'Relatively solid' bank results foreseen

Share

Canada's banking industry is set to begin posting another profitable quarter this week, but a lack of clarity on the global economic recovery and uncertainty about new financial regulations will continue to weigh on the sector for the rest of the year, analysts say.

The volatile stock market means there is little upside to this round of results, said Robert Sedran, an analyst with CIBC World Markets Inc. "An in-line quarter (or worse, a miss) will not be positive for the stocks," he warned in a report on the sector published last week, advising that "a measure of caution seems warranted on the quarter."

Mr. Sedran anticipates that the six largest banks will post average earnings-per-share growth of 6 per cent compared with the year-earlier period. Loan losses should rise modestly as the economy still struggles and margins will likely remain flat until interest rates begin to rise. Revenue from lending activities should rise 7 per cent, but "meaningful growth" of lending won't occur until next year when higher interest rates should feed fatter margins. Capital markets-related revenue will rise almost 4 per cent, tempered by a decrease in trading fees, which comprise more than half of this type of revenue, he said.

Peter Rozenberg of UBS Securities Canada Inc. is slightly more bullish about second-quarter results. He forecasts a 9-per-cent increase in share profit from the year-earlier period for the six biggest banks, due largely to more loans, better margins and a 20-per-cent decrease in their provisions for credit losses.

Both analysts value the major banks using an average price to earnings multiple of 12. The Big Six traded last week at 12.2 times Mr. Sedran's estimated earnings for the year, but just 10.4 times forecasted 2011 earnings.

"We expect the results this quarter to be relatively solid and supportive of our investment thesis, which holds that [fiscal]2011 will be a year of macroeconomic, and therefore earnings, recovery. In our view, the biggest risk to this thesis comes from macroeconomic factors beyond the banks' control," he wrote.

Applying a 12.5 multiple to estimated 2011 share profit would justify a one-year return of 13 per cent, in addition to an average dividend yield of 3.8 per cent, Mr. Rozenberg adds.

Cat:e528746c-3414-401a-b14b-50247e3bdf01Forum:d0fa4e14-88d2-41f9-8a19-896bdff9544b

Mr. Sedran favours both Bank of Montreal and Royal Bank of Canada, rating them as "sector outperform," compared with "sector perform" ratings on Bank of Nova Scotia and Toronto-Dominion Bank.

Mr. Rozenberg says Royal Bank and Canadian Imperial Bank of Commerce show the best prospects this reporting period. He points to RBC's strong presence in Canadian retail banking, the size and diversity of its capital markets business, and likely lower-than-expected provisions for credit losses as factors in the stock's favour. CIBC will likely benefit from declining provisions for credit card losses and strong trading revenues. In addition, the bank stands to benefit more than others from rising interest rates and is currently trading at a relatively low valuation, he said.

Over the next one to two years, one key differentiator among the banks will be how they deploy excess capital as Tier 1 capital ratios are adjusted. Mr. Rozenberg estimates that sum will amount to $39-billion between the banks in their fiscal year 2012 and could generate higher dividends and more investment. RBC could benefit the most given that it currently has the highest excess capital with a Tier 1 of 13 per cent, almost double what Canadian regulators require. In addition, National Bank of Canada, with the lowest dividend payout ratio at just 40 per cent, is most likely to increase dividends first, he said.

Looking beyond the fundamentals of their operations, Canadian banks face some indirect risks from Europe's debt crisis, namely a possible tightening of liquidity and a weaker global economy. But their direct exposure to European financial woes is immaterial, Mr. Sedran said.

Even with some risk attached to this reporting season, he still thinks the banks are a wise investment longer-term, regardless of whether we are heading into another downturn or see a full-fledged recovery in 2011.

"The Canadian banks have come out of the last crisis stronger than they went in," Mr. Sedran wrote. "In a time of global turmoil, the Canadian banks should be viewed as a safer alternative for financial services investors."

Big Six reporting dates