BUS 419 Canadian Chartered Financial Institutions Economic and Market Analysis
Agenda Structure of the Industry Scotiabank TD Financial Group Bank Comparison Recommendations
Structure of the Industry 14 domestic banks, 33 foreign bank subsidiaries, and 20 foreign bank –In 1999, restrictions on foreign bank operations lowered Managed over $1.7 trillion in assets, which account for over 70 % of the total assets of the Canadian financial services sector Big 6 accounted for over 90% of the assets of the industry 8,000 branches and close to 18,000 ABMs – the highest number of ABMs per capita in the world
International Dimension International operations accounted for 33% of their gross revenue in 2001 –United States Wealth management Corporate investment banking Electronic banking. –Latin America, Asia, and Caribbean Investment
Products Banking – Personal and business banking –TD Canada Trust –ScotiaOne Insurance – Creditor, life, health, travel, home, and auto products –TD Insurance –ScotiaLine, ScotiaPlan Investment – Wealth management services for private clients –TD Canada Trust – Money market, health protection –TD Waterhouse – Discount brokerage –Scotia McLeod Capital Market – products and services offered to corporations, governments, and institutional clients –TD Commercial Banking –Scotia Capital
Revenue Composition Major source of revenue –Net interest income Other non-interest income –Mutual fund –Wealth management –Foreign exchange –Derivative trading
Revenue Composition … cont ’ d Increasing of non-interest income over the past 10 years
Regulatory Environment BANK ACT –Federal government is responsible for the regulation of the banking industry in Canada The Office of the Superintendent of Financial Institutions (OSFI) –Reporting to Minister of Finance –Safeguard policyholders, depositors and pension plan members from undue loss
Regulatory Environment Hybrid nature of the banks activities –Some of their subsidiary activities are provincially regulated
Regulatory Environment “ The regulatory and supervisory structure in Canada is well developed, complies with the major international principles and standards, and is a source of international best practice in a number of areas ” ~~ IMF
Industry Players
Scotia Bank vs. TD Bank
SCOTIABANK Life, Money, Balance Both
Organizational Structure
Earnings by Business Line
Scotia’s Risk Management
Risk Management Structure
Credit Risk
Credit Risk (cont’d) Commercial & corporate credit requests assessed by credit units Assessment criteria: current & future credit statistics industry & economic trends geo-political risk management Assignment of risk rating using a rating system with 19 categories Decision factors to be considered, such as: Risk rating Facility risk Industry & country limits
Credit Risk (cont’d) Diversified Internationally… …and Diversified by Borrower Types
Market Risk Summary of Market Risks –FUNDING Interest Rate Risk Foreign Exchange Risk –INVESTMENT Interest Rate Risk Foreign Exchange Risk Equities Risk –TRADING Interest Rate Risk Foreign Exchange Risk Equities Risk Commodities Risk
Market Risk (cont’d) Risk Assessment & Measurement –Value at Risk (VaR) –Stress Testing –Sensitivity Analysis –Simulation Modeling –Gap Analysis Managed risks mainly through limits
Liquidity Risk Liquidity risk controlled through… –Liquidity position assessment –Scenario analysis and their assumptions –Contingency plans development Broad range of funding sources… –Capital –Deposits from retail / commercial clients –Wholesale funding Enhanced term funding through… –Note issuance program –Sale of mortgage-backed securities
Liquidity Risk (cont’d) As of October 31, 2003 –$75 billion liquid assets (26% of total assets), of which…
Derivative Securities 2 primary objectives: –Manage risks from funding & investment activities –Lower the cost of capital Markets derivatives to customers & take positions for own account Trades a wide variety of instruments –Forwards and futures –Interest rate swaps and options –Currency swaps –Equity and credit derivatives –Other more complex structured products
Derivative Securities (cont’d) To control credit risk of derivatives: –Use of credit mitigation techniques Applies limits to each counterparty Measures exposure as current fair value plus potential future exposure Portfolio of mostly short-term instruments Investment grade counterparties (90% of total credit risk) –Use of credit derivatives such as credit default swaps
Foreign Exchange and Gold Contracts
Total Notional Value of OTC and Exchange Traded Derivative Financial instruments
Proportion Invested in Each Derivative Instrument
Derivatives Instruments to Hedge Interest Rate
Trading vs. Non-Trading
Non-Trading Derivatives
Scotia’s Employee Stock Options
Employee Stock Options Exercise price will not be less than the closing price of common shares on the trading day before grant date Options vest over 4 years and expire after 10 years, subject to early expiration Outside Canada, where options granting are restricted, SARs have been granted instead Will start expensing options in 2004 due to new CASB rule Ownership requirement for chief executives = 3 times the base salary
Employee Stock Options Tandem stock appreciation rights (Tandem SARs) Deferred Stock Unit Plan (DSU) Directors ’ Deferred Stock Unit Plan (DDSU) Restricted Share Unit Plan (RSU) Scotia Capital Deferred Payment Plan
TD Bank Financial Group
History 1855 Bank of Toronto is founded 1871 The Dominion Bank is founded 1955 Bank of Toronto + The Dominion Bank = Toronto Dominion 2002 Acquire Canada Trust and become TD Canada Tust
TD Bank Composition
Operations
Overall Performance pg.18 Million
Income by Business Segment Adapted from: Note: Cash Basishttp:// Million
Risk Management
Risk Factors Strategic Risk Credit Risk Market Risk Operational Risk Liquidity Risk Investment Risk Regulatory Risk Reputational Risk
Risk Management Committees
Value at Risk ve 88% ve 96.4% Adapted from: annual report 2002http://
Value at Risk Adapted from: annual report 2002http://
Market Risk and Derivatives RiskDerivative Interest Rate RiskInterest Rate Swaps Forward rate agreements Foreign ExchangeForeign Exchange Swaps Foreign Exchange Forward Contracts Cross-currency interest rate swaps
Trading vs. Non-Trading Adapted from: pg.57
Non-Trading Derivatives Adapted from: pg.57
Derivatives used to hedge Foreign Exchange Risk
Derivatives Instruments to hedge Interest Rate
Total Notional value of OTC and Exchange traded Derivative Financial instruments
Concentration of Credit Risk – Derivative Financial Instruments by country
TD Bank’s Employee Stock Options
Employee Stock Options Options for common shares granted to eligible employees and non-employee directors of the bank Before Oct. 5, 2002Oct. 6, 2002 onwards Settlement terms of 10 years, vested for periods of 4 years Can settle the options for cash up to the intrinsic value of the option Reduced use of stock options Reduced terms to 7 years No longer settle for cash More disclosure from senior executive who plan to exercise More ownership req. for senior executives
Employee Stock Options
Asset Base Last Updated:
Stock Performance
ROI for Big 6 Banks
Comparison: Executive Stock Options ScotiabankTD Bank 10 year settlement terms Can receive cash for intrinsic value or settle for shares Moved from 10 year to 7 year settlement terms Can only be settled for common shares Increased executive share ownership requirements Reduced use of stock options
Recommendations Minimize spread between favourable and non-favourable Re-evaluating executive stock options –Reduce time to expiration –Expense options immediately Create a natural hedge for Foreign Exchange
Questions?
Sources Scotiabank Annual Reports, for fiscal years ending 1999 to 2003 TD Bank Financial Group Annual Reports, for fiscal years ending 1999 to 2003 “TD Bank Financial Group Enhances Corporate Governance Policies On Executive Compensation” from n_1.html, March 10, 2004