Thursday, October 23, 2008

Scotiabank is Downgraded

RBC Capital Markets, 23 October 2008

Our Underperform rating on Scotiabank's stock has primarily reflected our view that the high valuation multiple leaves little room for disappointment. Scotiabank trades at a high P/E and P/B multiple relative to Canadian banks. We think that Scotiabank's high valuation reflects (1) strong asset growth in domestic banking, international banking and corporate lending; (2) less exposure to U.S. lending than some of its peers; (3) high capital ratios; and (4) less exposure to structured finance and off balance-sheet conduits than most.

• In this report, we show how quickly the fortunes of many Latin American countries have shifted. Latin America represents about 20% of revenues and about 13% of earnings assets for Scotiabank.

• We lowered our 12-month target price to $43 per share from $46 to reflect deteriorating economic conditions in Latin America and drastically lower valuations of publicly-traded Latin American banks. Our target price of $43 is based on a P/BV of 2.0x, versus 2.2x today.

• We believe that Scotiabank is not as well positioned to outperform its peers from an operating perspective in 2009 compared to 2008. (1) We believe that structured finance/off balance sheet conduit issues are likely to cause lower writeoffs for the bank's peers than in 2008. (2) We expect the credit cycle to broaden to areas beyond U.S. residential real estate/U.S. consumer/U.S. residential construction lending, into areas where Scotiabank has more exposure such as traditional business lending in the U.S., Canada, Latin America and the Caribbean. (3) The economic environment in Latin America has deteriorated rapidly, which has negative implications in our mind for both earnings risk and the bank's multiple relative to peers. (4) Capital ratios are still industry leading but the Tier 1 ratio is projected to decline 47 basis points (from 9.8% at Q3/08) due to the acquisition of a stake in CI.

• We therefore believe that the valuation gap between Scotiabank and its peers is likely to narrow in 2009, although it should still remain one of the more highly valued Canadian banks. Our 12-month price target multiple still implies a premium multiple to most banks to reflect strong asset growth, high ROE, and strong capitalization.
Financial Post, David Pett, 23 October 2008

BMO Capital Markets downgraded Scotiabank to Market Perform from Outperform. "We continue to recommend CIBC and BMO – the two larger banks that have well-understood problems and are already trading at low valuations. We are somewhat concerned that Scotiabank still trades at one of the premium valuations in the bank group," said analyst Ian de Verteuil.