Tuesday, September 02, 2008

RBC CM: Still Too Early to Buy Banks

RBC Capital Markets, 2 September 2008

We believe that it is too early to buy Canadian bank stocks, reflecting our expectations for continued pressure on profitability due to both a slowing economy and credit markets that remain in turmoil, and valuations that are not overly cheap on a historical basis considering the challenges we think the banks will face. Median projected total returns to our 12-month target prices are 5%.

We believe that the banks' dividend yield and P/E valuations are attractive, but they are not necessarily indicators that the time is right to buy today.

• We are watching indicators in four key areas to pick a bottom in Canadian bank shares: (1) signs of credit market stress; (2) housing market strength; (3) employment growth; and (4) the price of oil. Those indicators are not overly positive.

Lowering rating on BNS; Upgrading rating on NA

We are lowering our investment rating on Scotiabank stock from Sector Perform to Underperform, reflecting primarily a valuation multiple that leaves little room for disappointment. We believe that the bank's industry high valuation could decline relative to peers when concerns over structured finance and U.S. credit abate and/or concerns over Canadian growth increases.

We are upgrading our investment rating on National Bank stock to Sector Perform from Underperform. (1) The bank should benefit near term from limited exposure to U.S. credit and structured finance, and expense initiatives are boosting bottom line growth in spite of weak retail revenue momentum. (2) We expect the gap between the more richly valued banks and the ones at the bottom to narrow in 2009 as we do not expect differences in operating performance to be as large as in the last 12 months. (3) A successful resolution of the non-party ABCP restructuring looks likely, which reduces risk related to those holdings.

Q3/08 results directionally as expected

Q3/08 core cash EPS declined a median 7% as wholesale earnings were down, retail growth of 6% was slow and credit losses were higher. Capital ratios rose as the banks were active in raising non-equity capital, which boosted Tier 1 ratios over and above what income generation would have provided.