Wednesday, June 27, 2007

Analysts' Comments on Effect of C$/U$ & Interest Rates on Banks

Financial Post, Jonathan Ratner, 27 June 2007

Given the Bank of Canada’s indication that it feels both inflation and economic growth have been stronger than expected, Citigroup analyst Shannon Cowherd thinks the bank will likely raise interest rates by 25 basis points eventually.
Its next interest rate decision is on July 10, while the key rate is currently 4.25%.

Higher short-term rates would likely hurt CIBC the most given the bank’s high leverage to domestic net interest income, she said in a research note.

In terms of the rising Canadian dollar relative to the U.S. greenback, she said Bank of Montreal and Royal Bank of Canada are most exposed given their U.S. operations.

The fall-out from sub-prime lending in the U.S. meanwhile, will also have some impact on Canadian players, although they have virtually no domestic exposure to non-prime residential lending, she added. However, the asset securitization market does present some U.S. exposure for Royal, BMO and CIBC, and is expected to impact them in upcoming results.

Ms. Cowherd reiterated her “buy” ratings on CIBC, BMO and Bank of Nova Scotia, while her estimates fall slightly below consensus due to expectations of higher provisions for credit losses in the second half of 2007.
Financial Post, Duncan Mavin, 27 June 2007

Bank of Nova Scotia’s international expansion makes it the Canadian bank with a plan when it comes to spending all that excess cash the banks are generating these days.

But having a high proportion of top line growth coming from overseas operations can also be a drag when the Canadian dollar is riding high.

“The rapid increase in the Canadian dollar, up 10.5% since February 7, 2007 is most negative for Scotiabank amongst the banks,” says RBC Capital Markets analyst Andre-Philippe Hardy. “About 45% of the bank’s income comes from outside of Canada, with the net highest bank at approximately 30%.”

Mr. Hardy also points out that Scotiabank’s Mexican unit, a key part of its international operations, could struggle to match high earnings expectations because of rising loan losses, the expiration of historical tax loss carry forwards, and rising costs associated with branch network expansion.

The RBC analyst has a 12-month target price of $57 for Scotiabank, with a “sector perform” rating. But that doesn’t make Scotia his least favourite bank stock.

Bank of Montreal, as well as National Bank, both get “underperform” ratings from Mr. Hardy.

“It is overly simplistic to suggest that BMO’s stock will outperform its peers solely based on having underperformed in recent years,” he says.

Among the reasons why Mr. Hardy doesn’t favour BMO: revenue growth will continue to struggle while cost-cutting measures are taking place; the bank can no longer justify being labeled Canada’s least risky bank; and with bank mergers unlikely in the near term “buying the bank’s stock in the hopes that it gets taken out is premature.

He has a $71 price target for the stock.