Fears of higher unemployment driving Canadian bank
Fears of higher unemployment driving Canadian bank stock discount
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John Shmuel
Wednesday, May 15, 2013
Canaccord Genuity says the only way to justify the current valuation of Canadian banks is if investors are expecting "materially higher unemployment in Canada." Brent Lewin/Bloomberg
Investors are too bearish on how much a slowing Canadian economy will impact the country’s bank stocks, says a new report by Canaccord Genuity.
In a comprehensive outlook for Canada’s biggest banks, the Canaccord report said the only way to justify the current level of bearishness is that investors are expecting a “materially higher” level of unemployment in Canada. Conversely, if that were to happen, loan growth at Canadian banks would take a big hit.
“In our view, the only logical way to justify the current discount valuation applied against Canada banks (relative to the insurers and relative to historical levels) is if one is making the call that materially higher unemployment in Canada will drive consumer loan growth to something approaching 0% and credit losses materially higher,” the report said.
The level of bearishness has led Canadian banks to see discounts even beyond those of Canadian life insurance companies, which don’t have the financial soundness and record of dividend growth that Canadian banks do. In fact, Canadian banks now have a higher dividend yield than life insurers (4.2% versus 4%).
And Canaccord expects that to increase even more, to 5% by early 2014. At current levels, the bank dividend will be 2.6 times more than the 10-year government bond yield — even as Canadian banks remain financially sound and continue hiking their dividends. Compare that to lifecos, which have not hiked dividends since the first half of 2008.
But while the Canadian economy will undoubtedly see cooling, Canaccord says there is no evidence Canada’s unemployment rate will go much higher meaning the current discount is unjustified.
The report forecasts healthy earnings growth for Canada’s banks over the next couple of years, averaging 7% in the 2013 and 2014 calendar years. That’s even accounting for modest expectations of only 3% growth in consumer loans. Canaccord expects banks will make up for that by seeing strong gains in commercial, wholesale and U.S. and international loan growth and acquisitions.
Of course, Canaccord expects certain banks to perform better than others. It rates Bank of Nova Scotia, Royal Bank of Canada and TD Group as stocks to buy. Bank of Montreal, National Bank of Canada and CIBC, however, are rated as holds.