Monday, June 26, 2006

Cdn Bank & LifeCo Week's Review

RBC Capital Markets, 26 June 2006

Excellent Time to Overweight Banks

Last week, the 10-year GoC bond yield moved up 20 basis points to 4.61%. At current bond yields, the sector forward P/E multiple of 11.9x remains below the 12.5x level predicted by our 25-year regression model. The group is now at an 8% discount to our target P/E of 13x forward EPS, offering an excellent entry point, in our opinion. Presently, investors can buy the banks at less than 11.5x estimated 2007 EPS. Alternatively, the current forward P/E of 11.9x equates to a yield level of ~5.00% according to our model. Banks tend to gain/lose ~1 P/E multiple for every 50bps decrease/increase in 10-year yields.

Lifecos Also Compelling

In our view, the Life insurers continue to offer excellent medium-term growth prospects, excellent dividend yield growth and continued solid capitalization. Lifeco earnings are, however, more pro-cyclical than the banks and trade on less volume, so the stocks may act just slightly less defensively.

Our P/E-to-Bond Yield valuation model indicates a 15x target P/E for lifecos under the same interest rate scenario as we have assumed for banks. Canadian lifecos are currently trading at 12.7x consensus forward earnings, just a 7% premium to the banks, and well below their 13% premium since demutualization. In our view, the lifecos offer excellent value, particularly if conditions hold with the current range of higher sustained interest rates, which are supportive of insurers’ product margins and volumes.

Share Buybacks Lift for Lifecos

MFC and SLF repurchased 11.1 million and 4.3 million shares respectively in the month of May. The repurchase activity was significantly higher than the historical monthly average (since 2003) of 2.9 million for MFC and 1.0 million for SLF. MFC’s buybacks represent ~11% of its program, while SLF bought ~15% of its program in the month of May. GWO was less active, buying back only 168,000 or ~6% of the program. IAG did not repurchase shares last month.

The Canadian banks were less active with respect to share buybacks in May. BMO was the only bank buying back stock last month, 1.2 million shares or ~8% of its program. The remaining banks with programs were not active last month - BNS, NA and RY. As a reminder, CIBC and TD do not currently have share repurchase programs in place.

CIBC Litigation Jitters Resurface

While the Global Crossing lawsuit poses a risk to the stock, we believe it is fairly well contained at this point. CIBC shares were weaker last week on news the bank is being hit with a lawsuit from the estate of Global Crossing Ltd. However, the bank indicated that the lawsuit adds no new claims against CIBC relative to an action filed in 2004; rather it seeks to add some CIBC affiliates. CIBC’s January motion to dismiss the claims is still pending, with no clear time frame for the decision. The bank maintains general legal reserves and believes they are adequately provisioned. Litigation is a sore spot for CIBC investors, as the bank is still licking wounds caused by a $2.8B settlement last August for its part in an Enron class action suit.