Friday, February 29, 2008

National Bank Q1 2008 Earnings

RBC Capital Markets, 29 February 2008

Q1/08 core cash EPS of $1.46 were in line with our estimate of $1.45 (consensus estimates were $1.38), representing YoY growth of 3%. All three divisions were close to our expectations and a lower share count (3%) helped offset weak net income growth. Our 2008 and 2009 cash EPS estimates are unchanged, as is our 12-month target price of $51 and our Underperform rating.

Our main concern with regards to National Bank's share price surrounds its ABCP holdings. We believe that many players are motivated to support a restructuring but the wider credit spreads get, and the longer they stay wide, the more risk there is to a successful restructuring. Credit spreads on North American investment grade debt have widened significantly since early February (from about 110 basis points to 154 basis points) and have essentially tripled since September.

We believe that most market participants are assuming a positive resolution in the restructuring of third party ABCP, and as such, we do not believe NA's share price has much upside if positive news comes out in upcoming days or weeks on ABCP. However, given that National Bank holds the most third party ABCP of all the Canadian banks, its share price is most at risk if the restructuring runs into difficulty, which we believe is possible. Management has a more optimistic outlook than us on the restructuring process.

If the ABCP restructuring proceeds well, there would be upside to our 12-month target price, but upside to NA's shares is limited by: (1) relatively weaker retail performance, (2) a larger wholesale earnings mix, (3) lower capital than peers, and (4) greater exposure to Central Canada. National Bank has put in place plans to improve retail performance, but we expect those to take time to show results. On the positive side, the bank has limited exposure to structured finance holdings and U.S. operations compared to peers, and its stock trades at a 2.3x P/E discount to its three highest valued Canadian peers.
Scotia Capital, 29 February 2008

• National Bank Q1/08 cash operating earnings increased 2% to $1.46 per share, better-than-expected due to extremely high trading revenue, second highest in history and continued high level of security gains.

What It Means

• Reported earnings were $1.58 per share, including a $0.12 per share gain from the sale of the bank's subsidiary in Nassau, Bahamas, net of the ABCP funding costs and professional fees.

• Return on equity for the quarter was 21.3% with return on risk weighted assets at 1.82%.

• Retail earnings increased 6%, with Wealth Management and Financial Markets earnings declining 7% and 12% respectively.

• Maintain 2-Sector Perform.
Financial Post, 28 February 2008

National Bank of Canada has been downgraded to “underperform” at RBC Capital Markets on growing concerns about the restructuring of the third party asset-backed commercial paper (ABCP) market.

Analyst Andre-Philippe Hardy also cut his price target on the bank’s shares to $51 from $55, telling clients in a note that the upside is limited given that most market participants expect a positive resolution to the ABCP restructuring.

National’s holdings of third party ABCP are valued at $1.7-billion, after a 25% writeoff, he noted, adding that it could handle a pre-tax writeoff of up to 70% before having to raise equity.

“However, given that NA holds the most ABCP of all the Canadian banks, its share price is most at risk if the restructuring runs into difficulty,” the analyst said.

Even if the ABCP restructuring proceeds well, the upside for National shares will be limited by a relatively weaker retail performance, a larger wholesale earnings mix, lower capital than its peers, and more exposure to central Canada, Mr. Hardy said, adding that improvement plans for the retail business will take time to produce results.

And while the probability of a liquidation scenario for National’s ABCP may be low, the analyst said the chances are nonetheless rising and nobody knows what these assets would be worth in this scenario.