Fred Lum/The Globe and Mail
Remind us again: Wasn't this supposed to be the year that Canadian bank stocks, hobbled by spent-out consumers and suffering from the bursting of a housing bubble, were to see the end of their magical run?
It didn't work out that way. Despite all the fears that surrounded 2013, the country's five biggest lenders saw their shares gain from 13 per cent to 19 per cent this year, doubling or better the performance of the S&P/TSX composite index.
So can we expect meaningful gains in 2014 as well?
The con side says the Canadian consumer is indeed slowing down, and the housing market is no longer white hot.
The pro side says consumers can breathe easy so long as interest rates remain low, which they will "for quite some time," according to comments from Bank of Canada Governor Stephen Poloz on Wednesday.
Each of the banks will feel these conflicting forces in slightly different ways.
To develop a scouting report on the financial giants' individual strengths and weaknesses, we surveyed the analysts who follow the sector.
Their answers suggest more gains may be in the offing – but the circle of winners may shrink over the next 12 months.
PRO: Which of the big banks could best withstand problems in Canada's housing sector? Analyst Stefan Nedialkov of Citigroup Global Markets, who performed a "triple stress test," says it's BMO, because it has the lowest exposure to residential real estate lending. Instead, BMO has the sector's highest exposure to "the promising Canadian corporate lending sector," according to Mr. Nedialkov, who has a $74 target price on its shares. In addition, the bank has been growing in the U.S., most recently with its acquisition of Wisconsin's M&I Bank in 2010. It trades at just two times tangible book value, easily the lowest of the Big Five by that measure.
CON: BMO suffered a fourth-quarter decline in earnings in both the U.S. and Canada, with a 25 per cent drop south of the border. (That excludes a one-time gain that was the only reason BMO achieved the earnings that analysts expected.) "They just haven't hit on all cylinders, like TD or Royal has in the past," says analyst Dan Werner of Morningstar, who estimates a $72 "fair value" for its share price. Brad Smith of Stonecap Securities says that while the overall tone of BMO management was positive after the recent results, some comments from the managers of BMO's various lines of business "signaled, to our ear, a tough first half of 2014."
PRO: With 11 million customers in 45 countries, Scotiabank is "easily the most international of the Canadian banks," notes Mr. Werner of Morningstar, who has a fair value estimate of $67 on its stock. The bank's foreign exposure is a strength, because the international loans it makes typically yield more than the ones at home. Not that Canada is a weak spot: The bank posts healthy returns in the domestic market and the acquisition of the Canadian business of ING Direct added 2 million customers to its files. Yet for all its potential growth, Scotiabank stock sits in the middle of the big banks on a number of valuation measures.
CON: Those higher-yielding international loans can also produce higher losses. In the fourth quarter, international net interest margins declined thanks to lower interest rates, increased competition and regulation, says analyst John Aiken of Barclays Capital, who has a "neutral" rating and $66 price target. He says he's "concerned with potentially greater earnings volatility." And the fact Scotiabank shares have lagged other Big Five stocks in 2013 is also a negative in Mr. Aiken's eyes.
Canadian Imperial Bank of Commerce
PRO: If you think all this concern about the Canadian consumer is overblown, this is the bank for you. Roughly two-thirds of the bank's revenues come from home, versus an average of about 40 per cent at its peers, notes Erik Oja of S&P Capital IQ, who has a target price of $90 (U.S.) on its shares. Given international worries about Canada, CIBC's heavy exposure to the domestic market means its shares trade at a lower price-to-earnings ratio than other banks, which could be attractive to bargain hunters. And for income investors? The bank didn't increase its dividend along with better-than-expected fourth-quarter earnings, but it had the wherewithal to do so, argues Michael Goldberg of Desjardins Capital, who has a target price of $97.50 Canadian.
CON: If you think all this concern about the Canadian consumer is appropriate, this is not the bank for you, for all the reasons above. Mr. Smith of Stonecap notes "rising evidence of eroding domestic loan and deposit market share, which if not arrested will lead to declining future earnings momentum over time." (He has a "sector perform" rating and $78 target price.) Morningstar's Mr. Werner expects CIBC's earnings to fall in 2014, partly as a result of the bank's loss of a chunk of the Aeroplan business to TD.
PRO: While RBC has the biggest retail network in Canada, its capital markets division is providing much of the recent excitement. Mr. Goldberg of Desjardins says RBC is strengthening that franchise by doing a better job of taking care of clients, rather than chasing the next big deal. He has an $81 target price on the shares. Mr. Oja of S&P Capital IQ, who has a $71 (U.S.) target price, views the company's sale of underperforming U.S. assets as a positive, and praises the company's low expense levels and high asset quality.
CON: RBC is now the most expensive of Canada's big-bank stocks, trading at three times its tangible book value. Its recent results may not justify that valuation. The positive surprise in fourth-quarter capital markets earnings offset relatively disappointing numbers in the retail segment and significant loss provisions in its wealth-management business, noted Mr. Aiken of Barclays. (He is "neutral" on the stock with a $69 target price.) "With retail banking and wealth management not generating a similar lift to earnings as capital markets, we believe it will be difficult for [Royal Bank] to add to its premium valuation," he says.
PRO: Do you believe the United States is where the growth is? Then TD has you covered. Loans in its U.S. business are growing at four times the rate of its Canadian business. Net interest margin, a measure of the difference between income on loans and the cost of funds, is expanding in the U.S. while contracting in Canada, Desjardins' Mr. Goldberg noted. (It's a "top pick" for him, with a $115 target price.) And not all the encouraging news is south of the border: TD is boosting its Canadian consumer business by seizing part of the Aeroplan business from CIBC.
CON: The bank's U.S. business may be growing, but from a profitability standpoint, it's a shadow of the Canadian operations. (TD's return on equity at its Canadian personal and commercial operations was 45.8 per cent in the fourth quarter, versus 7.5 per cent in the corresponding U.S. segment.) So, while U.S. growth may add pennies to earnings per share, it drags down the overall profitability of the company, notes Mr. Werner of Morningstar, who estimates fair value for its stock is $87 (U.S.) a share. "There's some room for them to improve [in the U.S.], and maybe that's why I should be more optimistic, but I haven't seen it yet," he says.
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To develop a scouting report on the financial giants' individual strengths and weaknesses, we surveyed the analysts who follow the sector.
David Milstead