28 October 2008

Dundee Securities Cuts Banks' Ratings

Dundee Securities Target Prices:

• National Bank - target price cut to $49 from $58
• RBC - target price cut to $43 from $54
• Scotiabank - target price cut to $36 from $49
• TD Bank - target price cut to $59 from $71
Financial Post, Jonathan Ratner, 28 October 2008

A bearish outlook for 2009 and expectations for a weak fourth quarter has prompted Dundee Securities to downgrade shares of Royal Bank from “buy” to “sell.”

Analyst John Aiken has increased his forecast for credit loss provisions in the quarter for those banks with material exposure to the U.S., which includes Royal, Toronto-Dominion Bank and Bank of Montreal. However, he expects the greatest impact will be felt in the latter part of 2009 as the U.S. recession truly takes hold and bankruptcies spread beyond sectors linked to real estate.

The risk that the Canadian economy could be impacted also forced Mr. Aiken to increase his provision estimates for each of the banks, with expectations that the third quarter will see the largest such increases.

With capital no longer as critical an issue as it was early in 2008, earnings growth concerns appear to be coming into focus. The analyst told clients “it is difficult to see how the Canadian bank valuations will receive any meaningful lift in the near term.”

While capital market revenues and spreads may moderate, Mr. Aiken said looming credit losses will be the next threat to bank valuations and earnings estimates going into 2009.

The traditional end-of-year balance sheet clean-up should therefore see a myriad of write-downs, he predicted, insisting that the banks will not do anything that could bring future earnings into question, given that they are all being valued off of 2009 expectations.

Mr. Aiken estimates that most bank could maintain their capital positions even with charges above $2-billion, but doesn’t expect to see any (including CIBC) above $1-billion.

The analyst also downgraded Bank of Nova Scotia from “neutral” to “sell,” and both TD and National Bank from “buy” to “neutral.” He now has no banks rated a “buy.”

Fourth quarter earnings are also expected to be negatively impacted by unprecedented interest rate spreads as banks shy away from lending to each other and make funding very expensive. Declining loan growth that is forecast to be a negative revenue headwind through at least the first half of 2009 and the evaporation of capital markets revenues are also causing pain. Volatility may be good for trading activity, but it is hurting banks’ higher margin advisory business. When the concerns do subside, Mr. Aiken anticipates that trading volumes will fall to levels not seen for several years “as investors hide and lick their wounds and participants disappear.”

And while credit quality is weakening, he does not see a sharp increase in provisions for related losses until later in 2009. He does expect a “plethora” of cost-cutting efforts.

The good news? Mr. Aiken says bank dividends are safe and National, Royal and Canadian Western Bank should announce fourth quarter increases, although they are not expected to be material. “With an average dividend yield above 5% for the Big 6, any increases would not have any real impact on valuations,” he added.
Canadian Press, 28 October 2008

Canada's big banks are facing further discouraging results, according to industry analysts who are slashing their ratings in the sector on lower confidence.

John Aiken of Dundee Securities says the banks' disappointing results will stretch into next year as capital market revenues moderate and credit quality weakens.

Mr. Aiken broadly downgraded bank stocks, including the remainder of the sector he had rated as a “buy.”

The downgrades include Royal Bank dropping from a “buy” to a “sell” and Scotiabank, cut from “neutral” to “sell.”

Also changed were National Bank and TD Bank both from “buy” to “neutral.”

“Although not likely to be the catastrophic failures that we have seen in recent quarters, fourth-quarter earnings will not generate any reasons to celebrate either,” Mr. Aiken said in a note.

“Further, many of the issues that dominate the fourth quarter are likely to persist for several more quarters, in a time where deterioration in credit quality will overshadow any recovery in earnings.”

Expectations for the coming year were also reduced by Blackmont Capital analyst Brad Smith.

He slashed forecasts for the banks' fourth quarter ending Oct. 31, as well as next year based on “continuing signs of building global economic weakness.”

Financial stocks moved up 4.2 per cent in morning trading on the Toronto Stock Exchange.

Overall, the banks have shown some improvements in their results, Mr. Aiken suggested.

He said some issues that have dominated attention this year are no longer a major concern, such as shoring up capital, because governments have intervened to help global banks.

But he expects a widespread focus on cost-cutting to counter lower revenues and declining loan growth.

Weaker credit quality is also anticipated next year, especially for the banks with greater exposure to the United States.
Financial Post, Eoin Callan, 27 October 2008

While economists debate whether Canada and the wider world is headed for recession, domestic banks have already cast their vote by easing back the throttle on dividends, analysis by Brad Smith of Blackmont Capital suggests.

The analyst has amassed data showing Canadian banks have downshifted dividend growth trajectory from high to nil at one of the fastest paces on record.

Historically, zero growth in bank dividends has historically coincided closely with periods of a significant recession, Mr. Smith found after trawling through a quarter-century of trends.

Blackmont points out that when there are signs banks are becoming more pessimistic, this can also mean they are more likely to cut back lending, which can in turn worsen economic downturns.

"Their willingness to lend is a major determinant of economic activity," said Mr. Smith.

But Blackmont points out that the positive for investors is that banks tend to maintain steady dividends during tough economic times.

But Mr. Smith added: "While taking solace in the payout ratio, we would be remiss if we did not acknowledge that given the state of global credit markets, funding stresses, if sustained, may also need to be considered when judging the sustainability of current dividend scales."