National Bank National Bank Financial analyst Gabriel Dechaine expects to see “a ‘tempered’ credit cycle shift” when Canadian banks disclose their third-quarter financial results.
“Deterioration in the economic outlook and factors such as inflation and the impact of higher interest rates on debt service ratios necessitate greater conservatism in provision accounting, in our view,” he said. “Mind you, banks still have 40 per cent of 2020′s performing ACL ‘build’ left on their balance sheets, which tempers the magnitude of the credit cycle shift. Our updated PCL forecasts assume performing ACL additions by all banks, with relatively larger ones for BNS and RY (since they have released 80 per cent of their 2020 ‘builds’).”
In a research report titled All eyes on credit (again), Mr. Dechaine predicted net interest margin expansion could be “a positive factor to offset the drag we expect from higher PCLs.” He said banks with U.S. exposure and large core deposit bases are expected to generate the most spread expansion, pointing to Bank of Montreal, Royal Bank of Canada and Toronto-Dominion Bank.
For equity investors, the analyst thinks short-term trading opportunities “abound,” but he thinks rate hike activity is “the ultimate catalyst.”
“Big-6 bank stocks are down 6 per cent year-to-date, underperforming the market by 140 basis points,” said Mr. Dechaine. “At this point, we are wondering if too much negativity has been reflected. We see forward P/E ratios that are 9 per cent below the historical average, and we estimate that P/B multiple compression from 2022 peaks implies a 50-per-cent probability of a recession. The catalyst for a re-rating, in our view, hinges on the outlook for rate hike activity. That is, market expectations need to shift to a more dovish stance from the Bank of Canada, which would deflate concerns related to the housing market (a primary sector overhang). We’re not there yet but could be getting close. In the near-term, we believe banks well positioned into the quarter include CM (laggard, relatively strong ACL ratio), NA (potential trading surprise, CET 1 strength) and TD (NIM expansion). On the other hand, we are more cautious on BNS (lower ACL ratio) and RY (ACL ratio, Cap. Markets headwinds).”
Ahead of earnings season, which kicks off on Aug. 23, Mr. Dechaine made four target price adjustments after modest reductions to most of quarterly projections to “reflect reduced investment banking fees, lower assets under management in Wealth and slightly higher PCLs, partly offset by higher NIM forecasts.”
His changes were:
- Bank of Montreal ( “sector perform”) to $151 from $152. Average: $151.93.
- Bank of Nova Scotia ( “sector perform”) to $90 from $91. Average: $89.60.
- Canadian Imperial Bank of Commerce ( “outperform”) to $83 from $84. Average: $77.81.
- Royal Bank of Canada ( “outperform”) to $147 from $148. Average: $140.76.
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