Monday, December 11, 2006

Banks Q4 2006 Summary

Report on Business Television, 11 December 2006

Click here for the ROBTv video clip, of Jamie Keating (Senior Bank Analyst, RBC Capital Markets) speaking about the Banks' Q4 2006 Earnings.
RBC Capital Markets, 11 December 2006

Banks Beat Consensus, But Quality a Concern for Some. The banks delivered 17% EPS growth YoY, led by CIBC up 40% and RY up 22%. BMO lagged, up only 7%. Earnings quality was weakest for BMO and BNS where retail operating leverage declined. TD also benefited from non-core items such as a low tax rate, but generated strong retail revenue growth and operating leverage, indicating high-potential sustainability.

Actions on CIBC, RY and BMO. We raised estimates and price targets by 10% for CIBC (upgraded to Outperform) and by 2% for RY (already rated O/P). We held our NA and TD estimates towards the high end of consensus, and lowered our estimates and price target for BMO. We gave BNS a pass on a considered EPS reduction because of strength in International and potential for domestic cost cuts. Our top 3 banks are TD, RY and CIBC. BMO and BNS are least interesting at these valuations.

RY and TD Dominate Domestic Retail. Retail spread held or rose at RY, TD and NA, while for BMO, BNS and CIBC retail spreads dove. Retail revenue and operating leverage followed spreads: up for RY, TD and NA, less so at BMO and BNS. CIBC is still very strong on cost cuts.

Marking the Credit Turn. Except for CIBC, impaired loans rose in both corporate and retail, and reserve coverage declined. This is as anticipated and should not come as a surprise. TD maintains the highest reserve coverage at ~320%, BNS at 139% is lowest. The sector average is ~180%.

Corporate Loans up Sharply. Wholesale loan growth accelerated for two reasons: (i) a bulge in M&A and related bridge loans, and; (ii) higher drawings on existing committed lines. We estimate balances were up ~30% YoY in the sector, but loan market liquidity remains strong and we see this as a balance sheet blip, ahead of a round of syndication & sales.

BMO Investor Breakfast. Senior management profiled objectives and priorities for 2007, but we heard no new news. The focus for a turnaround in domestic retail was in a more productive, larger sales force, and management hinted at raising front-line staff. We question how this would also involve lowering cost/revenue, at least in the near-term.

Tight Valuation Range. The sector P/E at 13.5x forward consensus EPS is in-line with where the 10-year bond yield relationship suggests is fair, however the peer range is at the low end of its historic range. Investors are giving little or no incremental value for performance record discrepancies. However, we see sustainable differences emerging in retail performance, which, in our view, should drive valuation premiums for RY and TD. We also believe BMO and CIBC should trade to relative discounts until they demonstrate some market share ‘staying power.’