Wednesday, February 13, 2008

Short Interest in Banks Near All Time Highs

Scotia Capital, 13 February 2008

Short Interest in Canadian Banks Near All Time Highs

• Short interest in Canadian Banks has risen significantly from the extremely low levels during the 2001/2002 credit crunch where Canadian Banks had very high absolute and relative exposure to the troubled Telco/Cable and Power/Power Generation sectors (Exhibit 1).

• The short interest in Canadian banks began to rise (Exhibit 8) from extremely benign levels during 2006 peaking in late 2007 with the exception of CIBC whose short position reached an all time high as at January 31, 2008.

• The short interest ratio for Canadian banks has increased from 1.0 to 2.0 in 2002 to levels ranging from 3.3 to 8.5.

CIBC - Highest Short Interest

• The short interest in Canadian Banks has been focused on CIBC with a short interest ratio of 8.5 followed by RY at 5.5, BNS 5.2 and TD at 4.9. BMO and NA short interest ratios have dropped from previous peaks to 3.3 and 3.8. In the past cycle short interest was not meaningful with the respective short interest ratios for BMO, BNS, CM, NA, RY and TD being 1.0, 1.0, 2.8, 1.0, 1.7 and 1.8, respectively.

• It is difficult to derive the share price impact as a result of these relatively aggressive short positions. However we believe it has contributed meaningfully to the share price declines of Canadian Banks. The R squared in the past six months (Exhibits 15-20) between CIBC share price and the Short Interest Ratio is 92%, followed by NA at 63% and BMO at 61%. The banks that have the least exposure to high risk assets have been less affected with RY at 40%, TD 39% and BNS a low of 19%.

Low Exposure to High Risk Assets

• We continue to believe Canadian banks' exposure to high risk assets/loans is at a historical low on an absolute and relative basis compared to past cycles such as 1982 (LDC), 1990s (CRE) and 2002 (Telco/Cable/Power/Power Generation). We expect the bank P/E multiple to rebound significantly in the next few years as it did subsequent to weathering the Telco/Cable/Power sector problems (trough ROE 15%). We expect the stress testing of bank earnings in fiscal 2008 will again lead to higher multiples.

Compelling Valuations - Recommend Aggressively Buying

• Bank Valuations Best in Decades or Ever? The bank dividend yields relative to bonds and equities (Exhibits 4 and 5) are at unheard of levels at 5.2 and 2.0 standard deviations above their historical means. Bank P/E multiples have retraced to 10.9x trailing similar to 2001/2002 bottom.

• The resolution of the U.S. monoline problems is expected to be a key positive inflection point for bank stocks. As well we expect Canadian banks' solid earnings, profitability and dividend increases in 2008 to buoy bank stocks as we move through the year.

• We continue to recommend aggressively buying bank stocks at these levels. Reiterate 1-Sector Outperform ratings on Toronto-Dominion and Royal Bank with 8% dividend increases expected at the end of this month.