19 August 2010

Credit Suisse: Revenue Growth to Slow for Banks

Credit Suisse, 19 August 2010

As Canadian bank earnings/returns on equity (ROE) benefit from declining credit charges, slowing revenue growth represents a headwind.

We forecast provisions for credit losses (PCLs) to decline 35% and 36% in 2010 and 2011, respectively, providing a substantial boost to group profitability. However, as this earnings/ROE driver loses momentum, the onus falls on revenue growth to drive the bottom line. On this front, we believe: (1) domestic retail lending is poised to slow; (2) wholesale revenues are falling as trading revenues normalize; and (3) competitive forces will restrict margins. Given our cautious outlook on the revenue front, we are forecasting the pace of group ROE expansion to fall to 37 basis points in 2012 from 61 basis points in 2010.

Capital regulation, capital management and (potentially) economic stability represent the most important near-term stock drivers. Uncertainty toward the regulatory capital landscape represents an overhang for the sector. Clarity should come at the end of 2010, allowing banks to revisit capital-management programs. We forecast the group to have $28 billion of excess capital by the end of fiscal 2012 under Basel III and our sector 2011 estimated dividend payout ratio is 44%. This cushioning should allow banks to raise dividends over the next 12 months.

A bias toward banks with significant foreign operations is counter intuitive given the strength of the Canadian economy. Our rationale is that top-line growth in Canada is slowing, while foreign activities are either tied to secular growth trends or are underappreciated by the Street.

Stock selection favors a basket of growth potential and defense. Our stock selection emphasizes: (1) relative growth positioning; (2) dividend growth potential; (3) relative valuation; (4) revenue mix tilted toward P&C [personal and commercial] banking; and (5) excess capital and/or deployment opportunities.

We've assigned Outperform ratings to the Bank of Nova Scotia (BNS) and Toronto-Dominion Bank (TD), as they play well into our offensive themes of growth positioning and capital-deployment opportunities, while also offering a favorable mix of personal and commercial-banking revenue.

We also rate National Bank of Canada as Outperform, as it screens well against our criteria of dividend growth and relative valuation.

We are Neutral on Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CM) and Royal Bank of Canada (RY).