RBC Capital Markets, 1 August 2007
• Lowering target prices based on capital markets weakness. We have lowered our EPS estimates for wholesale and wealth management based on the risk of continued weakness in capital markets by 5%. Our new estimates reflect our view that capital markets earnings will not be as strong as previously anticipated; we may need to review them as the revenue outlook is unclear. We also lowered our multiples on wholesale earnings to 8-10x to reflect rising uncertainty. Our target prices for Scotiabank and CIBC are most negatively impacted (5%), although for different reasons, while TD is least impacted (-1%).
• Target multiples below 5-year average. Our new target valuations aggregate to 11.7x forward EPS (5-year average is 12.2x). We believe this is justified by the likelihood of less buoyant capital and credit markets, and a likely slowdown in wealth management revenue growth.
• Banks with a retail focus should outperform wholesale banks. TD appears best positioned with a dominant retail franchise and an earnings mix that is more weighted to retail (20% wholesale in the last 12 months versus a 30% group median). RY also has a dominant retail franchise, and its wholesale mix is in line with group median.
• Continued weakness could lead to buying opportunities. If banks trade toward the 5-year trough (10.5x in 2002), we believe it would be worth looking through short-term volatility and buying the Canadian banks aggressively.
• Increasing price of risk has negative implications for many businesses. Fixed income trading, debt and equity underwriting, M&A, bridge financing and asset management could all suffer. Partially offsetting those negatives, trading volumes spiked in many asset classes and volatility increased in recent weeks. Also, large sudden moves can lead to large gains.
• CIBC is most exposed to U.S. sub-prime real estate. CIBC and RY acknowledged exposure to securities backed by U.S. sub-prime real estate when releasing Q2/07 results. The cushion that banks have in higher-rated CDO tranches is getting thinner as delinquencies in underlying assets are rising, and weakness in CDO prices is likely to force both to mark down the value of their assets when Q3/07 results are released. We believe the mark-down at CIBC could exceed our previously estimated range ($50-100 million) given the continued rapid deterioration in asset prices backed by U.S. sub-prime real estate.
• 12 Month Target Price
.............Old........New
BMO.. $ 71.00 $ 69.00
BNS... $ 57.00 $ 54.00
CM .. $114.00 $108.00
NA.... $ 65.00 $ 64.00
RY.... $ 64.00 $ 63.00
TD.... $ 82.00 $ 81.00
;
• Lowering target prices based on capital markets weakness. We have lowered our EPS estimates for wholesale and wealth management based on the risk of continued weakness in capital markets by 5%. Our new estimates reflect our view that capital markets earnings will not be as strong as previously anticipated; we may need to review them as the revenue outlook is unclear. We also lowered our multiples on wholesale earnings to 8-10x to reflect rising uncertainty. Our target prices for Scotiabank and CIBC are most negatively impacted (5%), although for different reasons, while TD is least impacted (-1%).
• Target multiples below 5-year average. Our new target valuations aggregate to 11.7x forward EPS (5-year average is 12.2x). We believe this is justified by the likelihood of less buoyant capital and credit markets, and a likely slowdown in wealth management revenue growth.
• Banks with a retail focus should outperform wholesale banks. TD appears best positioned with a dominant retail franchise and an earnings mix that is more weighted to retail (20% wholesale in the last 12 months versus a 30% group median). RY also has a dominant retail franchise, and its wholesale mix is in line with group median.
• Continued weakness could lead to buying opportunities. If banks trade toward the 5-year trough (10.5x in 2002), we believe it would be worth looking through short-term volatility and buying the Canadian banks aggressively.
• Increasing price of risk has negative implications for many businesses. Fixed income trading, debt and equity underwriting, M&A, bridge financing and asset management could all suffer. Partially offsetting those negatives, trading volumes spiked in many asset classes and volatility increased in recent weeks. Also, large sudden moves can lead to large gains.
• CIBC is most exposed to U.S. sub-prime real estate. CIBC and RY acknowledged exposure to securities backed by U.S. sub-prime real estate when releasing Q2/07 results. The cushion that banks have in higher-rated CDO tranches is getting thinner as delinquencies in underlying assets are rising, and weakness in CDO prices is likely to force both to mark down the value of their assets when Q3/07 results are released. We believe the mark-down at CIBC could exceed our previously estimated range ($50-100 million) given the continued rapid deterioration in asset prices backed by U.S. sub-prime real estate.
• 12 Month Target Price
.............Old........New
BMO.. $ 71.00 $ 69.00
BNS... $ 57.00 $ 54.00
CM .. $114.00 $108.00
NA.... $ 65.00 $ 64.00
RY.... $ 64.00 $ 63.00
TD.... $ 82.00 $ 81.00
