BNS Scotia Capital analyst Phil Hardie thinks economic concerns are likely to weigh on valuations for TSX-listed small-cap lenders through earnings season.
“The mortgage finance and non-prime consumer lending sectors tend to be viewed as highly cyclical,” he said. “Rising recession risk triggered by a central bank policy error of raising rates too far, too soon, amid a myriad of uncertainties has likely fostered a cautious tone and put pressure on multiples across the space with the non-prime consumer lenders experiencing the most significant near-term contraction.
“Further clouding the outlook for the mortgage lenders is a transitioning housing market. We believe strong immigration and solid labour markets are likely to remain supportive to the housing sector. That said, the pace of the rise in mortgage rates is likely to 1) pose risks to how orderly the housing market transitions, and 2) add stress on more leveraged households. We believe that a rapid trajectory of interest rate increases risks putting near-term pressure on net interest rate margins of mortgage lenders that are heavily dependent on GICs. This reflects a timing issue, where we would expect a more rapid response in GIC pricing, while “rate holds” and competitive dynamics are likely to result in a more delayed response of the higher-yielding loans being added to loan book as an offset to the higher deposit costs.”
With that view, he expects lender stocks to be driven “much more by shifts in sentiment and valuation multiples than revisions to the earnings outlook” in the coming months. That’s under his assumption that economic growth will continue through next year and a recession is avoided.
Mr. Hardie trimmed his target prices for stocks to reflect a reduction in his multiples. His adjustments are:
Propel Holdings Inc. (“sector outperform”) to $15 from $16. Average: $15.83.
“We expect to see PRL report a strong q/q rebound in EPS and in profitability margins in Q1/22. This is likely to reflect seasonality where we anticipate lower level of originations to reduce the effective ‘sales strain’ we have seen over recent quarters,” said Mr. Hardie.