to reverberate across the Canadian nancial landscape and

put its banking stocks under pressure.

Shaken by falling prices for Canadas main commodities

and renewed fears in credit markets, the S&P/TSX

Composite Index, the Tees benchmark index, dropped

1,072.13 points to 12,064.57 over the six-month period

ending September 18. Following dismal news that Lehman

Brothers led for bankruptcy protection and after the take

over of Merrill Lynch, investors dumped their stocks which

resulted in a massive sell-off in North American stock

markets. On September 17, S&P/TSX Composite Index

was at its lowest at 11,877.69 points. The share prices of

several banks tracked by Mergent were dragged down by

the widespread US contagion, fresh rounds of write-downs

and worries about overall nancial market stability. The

two biggest weighted losers were TD, sliding by C$3.72

(US$3.51) or 5.9% to C$59.25 (US$55.91), and Canadian

Western Bank (CWB) (TSX: CWB), the nations eighth

largest lender, down 3.0% to C$22.06 (US$20.82). TD

saw its shares pushed lower by investor concerns about

mounting credit losses while CWB said that disruption in

Sector Overview


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9

Current Environment - Canada

the global nancial markets may keep the regional bankfrom meeting its prot growth targets for the year.

Other banks that joined in the list of fallers were Canadian

Imperial Bank of Commerce (CIBC) (TSX: BCM) and

Laurentian Bank of Canada (TSX: LB), which slipped 1.8%

and 0.1% to close at C$59.68 (US$56.32) and C$41.95

(US$39.59), respectively. Market conditions hurt CIBCs

wholesale and retail brokerage operation. By far, CIBC

took the unwanted prize as the worst suffering of the banks

hit by exposure to the US subprime crisis. The broader

market overall was perturbed by concerns over how much

the US Governments US$700 billion bailout plan, which

was initiated earlier, to take over bad mortgage-related debtfrom nancial groups will help nancial markets in the long

run. Investors were not sure over the effectiveness of the

plan and whether it can successfully mop up the problem.

However, not all experienced bad news. On the upside, the

shares of Bank of Montreal (BMO) (TSX: BMO) jumped

C$7.46 (US$7.04) or 17.8% over the six-month period

ending September 18, while smaller rival National Bank

of Canada (NBC) (TSX: NA) added C$4.39 (US$4.14) or

9.3% to C$51.35 (US$48.46). Meanwhile, Bank of Nova

Scotia (BNS) (TSX: BNS) and Royal Bank of Canada

(RBC) (TSX: RY), Canadas biggest lender, both climbed

by 7.3% and 3.1% to close at C$47.37 (US$44.70) andC$47.99 (US$45.29), respectively on September 18.

BNS, faced with lesser mortgage and credit losses, is

geographically limited with excellent growth exposure inthe Caribbean, South America and Mexico.

Leading Players

As the earnings season wrapped up, Canadian banks were

seen to hit a steep prot decline on losses from bad loans and

slowing revenue from equity markets. Since last summers

nancial crisis began, the major banks went through a

rough stretch and endured weaker results although they

eluded the state of calamity. The major banks in Canada

have taken about C$11.6 billion (US$10.95 billion) in debt

write-downs since the collapse of the subprime market last

year and overall earnings were cut nearly in half to C$2.47billion (US$2.33 billion) in the second quarter ended April

30. The prot continued to retreat in the third quarter and

the nations six biggest banks RBC, TD, BNS, BMO,

CIBC and NBC recorded a 21% drop in combined

total earnings. Although the results were somewhat better

than investors expected and write-downs were pale in

comparison with their counterparts, prots were down to

C$4.15 billion (US$3.92 billion) from a year ago C$5.26

billion (US$4.96 billion) due primarily to the major banks

slacking capital markets divisions.

The leading banks practically spent the quarter logging

more credit losses with CIBC the far worst affected amongCanadas big banks. CIBC, ravaged by write-downs from

its subprime mortgage and CDO exposure, saw its earnings

Table 4: Performance of Canadian Banking Stocks

BankClosing Share Price as on Percentage of

Change (%)March 18, 2008 September 18, 2008

Decliners

Toronto-Dominion Bank C$62.97 C$59.25 -5.9%

Canadian Western Bank C$22.75 C$22.06 -3.0%

Canadian Imperial Bank of Commerce C$60.75 C$59.68 -1.8%

Laurentian Bank of Canada C$42.00 C$41.95 -0.1%

Gainers

Bank of Montreal C$41.89 C$49.35 17.8%

National Bank of Canada C$46.96 C$51.35 9.3%

Bank of Nova Scotia C$44.16 C$47.37 7.3%

Royal Bank of Canada C$46.53 C$47.99 3.1%Source: Mergent Analysis, September 2008


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10


tumble 91% year-over-year to C$71 million (US$67million), compared with C$835 million (US$787.96

million) in the corresponding period of 2007. The fth

largest bank, which sold off its US investment banking

division to one of the leading national investment boutiques

to Oppenheimer Holdings Inc (NYSE: OPY) late last year,

took a total of C$7.58 billion (US$7.15 billion) in write-

downs over the past nine months. By far, the gure was

the greatest wallop from the credit crunch among Canadian

banks. However, the prot numbers were not as bad as

previously thought. CIBC moved into the black after two

consecutive quarterly losses.

Meanwhile, the prots for BMO, Canadas fourth largestbank, and BNS, the No. 3 lender for the third quarter

slipped from last year on rising loan losses. After taking

a C$96 million (US$90.59 million) after-tax charge

stemming from capital market losses, BMOs performance

was less than stellar and displayed a drop in its prot. Its

net income for the period dropped 21% to C$521 million

(US$491.65 million), its fth straight prot slide. BNS, on

the other hand, fared better than BMO due to its limited

US operations. BNS, which operates mainly in Canada,

Mexico and Latin America, saw its net income for the

period ended July 31 down only by 1.9% to C$1.01 billion

(US$953.09 million). The Toronto-based banks strategy

of diversifying across business lines and geographies hasenabled it to perform better.

Montreal-based NBC, the smallest of the Big Six, was a big

winner in the third quarter. Compared with disappointment

at several of the nations banks, NBC did not suffer the

same fate but instead was the only one of the Big Six to

report a higher prot. Although having to struggle with aC$37 million (US$34.92 million) pre-tax loss from asset-

backed commercial papers (ABCP), NBC reported a solid

performance in the third quarter and actually saw its prot

rise to a record C$286 million (US$269.89 million), up

from C$243 million (US$229.31 million) a year earlier.

While its peers took further hits on their troubled credit

portfolio, NBCs good surprise was driven by a solid

contribution from the nancial markets segment, as well as

by personal and commercial lending.

After taking a C$498 million (US$469.94 million) hit in

pretax write-downs, RBC faltered and reported a lower

prot. The third quarter prot at the nations largest bankwas C$1.26 billion (US$1.19 billion), down by 10% from

a year ago. The prot, which declined for a third straight

quarter, its longest streak in nine years, was hurt by capital

markets charges and higher loan loss provisions largely in

its US banking operations. During the quarter, RBC set

aside C$334 million (US$315.18 million) for bad loans,

almost double from a year earlier. Its earnings from the

RBC Capital Markets investment banking unit tumbled

25% to C$269 million (US$253.84 million) as stock sales

and takeovers in Canada cooled, while RBCs international

consumer banking unit reported a C$16 million (US$15.09

million) loss, versus a prot of C$87 million (US$82.09

million) a year earlier.

TD Bank, Canadas second largest bank, was not fortunate

either. Compounded by a signicantly large drop (down by

85%) of net income at its wholesale banking unit, overall

third quarter prot fell to C$997 million (US$940.83

million) from C$1.1 billion (US$1.04 billion) from the

Table 5: Key Players in the Canadian Banking Industry

AssetRank

BankReported Assets

(C$ million)as of July 31, 2008

Reported Assets(C$ million)

as of July 31, 2007

PercentageOf Change (%)

1 RBC Financial Group 636,792 604,582 5.32 TD Bank Financial Group 508,839 403,890 25.9

3 Bank of Nova Scotia 462,407 406,115 13.9

4 Bank of Montreal 375,047 359,154 4.4

5Canadian Imperial Bank ofCanada

329,040 338,881 -2.9

6 National Bank of Canada 121,931 123,353 -1.1

Source: Mergent Analysis, September 2008


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11


same time in 2007. While it was clearly a tough quarter for

its wholesale bank, TD Canada Trust, its main Canadianretail operation, registered record earnings of C$644

million (US$607.72 million) in the third quarter, up 8%

over the corresponding period last year. In further good

news, earnings at its US personal and commercial banking

unit, which now includes New Jersey-based Commerce

Bancorp (NYSE: CBH), more than doubled to C$244

million (US$230.25 million).

Mergers and Acquisitions

During the rst three months of 2008, lingering concerns,

tighter equity markets, higher borrowing costs and

economic uncertainty in the US and Canada continued tocurb M&A activity in Canada. M&As in Canada were much

rarer and went back to their lowest level since early 2005

after a three-year long boom. M&A activity was on hold

as buyers questioned just how much the market had fallen,

while sellers were not comfortable that the buyers were the

right solution at the right price. Stronger and capable banks

decided to wait until the economy and housing market

showed signs of stabilizing. Compared to a year ago, the

value of M&A continued its downward trend and recorded

a dramatic drop from C$62 billion (US$58.51 billion) to

C$24 billion (US$22.65 billion) in the rst quarter of 2008,according to Toronto-based investment bank Crosbie & Co.

There were only 338 transactions, well off the 523 deals

in the rst quarter of 2007. It was noted that the nancial

services group made 23 deals during the January to March

period, down from 43 deals in the corresponding period

of 2007.

Throughout the years, Canadian banks have grown their

banking businesses outside of Canada signicantly through

acquisitions and organic growth after facing ceaseless

frustration in their attempts to merge domestically. The

Canadian Government has effectively ruled out big

domestic bank mergers ever since 1998, with fears thatsuch deals would lead to price-gouging or higher service

charges and would have a negative effect on services. With

deals off the table in the domestic market, major banks

such as RBC, BNS and TD have ed to expand in south of

the border over the past years.

RBC has made more than 20 acquisitions in a range

of business lines over the past eight years and intends

to grow its capital markets business through building

Table 6: M&A Activity by Industry

First Quarter 2008 First Quarter 2007

Industry Group No. of DealsValue

(C$ millions )No. of Deals

Value(C$ millions )

Industrial Products 91 2,892 98 15,967

Oil & Gas 70 7,429 85 8,786

Metals & Minerals 40 2,360 68 2,528

Real Estate 28 1,339 113 7,677

Financial Services 23 1,982 43 9,148

Consumer Products 19 707 39 851

Merchandising 19 217 33 1,559

Transportation & Environmental Services 11 221 10 253

Utilities 11 3,517 10 5,098

Gold 10 3,224 5 546

Communications & Media 10 183 14 4,071

Paper & Forest 6 210 4 3,977

Pipelines 0 0 1 1,060

TOTAL 338 24,281 523 61,521

Source: Crosbie & Co, May 2008


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12


businesses and making small acquisitions such as energyrms, money managers, wealth managers and investment

management companies. In June, RBC bought Boston-

based money manager Access Capital Strategies LLC,

its second acquisition in the month and its 11th in the

past two years. A few weeks earlier, the countrys largest

bank completed its acquisition of Richardson Barr & Co

(NYSE: RY), a leading Houston-based energy advisory

rm. The acquisition was expected to strengthen RBCs

US investment banking business. The terms of both deals

were not disclosed.

With US banks looking increasingly vulnerable and rather

cheap and with Canadian banks armed with a strongerloonie, there was no better time than this year to seize the

opportunity to buy up more US banks. Canadian banks

have tended to be labeled as timid and criticized as not

being able to complete globally because they are too small.

However, thanks to the credit crisis, they might have the

chance to do transformative deals that could make them

bigger North American players. Although it may sound

attractive, Canadian banks are unlikely to buy US banks

just because they are cheap and may prefer to pay more

but be very comfortable with a banks assets. From the

banks perspective, it is a time to be extremely cautious and

avoiding deals that might prove to be disastrous. The banks

may not rush into a spending spree in the US and get caughtin potential targets weak balance sheets. Furthermore, the

targets the Canadian banks are scouting for are much more

likely to be solid acquisitions that complement existing

plans.


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13

Industry ProfileUnited States

One role of banks is to support the growth of its countrys

economy and create jobs. Playing a central role in keeping

the many parts of the nations economy moving, banks turn

new deposits into funds that can be lent out to individuals

and businesses. This stimulates growth and promotes

economic exibility. The recently unveiled rst quarter

2008 gures by the Federal Deposit Insurance Corporation

(FDIC) show that the US banking industry held a total of

US$7.97 trillion of loans in its own portfolios.

Moreover, the physical presence of 99,221 bank ofces and

branches and the convenience of 415,321 ATMs not only

assures convenient access to local nancial services, but

gives banks a personal stake in the economic growth and

vitality of both small towns and large cities everywhere.

US banks hold US$8.56 trillion in total domestic deposits

and process more than 40 billion checks each year. The

widespread adoption of ATMs has enabled the total US

ATM transaction volume to increase to 14.9 billion in

2007 from 10.7 billion in 1996. The number of ATM

machines also tripled from 139,134 in 1996 to 415,321

in 2007. In addition to the contribution banks make to

general economic growth, the banking industry itself is

an important component of the economy. The industry

employs 2,212,766 people.

Banks in the US have always supported the nancial

needs of businesses both large and small, from start-ups

to multinational corporations. Bank credit helps small

businesses, which represent 99.7% of all rms in the US

and are responsible for generating 60-80% of net new

jobs annually over the last decade, according to the SmallBusiness Administration (SBA). US banks had almost

US$600 billion in small business loans in 2007, accounting

for almost a quarter of bank business lending. Meanwhile,

gures from FDIC show that loans to individuals were

US$1.05 trillion and farm loans reached US$53.89 billion

in the rst quarter of 2008, supporting the credit needs of

rural Americans and improving the nations agricultural

activity.

However, as the nations economy slows and banks

reel from the housing crisis, getting a business loans

is becoming much harder and more expensive. Credit

Industry Size and Value

Table 7: Share of US Banking Industry Assets by Group

Source: Federal Deposit Insurance Corporation, July 2008

International Banks, 23.1%

Agricultural Banks, 1.2%

Credit Card Lenders, 3.4%

Commercial Lenders, 39.4%

Mortgage Lenders, 10.2%

Consumer Lenders, 0.5%

Other Specialized>$1 Billion, 0.3%

All Other >1 Billion, 0.8%

All Other >1 Billion, 21.1%


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14

Industry Profile - United States

extended by banks to companies and consumers still grewat double-digit rates earlier this year but, by mid-June,

bank credit declined at an annualized pace of more than

6%. Banks, ghting for their nancial life and shocked by

their multibillion-dollar losses on real-estate, scaled back

loans to American business, depriving even healthy rms

of money for hiring and expansion. According to Federal

Reserve data, two vital forms of credit used by companies

short-term commercial paper not backed by collateral

and commercial and industrial (C&I) loans collectively

fell almost 3% over the last year, from US$3.36 trillion to

US$3.27 trillion. The gure was the largest annual drop

since the credit tightening that began with the last recession

in 2001.

FDIC gures put assets held by the industry at the end

of March 2008 at US$13.37 trillion, an increase from

US$13.03 trillion from the rst quarter of 2007 and

US$11.86 trillion from the rst quarter of 2006. Large

nancial banks, which hold more than US$15 billion in

assets, continue to dominate and remain the market share

leaders. The total assets of the nations three banking titans

Citigroup, BofA and JPMorgan Chase total US$5.59

trillion. Citigroup, which previously ranked number one,

even lost to fellow rivals BofA and JPMorgan & Chase,

revealing major surprises and the most noticeable change

in the breakup of the US domination.

Statistics from FDIC show that the number of banking

institutions dropped from 15,158 in 1990 to 8,494 in the

rst quarter of 2008. The total comprises 7,240 commercial

banks and 1,254 savings banks or thrifts. There was a

55.4% drop in the number of thrifts from 1990 to March

2008 due mostly to acquisitions by, or conversions to,

commercial banks or other savings banks, while the number

of commercial banks fell by 41.3% to 7,240. Thrifts that

tend to be small were originally established to promotepersonal savings through saving accounts and home

ownership but now provide a range of services similar to

many commercial banks.

Industry Focus

Banks Latest Efforts to Raise New Capital

Maimed by self-inicted wounds and lost money from

wrong-way bets on mortgage-backed securities and other

risky investments, the nations banks are in need of new

capital. The enormous losses on bad loans have shrunk the

capital of banks, threatening to leave them in a dangerous

state and further hampering their ability to continue to

make new loans. This has implications for the broader

economy. Since the credit crunch began, US banks large

or small have estimated to raise more than US$120 billion

while all global nancial services companies have raised

over US$300 billion. Even further efforts to repair balance

sheets and raise capital are likely as conditions worsen and

more banks announce grim results and are forced to take

further losses.

To ensure that banks have enough money to repay

depositors and investors and to continue making loans to

consumers and businesses to provide credit that fuel the

economy, banks were forced to increase their capital levelsthrough several methods and diverse sources including

slashing dividends, new stock offerings and raising

billions of dollars from large shareholders, private-equity

rms and other institutional investors that are willing to

plunge billions of dollars into the foundering sector. Both

methods of cutting dividends and issuing more shares will

eventually erode shareholder value because prot gets split

among more shares.

Table 8: Size of US Banking Industry (as of March 2008)

First Quarter 2008 All Institutions Commercial Banks Savings Institutions

Number of FDIC-Insured 8,494 7,240 1,254Total Assets (US$ billion) 13,369 11,495 1,875

Total Loans (US$ billion) 7,968 6,666 1,301

First Quarter 2007 All Institutions Commercial Banks Savings Institutions

Number of FDIC-Insured 8,649 7,379 1,270

Total Assets (US$ billion) 11,982 10,135 1,847

Total Loans (US$ billion) 7,278 5,972 1,306Source: Federal Deposit Insurance Corporation, July 2008


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15

Industry Profile - United States

Federal regulators and the US Government have beenpressuring banks to increase their capital levels and not

hesitate to curb their dividend and share-repurchase

programs to strengthen their balance sheets. With credit

losses clearly on the rise in a number of different categories

of assets, capital and higher loan loss reserves are the best

buffer. For now, before further credit problems make

raising capital even more costly and difcult, regulators

main emphasis is to see banks restore their balance sheets

in a proactive manner. Without banks able and willing to

extend loans, the nations economy could weaken further

and negatively affect economic expansion.

The fact that big banks such as Citigroup, Wells Fargo,

Wachovia and investment giant Merrill Lynch are running

out to raise capital just proves how bad the situation really

is and that capital cushions are shrinking. After coming

up with US$35 billion since last year, Citigroup also sold

US$6 billion in preferred stock in April hoping to offset

mounting losses that the bank has taken. The New York-

based bank planned to sell close to US$400 billion in assets

over the next two to three years. Fellow rivals BofA and

JPMorgan & Chase followed suit and issued US$4 billion

and US$6 billion of preferred shares, respectively.

The US housing crisis that continued to devastate the

nations banking sector has led tarnished Wall Street

and forced Merrill Lynch to dump billions of dollarsof mortgage debt at a steep loss and shed assets to raise

US$805 billion in capital. Fundraising at the worlds largest

brokerage included selling 20% stake in nancial news

and data group Bloomberg Lp for US$4.4 billion, and its

controlling interest in Financial Data Services for at least

US$3.5 billion. Merrill also plans to raise US$8.5 billion

selling new common stock to bolster its capital position.

Temasek Holdings, a Singapore state-owned investment

rm, committed to buy a US$3.4 billion chunk of the new

shares. The move rocked the condence in the banking

sector, renewing fears that the credit crisis had more to

run.

Policy and Regulatory Environment

The lax risk management at banks that contributed to

credit turmoil has driven regulators to push for improved

disclosure by banks to boost transparency and greater

market discipline. In the rst quarter, banking and mortgage

bankers group such as the Arlington, Virginia-based trade

group Consumer Bankers Association (CBA), and the

Mortgage Bankers Association (MBA) spent US$768,000

and US$1 million respectively lobbying on issues andlegislation related to mortgage lending, credit reporting,

credit card fees, bankruptcy, housing policy and other

issues. In a war that aims to crack down on what they say

are unfair, abusive and shady lending practices, the Federal

Reserve unanimously approved a nal mortgage lending

rule on July 14 to better protect consumers and facilitate

responsible lending.

The nal rule, which modies Regulation Z (Truth in

Lending) and was adopted under the Home Ownership

and Equity Protection Act (HOEPA), primarily follows a

proposal issued by the Federal Reserve Board in December

2007. Although the proposals will not help the millions of

homeowner defaulters, the Fed aims to prevent another

catastrophe and has vowed to vigorously enforce the new

rules, which take effect on October 1, 2009.

Dubious lending practices, particularly those involving

subprime loans made to borrowers with poor credit histories,

have gured prominently in the housing crisis, contributing

to an economic downturn and propelling delinquencies

and foreclosures to record highs. Lax lending during the

heady days of the housing boom only ended up burning

a massive hole among the riskiest subprime borrowers in

addition to the rapid rise of rates of mortgage delinquencies

and foreclosures that imposed huge costs on borrowers,

their communities and the national economy. Lenders thataggressively sold deceptive loans to lure borrowers with

promises of low initial interest rates into loans they could

not even afford contributed to the housing slump when

those risky subprime loans turned sour.

The proposed new rule, as expected, would among other

things, prohibit lenders from making loans without

considering the borrowers ability to repay a home loan

from sources other than the homes value. Lenders will

have to make sure that risky borrowers set aside money

to pay taxes and insurance. The plan would also restrict

lenders from penalizing risky borrowers who settle their

loans early and bans prepayment penalties if the loanpayment amount can change during the initial four years

of the mortgage. Finally, the rule requires all mortgage

advertisements to include information about rates, monthly

payments and other details.


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16

Industry ProfileCanada

As a major industry in Canada, banking plays a key role

in the countrys economic growth and nancial system.

Canadian banks, also called chartered banks, are essential

contributors to economic growth and remain important

in facilitating the well-being of the country. Engaged in

various businesses and providing myriad products and

services, Canadian banks have diverse revenue streams.

This variety helps make a secure, stable and reliable

banking sector that contributes signicantly to Canadians

and the economy. In fact, the banking sector generates

C$39.8 billion (US$37.56 billion) of gross domestic

product (GDP), representing about 3.3% of total Canadian

GDP directly.

As one of the Canadas largest employers, banks and

their subsidiaries employed 257,000 Canadians and paid

C$20.6 billion (US$19.44 billion) in salaries and benets

in 2007, according to a report released by the Canadian

Bankers Association (CBA). Industry employment has

grown by 16.1% over the last ten years. More than 71,000

employees work in other countries for Canadian banks.

However, difcult economic conditions and depressed

results among the banks capital markets divisions in the

second quarter forced banks to explore layoff options to cut

costs. Widespread pressure on capital markets operations

translated into to 150 job cuts in BMOs securities business,

while CIBC slashed 100 people from its capital markets

division in June.

While core activities among US banks and Canadian banks

are similar, Canadian banks are much smaller in real terms

than those in the US. There are 7,240 domestic commercial

banks in the US versus Canada 20 banks. As of January

31, 2007, the banking industry comprised 73 banks

20 domestic banks, 24 foreign bank subsidiaries, 22 full

service foreign bank branches and seven foreign bank

lending branches in Canada, according to the Ofce of the

Superintendent of Financial Institutions (OSFI). In total,

these institutions managed over C$2.6 trillion (US$2.45

trillion) in assets, accounting for over 70% of the total

assets of the Canadian nancial services market. The six

largest domestic banks continue to dominate the banking

system and together control about 90% of the nations total

assets.

Canadian banks continue to provide reliable, secure,

affordable and greater exibility and accessibility to their

consumers, who have enormous appetites for choice and

convenience in managing their nancial affairs. With

its vast network of electronic and branch access points

among the most extensive in the world, 96% of Canadians

have an account with a bank and the country now has the

highest number of Automated Business Machines (ABMs)

per capita in the world (1,631 ABMs per one million

inhabitants). Along with branch services, internet banking

and phone banking services, Canadas banks invest heavily

in the ABM network to provide their customers with 24/7

access to banking services. In 1982, there were only 965

ABMs that could only be used by customers of the bank

operating the machine but in 2007, the number of cash

dispensing ABMs has snowballed to 16,424, statistics from

CBA shows. The number of banking ABM transactions

logged in 2007 reached 1.01 billion in volume. The credit

card market in Canada is highly competitive with over

550 institutions issuing Visa and MasterCard products

through 23 principal issuers. As of May 2008, there were

64.1 million Visa and MasterCard cards in circulation

throughout the country.

Industry Size and Value

Table 9: Size of Canadian Banking Industry

Contribution to total Canadian GDP 3.3%

Domestic banks 20

Foreign bank subsidiaries 24

Full service foreign bank branches 22

Foreign bank lending branches 7

Total Banks 73

Total Employees 257,000

Total Assets C$2.6 trillion

Total ABMs 16,424

Total ABMs transaction logged on 1.01 billion

Credit Cards in circulation 64.1 million

Source: Canadian Bankers Association, 2008


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17

Industry Profile - Canada

Industry Highlights

On the Road to Customer-centricity

Long before the credit crisis hit, the shift in focusing on

customers was well underway. Particularly higher emphasis

has been placed on customer service and placing customer

at the center. Canadian banks are going back to basics

and touting their commitment to become more customer-

centric and more service-oriented, believing there is space

in the market to differentiate themselves from the rest by

providing better customer service.

Aware of their customers attitudes towards their banksand the impact perceptions have on protability, Canadian

banks may discover new opportunities to earn market share,

attract new customers and improve customer retention by

rendering genuine value-added and personalized services.

While focusing their attention on renewing core banking

systems and embedding customer centricity into core

banking, branch platforms and system renewal strategies,

Canadian banks are increasingly rolling out analytical tools

and building attrition models to retain existing customers

and acquire new ones.

TD Canada Trust was ranked the highest in customer

satisfaction according to a customer satisfaction studyreleased by J.D. Power and Associates, a global marketing

information services rm, for the third consecutive year

in August 2007. It achieved high scores in transaction

experience, account setup and product offerings, account

statements, facility and problem resolution. Rather than

operating only during traditional banking hours, the bank

opens longer hours, opening 50% longer than the other

banks for customers.

Meanwhile, BMO, struggling to keep pace with its

domestic peer group and recently announcing 1,000 job

cuts, made a big push to improve customer service at its

Canadian branches by upgrading the branch network andrevamping debit and credit card offering. BMO is now

intent on changing some of the processes supporting staff

in sales and customer service roles. Its effort have begun to

show some results, with loan growth up 17% on last year

in the rst quarter of 2008 and retail deposit market share

stabilizing to about 12%.

Another bank raising its game and competitiveness in

domestic retail banking was BNS. Striving to become the

best Canadian-based international nancial services group

by building strong relationships with its customers, the bank

rolled out a new customer-centric approach to banking in

retail branches. The program includes building everything

from scratch an industry-leading customer data warehouse,

an essential tool for targeted marketing, cross-selling and

customer retention activity. For BNS, the program aims to

change the branch culture to focus on serving customers.

The bank is planning to roll out its model in a phased

approach throughout the Caribbean, Latin America and

Mexico over the next few years. However, although banks

are focusing on transforming their businesses to providebetter customer service, the task is not that easy and requires

rigorously managed incremental change. Satisfying

customers demands comprehensive changes in strategies,

business processes and underlying technologies.

Policy and Regulatory Environment

Fearful of what was coming out of the US in terms of rises

in the number of defaults and foreclosures, the Canadian

Government tightened the rules for government-guaranteed

mortgages in July to prevent a similar housing market

collapse scenario in Canada. The adjustments marked a

measured approach by the Government to protect andstrengthen the Canadian mortgage system and forestall any

mortgage crisis.

Days of zero down payments and a 40-year mortgage

were over for Canadians starting from October 15, with

consumers thinking about buying a home needing to

produce a 5% down payment. Further, loans can no longer

be amortized over 40 years, with the maximum length

reduced to 35 years. The new rules also require a consistent

minimum credit score requirement and introduce new

loan documentation standards for those applying for a

mortgage, making it tougher to borrow money to buy

a home. A maximum 35-year term and higher downpayment requirements mean some buyers will not be able

to afford to pay as much. The new rules only apply to

new mortgages that require government-backed mortgage

insurance but will not affect mortgages that are already

held by Canadians.

Currently, mortgage insurance that protects mortgage

lenders from losses if a borrower defaults is required on

all loans where the down payment is less than 20% of


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18

Industry Profile - Canada

the purchase price of a home. The Governments federal

housing agency, Canada Mortgage and Housing Corp

(CMHC), is the largest provider of mortgage insurance in

the country, but the Government backs private mortgage

insurers. Some private rms could still offer mortgage

insurance at no longer supported terms, but they will not

have federal backing. Changes in the rules came after theBOC and Finance Minister Jim Flaherty expressed concern

about the proliferation of looser mortgage conditions

ushered in less than two years earlier. It suggested loans

were feeding a bubble and encouraging people to buy

homes they could not afford. Longer amortizations create

greater affordability for housing but it comes at a big price.

Lowering the monthly installments simply means that

buyers can go into more debt, and more debt means more

interest and less equity.

Although fundamentals are still good and Canadas lending

practices have tended to be more prudent than south of the

border, the Canadian housing sector is cooling after six torridyears of growth. Even before the tighter rules, residential

home sales in Canada are expected to fall by 11.5% to

460,900 this year from last years record of 520,747, the

Canadian Real Estate Association (CREA), a major real

estate organization forecasts. Except for Saskatchewan and

Newfoundland and Labrador, the forecast sees falls in 2008

in all provinces with the biggest sales tumbles taking place

in Alberta, where sales are poised to slide by almost 19%.

Nevertheless, the US mortgage crisis has not ltered into

Canada and, although there are signs of cooling, it is not

as dramatic as in the US. Canadas housing and mortgage

markets are performing much better.

Table 10: Average Residential Price Forecast

Region2007 Average

(C$)2008 Forecast

(C$)% Change

British Columbia 439,123 485,900 10.7%

Alberta 356,235 373,000 4.7%

Saskatchewan 174,405 208,400 19.5%

Manitoba 169,189 187,800 11.0%

Ontario 299,544 312,400 4.3%

Quebec 208,240 218,000 4.7%

New Brunswick 136,603 142,800 4.5%

Nova Scotia 180,989 189,100 4.5%

Prince Edward Island 133,457 141,000 5.7%

Newfoundland & Labrador 149,258 159,200 6.7%

CANADA 307,265 323,500 5.3%

Source: Canadian Real Estate Association, May 2008


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19

Market Trends & OutlookUnited States

Frustration is obvious among banks as banking crime,

ranging from fraud to phishing (sometimes referred to

as carding or brand spoong that captures personal data

by sending out email messages) and identity theft, are

mounting. More criminals now know how to turn stolen

nancial data into steady income, disrupting the peace

and tranquility of the banks. Bank crime rarely involves

traditional robberies but instead, money and data are stolen

remotely via electronic and paper fraud at seemingly less

risk to the criminal, who often cannot be spotted by securitycameras. The act of stealing can even be done from the

other side of the world, starting with a simple phone call

by fast-talking criminals requesting information from

individuals such as bank account balances. From there, the

data is resold and reused, leading to crimes from simple

credit card fraud to full-blown identity theft resulting in car

loans or even equity loans.

Two of the fastest-growing crimes in the US today are

check fraud and identity theft. While the American Bankers

Association (ABA) says check fraud grows by 25% each

year, the cost of identity theft to banks and businesses is

at US$53 billion a year, the Federal Trade Commission(FTC) reveals. A study, Measuring Identity Theft at Top

Banks released by the FTC in February 2008, found that

major banks and telecommunication rms are among the

companies that suffer the most from identity theft. In terms

of the sheer number of complaints, BofA topped the list

of banks, followed closely by JPMorgan, Capital One

(NYSE: COF) and Citibank, the consumer and corporate

banking arm of Citigroup. Limping home mortgage lender,

Countrywide already hit hard by the lending crisis, faced

another crisis when it suffered insider data loss when an

employee stole the condential data of its customers

throughout the country over a two-year period. The former

employee was suspected of downloading the informationfrom about 20,000 customers each week for two years and

pocketing about US$70,000 from selling the data.

Fraud is now shifting from a crime of prot to a crime of

desperation, with mortgage lenders desperate to close sales

and maintain their income. Three of the nations largest

subprime mortgage lenders Countrywide Financial

Corp, New Century Financial Corp and IndyMac Federal

Bank have been probed by the authorities including the

Federal Bureau of Investigation (FBI) for possible fraud.

Over the past year, reports of mortgage fraud rose as the

subprime mortgage market collapsed, and defaults and

foreclosures skyrocketed. The FBI is looking at whether

the banks were a sometimes a party to fraud in connection

with loans made to homebuyers with poor credit. Since

the subprime loan crisis erupted, the bureau has had 21

corporate fraud probes of investment banks, hedge funds

and mortgage companies. In addition, it also has more than

1,400 pending mortgage fraud cases looking at individuals

such as brokers, appraisers and borrowers.

Foreclosures and Delinquencies Still Building

An overstretching of buyers to get into homes they cannot

afford and an overextending of credit by lax lenders who

were willing to take risk led mortgage foreclosures to hit

a record high at the end of 2007 in the US. A combination

factors declining home values, weak housing sales,

tighter lending criteria and slowing US economy has

left a trail of destruction where nancially strapped

homeowners found themselves under water and were left

with little option than to avoid foreclosure. Compared with0.54% a year earlier, around 0.83% of US loans entered

the foreclosure process in the last three months of 2007,

a report by the MBA concludes. The report also shows

that subprime adjustable-rate mortgages that entered the

foreclosure process jumped to a record 5.29% in the same

period.

The grim news was a new blow to the US economy, which

had been rocked by the subprime crisis. A US Foreclosure

Market Report by California-based RealtyTrac, which

publishes one of the largest national databases of pre-

closure, foreclosure, owner-sold, resale and new homes,

shows a total of 2,203,295 lings consist of default notices,auction sale notices and bank repossessions in 2007, a

surge of 75% from 2006. Separately, the Fed estimates the

net wealth of US households dropped for the rst time in

ve years over the same period as the value of real estate

holdings and stocks deteriorated.

While last year was a bad year for home foreclosures, 2008

so far has been worse. Driven higher by increasing housing

despair, the foreclosure hammer has pounded even harder.

Electronic Bank Crime on the Rise


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20

Market Trends & Outlook - United States

In the second quarter, the skyrocketing rate of foreclosures

continued to provide headaches for US lenders. As plunging

home prices left borrowers owing more on mortgages

than their properties were worth, US foreclosure lings

more than doubled from a year earlier. One in every 171

households was foreclosed, representing an increase of121% over the second quarter of 2007 and 14% from the

previous quarter, Realtytrac says. The grim numbers were

obvious especially in May where 261,255 homes received

at least one foreclosure-related ling, surging by 48% from

May 2007, the highest monthly rate since 2005.

Two states California and Florida continue to display

high levels of activity, with the most fallout and leading the

nation in foreclosures. Together, they accounted for 109,014

of new lings in May while Arizona, Michigan and Ohio

were next between 12,000 and 13,000. With this, there is

no reason to believe the current wave of foreclosures will

subside anytime soon, because more borrowers continueto fall behind on their payments. Although the Bush

Administration has developed a number of plans to delay

foreclosure proceedings, it has been criticized for not

acting quickly enough to aid those affected.

Mortgage Applications Slow

With loan rates hovering near one-year highs exacerbating

the housing markets difculties, application volumes for

US home mortgages tumbled to their lowest pace in July

since December 2000. The Mortgage Bankers Associations

(MBA) index of applications to purchase a home or

renance a loan declined by 14.1% to 420.8 in the week

ended July 25 from 489.6 the prior week. The Washington-

based MBA, which has compiled a loan survey every weeksince 1990, believes that the culprit behind the drop has

been renance volumes, which plummeted by 22.9% to

1,074.4 during the week, also the lowest since the end of

2000. During the week, renance applications accounted

for 35.2% of all applications. US homeowners are

discovering that they do not have enough equity to renance

their homes. Furthermore, tighter lending standards and

plunging property values are keeping prospective buyers

out of the market and may extend the three-year housing

slump. In turn, falling house prices are making it difcult

for homeowners to re-nance their mortgages.

Banks in the US continue to tighten mortgage lendingcriteria and restrict loan approvals only to those with

larger deposits, which could hamper home sales further.

Mortgage lending choices have all but dried up and, as a

result, fewer companies control more of the market, with

rates and ultimately the housing market suffering as well.

Following in the footsteps of so many mortgage-heavy

banks, Wachovia Corp, which posted dismal results in the

second quarter, is scaling back mortgage lending in 19

states. The bank that made an untimely expansion into the

Table 11: Top Ten Foreclosures States (May 2008)

Source: Realtytrac, June 2008

California 71508

37506

12964

12764

12305

10245

10030

9877

8895

7441

Ohio

Arizona

Texas

New Jersey

0 4000020000 60000 80000

Florida

Georgia

Nevada

Michigan

Illinois


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21


mortgage business by acquiring California-based GoldenWest Financial Corp in 2006 at the peak of the housing

boom, decided to exit its wholesale mortgage lending

business starting July 25.

The credit crisis has hurt banks ability to support the

market for mortgage-backed securities, causing rates that

lenders charge to consumers to spike upward. In the fourth

week of July, mortgage rates have soared in the US with

30-year xed rate mortgage surging to the highest level

in nearly a year. According to troubled home funding

company Freddie Mac, US 30-year mortgage rates grew

to an average of 6.63% from 6.26% the week before while

15-year mortgages averaged 6.18%, rose sharply from

5.10% in the third week. Mortgage rates are on the rise due

to troubles at Fannie Mae and Freddie Mac, threatening to

deal another blow to the already frail housing market.

Market Outlook

The US economy continues to tread water and the woes of

US credit market coupled with housing slump, a strained

banking system, spreading unemployment and rising oil

prices are the undercurrents trying to pull it down in the

second half of the year. At the same time, there is also fear

that upside risks to the ination outlook have intensied

lately. The barrel of ination has run wild with US pricesrising by 5.6% in the year to July, the fastest ination rate

for more than 17 years.

Although economic growth picked up in the second quarter

at an annual rate of 1.9% compared to the feeble 0.9%

growth logged in the rst quarter of 2008, thanks to the

federal tax rebates that energized consumers, the rebound

was not as robust as economists in the nation had hoped.

The growth was less than the earlier forecast 2.4% pace.

The revised data from the US Department of Commerce,

however, indicates that it was a soft pace but enough to

move it away from the path of recession. The arduous task

of cleaning up the subprime mess could take a while, and

the nations economy will require at least months to recover

from its slowdown. In Washington, President Bush urged

Americans not to lose faith as they brace the economy

that falters on a cloudy future and problems at the banks

deepen.

Crucially, a healthy banking system is vital to the economy,

but now economic weakness and a plunge in bank stocks

have raised the prospect of more bank failures, probably

within months, and the need for federal intervention. The

weak economy is hurting consumer lending operations and

mortgage losses may escalate among banks. The current

Table 12: Quarter-to-Quarter Growth in real GDP

Source: US Bureau of Economic Analysis, July 2008

Percent

6

4

2

0

2004 2005 2006 2007 2008

-2

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q

Previously published Revised Advance estimate


22/36



22


credit crunch is more acute than one that followed thesavings and loan crisis in the early 1990s and could run

into 2009, with the nervousness that follows threatening

market stability, especially after the Government took over

IndyMac on July 11. Within the next 18 months, as many

as 200,000 US banking jobs are expected to be slashed,

with more than half forecast to be in the mortgage lending

sector. This is hardly a surprise with more banks expected

to be on the brink. Around 22,000 jobs were cut during the

rst two months of 2008.

In todays faltering economy, banks are expected to tighten

lending standards for US households and businesses

through to the end of the year and into 2009. The year-long

credit crunch is far from easing and banks are hoarding

more capital and making it harder to borrow. Tighter

lending standards, which are typical in a weakening

economy, create headwinds that will delay recovery, along

with a worsening housing slump and elevated fuel prices,

further dampening any hope of a quick end to the credit

squeeze.

The Fed, which took the nations lending pulse in July,

revealed that lending has slowing. With loss and write-

downs still ongoing, some banks will likely need to raise

additional capital and slash dividends to cover losses and

shore up their balance sheets. So far, US banks have raised

about US$120 billion and may need to raise US$65 billionto cope with mounting losses. Insufcient capital to cover

bad debts is making the banks even more wary of lending

to one another. Indeed, things are going to get tougher

before they get better. Fears over which banks might be

allowed to fail next have completely rocked the condence

in the nations banking system.


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Market Trends & OutlookCanada

As with banks around the world, the internet has created a

momentous and sweeping change in the Canadian banking

industry. It has reshaped the way customers carry out

transactions, transforming traditional face-to-face human

interaction at local branches to the concept of anywhere

banking that allows customers to access their accounts

by just a mouse-click away without stepping a foot inside

a bank. The goal of most Canadian banks is to provide a

true e-banking solution through secure online banking

capabilities for their commercial and personal customers

who now demand more convenience. This including

access to real time account information, balance transfers,

purchasing options and credit card payment. Online

banking in Canada is a must for even the largest banks

survival over the longer term and, due to well-developed

banking system and erce competition in the country, it is

pivotal to meet the needs of online consumers in order to

expand.

Online banking continues to grow in popularity and is the

service of choice to settle bills, check account balances and

activity. A July report released by comScore, a global internet

information provider, brought to light that Canadians are

leading the way with online banking and rank rst in online

banking adoption among the 37 global markets individually

surveyed by the web metrics rm. Specically, the survey

found that 67.1% of Canadians did their banking online

in April, far ahead from other English-speaking countries

which had signicantly lower penetration, including the

UK (49.5%), US (44.4%) and Australia (41.7%). Typically

very savvy internet users, Canadians also led the rest of

the countries in online banking frequency, according to

the survey, with an average of eight usage days and 10.5

online banking visits per visitor in April alone. On average,

Canadians spend 46 minutes on banking sites, viewing

approximately 121 pages per viewer.

Out of nearly 24 million Canadian internet users, 15.5

million visited a banking site in April. Banks in Canada

have been pushing their customers to embrace e-billing,

which seems to be meeting with some success. RBC led

the category with 4.6 million visitors, the most of any

Canadian bank. The bank has added Web 2.0 tools to

ensure that even the tech-shy can get something out of the

web experience where a virtual host was used as a demo

for online bill payments and interactive video session of

loan packages that they offer. A close second, TD Bank had

north america a company and industry analysis - mergent

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