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Inside the Market’s roundup of some of today’s key analyst actions

Canadian banks should continue to deliver “solid” returns to shareholders, said CIBC World Markets analyst Robert Sedran in a research note previewing the fourth-quarter earnings season, which begins on Nov. 29.

“Though our crystal ball is never quite as clear when we stretch our horizon to add another year to our published forecasts, there is something enjoyable about working with a clean year that is untouched by some of the near-term issues that can bring volatility to the quarterly results,” said Mr. Sedran. “As we contemplate fiscal 2018, we see mid-to-late-cycle type growth, which is to say landing in the mid-single digits ... about right for this point in the cycle.

“The most difficult items to forecast when we add a new year are the more cyclical ones: the net interest margin, which is sensitive to the level and shape of the yield curve, and loan losses. On the latter, we have a small decline in loan loss ratios built into fiscal 2018 from what we assume will be a near-term plateau in fiscal 2017. On the former, though the rate environment does seem to have shifted since the U.S. election, we still assume that changes to the front end of the yield curve will be slow in coming and so forecast a stable margin that sees the slow leak we have been witnessing in recent years stop but not yet reverse (more hawkish monetary policy on either or both sides of the border could provide some upside to our revenue forecasts).”

Mr. Sedran said the fourth quarter will end a better-than-expected year for the sector.

“We forecast a sequential decline of 2 per cent for the large banks in Q4/2016, which implies 3 per cent year over year earnings growth,” he said. “The sequential decline is a product of moderately rising loan losses, seasonally higher expenses, and lower capital markets related revenues (CMRR) from a strong FQ3 (some of the indicators we track point to less activity in the period and FQ3 saw a benefit to trading revenues from Brexit-related volatility). For revenues, we look for moderate growth in lending NII and average earning assets, but anticipate some margin compression following generally modest progress on margins in Q3/F16. We also forecast a decline in fee-based income given strong growth in fee-based income last quarter. On loan losses, we look for an increase on average generally driven by higher Q/Q loan losses on oil & gas portfolios. The banks showed better credit quality in Q3 and we look for provisions to fall somewhere between Q3/F16 levels and elevated Q2/F16 levels, with a bias towards the former.”

In the report, Mr. Sedran raised his target price for stocks in the sector. His changes were:

- Bank of Montreal (BMO-T, sector performer) to $94 from $90. Consensus is $87.60.
- Bank of Nova Scotia (BNS-T, sector performer) to $79 from $74. Consensus is $74.71.
- National Bank of Canada (NA-T, sector performer) to $52 from $48. Consensus is $51.54.
- Royal Bank of Canada (RY-T, sector outperformer) to $95 from $87. Consensus is $86.45.
- Toronto-Dominion Bank (TD-T, sector performer) to $67 from $61. Consensus is $62.65.
- Canadian Western Bank (CWB-T, sector underperformer) to $29 from $27. Consensus is $26.73.
- Laurentian Bank of Canada (LB-T, sector performer) to $56 from $53. Consensus is $52.91.

“With bank shares having entered the year weighed down by oil concerns, the better-than-expected earnings performance led to still better share price performance as multiples expanded to reflect the fact that – who knew? – these are strong and diversified banks that were not going to be taken down by a commodity correction,” said Mr. Sedran. “With the expansion achieved so far this year, bank multiples sit at roughly post-crisis averages and below longer-term averages. Moreover, the seven multiple point discount to the S&P/TSX P/E [price-to-earnings] multiple is much wider than the four point long-term average. With solid dividend yields (and dividend growth forecast), we expect the sector to continue to generate good total returns from here. Our price targets are now based on F2018 earnings estimates.”

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