Monday, April 14, 2008

Diverging Analysts Opinions on Bank Stocks

Financial Post, Jonathan Ratner, 14 April 2008

If you’ve done well with Canadian financials during the past few weeks, congrats. But its time to sell at least some of the Canadian bank stocks you’re holding, says one analyst, because waiting to see what the earnings from U.S. banks look like may cost you.

Recent market optimism is misplaced and another round of securities losses and a weaker earnings outlook for U.S. banks will continue to weigh on valuations there, according to Dundee Securities’ John Aiken, who said this will infect Canadian banks as well. However, he does not believe they will have to raise additional common equity or cut dividends.

While the analyst admits that valuations are cheap and very attractive for long-term investors, he expects continued pressure during the next six months will yield a much better entry point.

“We firmly believe that investors should take some early gains and sell into this rally,” Mr. Aiken said of Canadian bank stocks.

Investor behaviour has shown that incremental write-downs and capital infusions both at U.S. and European banks have been viewed positively at times, due to hopes that the end may be near as balance sheet relief arrives. But “Don’t kid yourself, more pain is coming,” and the earnings outlook for this sector is weak, Mr. Aiken told clients in a note.

He believes that consensus earnings estimates are too high and will need to come down to better reflect declining wholesale revenues and “rising provisions from deteriorating credit quality as a result of U.S. recession.” As a result, he said true price-to-earnings ratios are higher than they appear.

While Mr. Aiken is more confident in the Canadian banks given their ability to withstand significant pre-tax write-downs, he cut his second earnings estimates for each of Canada’s Big 6 banks as a result of “the significantly weaker environment for capital issuances and merger and acquisition activity.” He forecasts that each of their advisory revenues for the coming quarter will match their weakest level of the past four years. Even if the BCE deal closes– the only major M&A action around – it is expected to be included in the banks’ third quarter earnings. And as for trading revenues, Dundee’s expectations that the market volatility will subside somewhat later in the year, likely means declines there too.

Mr. Aiken said he is more concerned near-term about names like Royal Bank, Toronto-Dominion and Bank of Montreal since they have U.S. retail exposure, but feels that all of the Big 6 will experience deteriorating credit quality. BMO, Bank of Nova Scotia and National Bank meanwhile, were cited as having more risk given their higher levels of business lending exposure. He has increased his provisions for credit losses for all of the banks and expects others will do the same.

Mr. Aiken continues to rate BMO, CIBC and Royal at "sell," but cut TD, Scotia and National to "neutral" from "buy."
Financial Post, Jonathan Ratner, 11 April 2008

Loan loss provisions may rise and earnings growth may moderate to 5% to 10%, but UBS analyst Peter Rozenberg doesn’t think this will have a negative impact on earnings per share (EPS) at Canadian banks. Instead, it is projected capital market revenues that may lead to a decline in EPS.

But he suggested this risk will be likely be captured by the second or third quarter. And given that the market is increasingly discounting peak provisions, Mr. Rozenberg thinks bank stocks will eventually re-rate higher and have largely bottomed.

“Credit costs are increasing but remain stable,” he told clients in a note, adding that the structural underpinnings for significant credit losses are not evident. The analyst also noted that business loan provisions would have to quadruple to match the levels of previous peaks.

So while returns on equity (ROE) are expected to decline as economic growth slows, provisions rise, capital market revenues dip and de-leveraging continues, Mr. Rozenberg continues to think valuations are attractive given this contained credit risk. In fact, while price-to-book ratios for Canadian bank stocks are relatively high at 2.0 times versus 1.2x for their U.S. counterparts, ROEs are nearly twice as high.

However, the analyst did note that there has been a 94% correlation between the performance of Canadian and U.S. banks during the past 12 months. And while the U.S. backdrop continues to be negative, “banks typically lead recoveries and monetary and fiscal policies have been aggressive with more action likely, although details are still lacking,” he said.

Mr. Rozenberg estimates the downside risk for Canadian bank stocks at 10%, but with upside at 20% to 25% for the next year.