* Q4 EPS C$0.83, near expectations
* Loan loss provisions C$420 mln vs C$207 mln
* Shares fall 2.2 pct (Adds CEO comment from conference call)
TORONTO, Dec 8 (Reuters) - Bank of Nova Scotia (BNS.TO) said on Tuesday quarterly profit surged, but its shares dropped after a string of strong results from rival banks last week led analysts to ratchet up expectations for Canada's No. 3 lender.
Scotiabank said domestic and international banking profits climbed in its fiscal fourth quarter and capital markets surged, offsetting a rise in the amount of money set aside to cover bad loans.
While profit of 83 Canadian cents a share came in close to market expectations, Scotiabank shares fell 2.2 percent in late afternoon trade on Tuesday, the biggest drop among the slumping bank sector. The Toronto Stock Exchange's broader financial index was off 1.4 percent.
"One of issues for Scotia today was that the expectations have gotten pretty lofty for the Canadian banks at this point," said Edward Jones analyst Craig Fehr, who said Scotia needed to sail past published forecasts to avoid a sell-off.
While the banks generally outperformed on their bottom lines, Fehr said there were lingering concerns about a sector that had avoided the worst of last year's global credit crisis.
"While we did see some stronger indicators of improvement for the banks, Scotia included ... there are still some significant credit headwinds for the industry as a whole, so we're seeing some disappointment in the market today."
Canadian banks have increased loan loss provisions through most of 2009 as consumers and businesses struggled to repay their debts in the recession, but analysts have been watching for the tide of bad loans to ease.
Scotia's biggest domestic rivals -- Royal Bank of Canada (RY.TO), Toronto Dominion Bank (TD.TO), Bank of Montreal (BMO.TO) and Canadian Imperial Bank of Commerce (CM.TO) -- have already reported fourth-quarter earnings that were mostly stronger than expected.
Toronto-based Scotiabank said net income rose to C$902 million ($859 million), or 83 Canadian cents a share, in the quarter ended Oct. 31, from C$315 million, or 28 Canadian cents, a year earlier.
Barclays Capital analyst John Aiken said core earnings, which exclude one-time items, were 87 Canadian cents a share. That was in line with average estimates of 87 Canadian cents a share, according to Thomson Reuters I/B/E/S.
Scotiabank's fourth-quarter results last year were affected by a C$595 million writedown due to sliding markets that hit the value of securities and debt obligations.
Chief Executive Rick Waugh said he expected a better 2010 as the global economic recovery gained traction. While trading revenues are expected to fall as markets normalize, Waugh said loan loss provisions should begin to improve late in the year.
"We are planning continued earnings growth in 2010, but at lower recovery levels from past cycles due to the less robust macroeconomic growth. We anticipate this growth will be from solid contributions from all three of our business lines and should accelerate towards the second half of our year," Waugh told analysts on a conference call.
Domestic banking income rose 8 percent from a year earlier, while international banking surged 25 percent. Scotiabank is Canada's most international lender, with strong retail operations in Latin America and the Caribbean and a smaller but growing presence in other developing markets.
The bank's capital markets segment also notched its second- strongest quarter on record, with a profit of C$353 million, as strong trading revenues powered overall income. All of the Canadian banks benefited from strong trading gains in 2009 as volatile markets and industry upheaval spurred activity.
The gains were offset by a surge in the amount of money the bank set aside to cover bad loans. Scotiabank said provisions for credit losses rose to C$420 million from C$207 million a year earlier, but were down from C$554 million in the third quarter.
Aiken said the quarter-to-quarter drop in provisions -- a bigger improvement from the third quarter than analysts had expected -- may not be viewed as entirely good news.
"Ironically, this could weigh on the bank's valuation for two reasons. First, in this environment, the market may believe that the provisions are insufficient to cover off future deterioration and may anticipate elevated levels in future quarters," Aiken said in a note to clients.
"Second, the fact that earnings were essentially in line with expectations, despite the lower-than-anticipated provisions ... highlights that other areas in Scotia's operations were weaker than the Street had forecast."
Scotiabank also said it had built its stable of cash in the quarter, boosting its Tier 1 capital ratio to 10.7 percent from 10.4 percent in the third quarter.
While that is not as high as some domestic rivals, it is well above most global financial institutions and gives the bank flexibility to pursue acquisitions or return value to shareholders through share buybacks or dividend increases as the financial crisis retreats.
($1=$1.06 Canadian) (Reporting by Andrea Hopkins; editing by Frank McGurty)