Thursday, November 01, 2007

Banks May Post Slowest Profit Growth in 5 Years

The Globe and Mail, John Heinzl, 1 November 2007

Bank stocks have been anything but money in the bank this year. Hammered by turmoil in credit markets, the group has slipped about 2 per cent in 2007, with National Bank and Bank of Montreal posting double-digit drops.

Our beloved deposit-taking institutions have been getting pummelled even as the S&P/TSX composite index has surged 13 per cent this year. That's the third-worst relative performance for our banks in the past 40 years, says Scotia Capital analyst Kevin Choquette.

So is it time to sell?

Heck, no. It's time to buy. In fact, Mr. Choquette calls it "the best buying opportunity in five years."

Here's why:

Canadian banks have largely sidestepped the U.S. subprime mortgage meltdown. Canada's subprime market is tiny, and credit standards on residential mortgages are much higher. What's more, our banks have only minimal exposure to high-risk collateralized debt obligations and leveraged buyouts.

The stocks are cheap. As a group, the banks are trading at 12.7 times trailing earnings and 11.1 times 2008 estimates - a 30-per-cent discount to the S&P/TSX.

Dividends are rich. Bank yields range from 3.3 per cent for Toronto-Dominion to 4.5 per cent for BMO. Bank yields are near record highs relative to those on 10-year government bonds, pipelines, utilities and income trusts.

Fourth-quarter earnings, which start coming out at the end of November, will help ease fears about the impact of the credit crisis. Mr. Choquette predicts earnings will rise 3 per cent year over year, and return on equity - a key measure of bank profitability - will be a healthy 20 per cent.

There could be some bumps, including a possible $500-million writedown on National Bank's asset-backed commercial paper holdings and further losses on Bank of Montreal's natural gas trading portfolio.

But all things considered, "we expect Canadian bank stocks to rally upon the release of fourth-quarter earnings," he said. And the future looks even brighter: Thanks to their strong balance sheets and the soaring loonie, Canadian banks are in a position to expand by acquiring international players.
Bloomberg, Sean B. Pasternak, 31 October 2007

Canadian banks may post average profit growth of 3 percent in the fourth quarter, the smallest increase in five years, because of writedowns and a capital markets slump, Scotia Capital analyst Kevin Choquette said.

Earnings for the fiscal quarter that ends today ``carry the greatest uncertainty of any bank quarterly earnings release since the fourth quarter of 2001,'' Choquette wrote in a research note today.

Canadian bank shares this year have had their third-worst performance in 40 years because of credit concerns stemming from the collapse of the subprime mortgage market in the U.S. While the impact to Canadian banks ``will be relatively modest compared with global peers,'' the lenders aren't immune to the same credit issues, the analyst wrote. The banks had average profit growth of 10 percent in the third quarter, he said

Choquette expects Bank of Montreal, the country's fourth- biggest bank, to post the biggest profit decline because of potential writedowns related to natural-gas trading and investments in U.S. structured investment vehicles.

Canadian Imperial Bank of Commerce, the fifth-largest bank, may write down its investments for collateralized debt obligations, while National Bank of Canada may write down C$500 million ($525 million) for its investments in asset-backed commercial paper, the analyst said.

The banks begin reporting results on Nov. 27, beginning with Bank of Montreal. Choquette's estimates are for profits before one-time items.
BMO Capital Markets, 29 October 2007

We are downgrading RY shares to Market Perform from Outperform, and we upgraded National Bank to Outperform from Market Perform. This effectively reverses the rating changes made six months ago.

The reduced rating of RY simply reflects a more cautious stance on capital markets (especially U.S. and European Capital markets) for the next 12-18 months. Royal has been more successful than its Canadian peers in building out a global fixed income presence. As a result, it should have above-average exposure to the problems of structured credit globally.

One issue that concerns us is the difficulty in establishing price levels in structured credit markets. While we are confident that Royal will be proactive and conservative in attempting to value residual and trading positions, this is an issue that will likely hound all global fixed income players for some time.

Part of our downgrade of RY reflects our preference for NA as a 'play' on the possibility that market settle after a rocky three-month period. In a more sanguine environment, NA shares, which have been the worst-performing shares over the past year, offer better short-term upside. If the environment remains hostile, NA's share price already incorporates a high degree of skepticism. As we show below, National shares are currently cheap relative to Royal.