National Bank’s Allure Fades as Lending Hits Zenith
National Bank of Canada generated the best risk-adjusted returns among Canadian banks through the global financial crisis by focusing on its home market. Some analysts say that strategy is now working against the bank.
National Bank’s stock rose 2.6 percent in the five years through today after adjusting for price swings, the top among Canada’s eight-biggest banks, according to a Bloomberg Riskless Return ranking. The lender, based in Montreal, had the highest total return among its peers at 81 percent and less volatility than larger peers Royal Bank of Canada and Canadian Imperial Bank of Commerce.
The bank, which operates mostly in Quebec, outperformed larger Canadian lenders which expanded in the U.S., Europe, Latin America and Asia over that period. The domestic concentration sheltered the lender from the turmoil of the U.S. subprime mortgage collapse and financial upheaval as well as Europe’s debt crisis.
“Canadian retail banking may have hit its zenith in terms of earnings growth,” John Aiken, an analyst with Barclays Plc, said in an interview. “If we’re going to look at some of the other banks that have access to broader global business lines, National’s performance may not be top-of-class going forward.”
Standard & Poor’s yesterday lowered issuer credit ratings on six Canadian lenders including National Bank and Bank of Nova Scotia (BNS) by one level as they face “incremental pressure from headwinds facing the Canadian economy.”
National Bank shares fell 0.1 percent to C$76.87 at 4 p.m. in Toronto. The stock has risen 6.6 percent this year, compared to the 11 percent return of the S&P/TSX Financials Index.
National Bank’s risk-adjusted return over five years was almost double that of Quebec competitor Laurentian Bank of Canada, the second-best performer with a return of 1.5 percent, and twice the 1.3 percent return of Royal Bank, the country’s largest lender, according to the Bloomberg ranking. National Bank also outperformed CIBC, the Toronto-based lender that sought to reduce risk after taking more writedowns in the financial crisis than any of its Canadian peers.
“Our presence in Canada as a super-regional bank has allowed us to keep better results and avoid the more risky areas,” said Jean Dagenais, National’s senior vice president, finance and taxation. “People saw in the bank stock some kind of a refuge, a pure Canadian play.”
The risk-adjusted return, which isn’t annualized, is calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
National Bank’s performance when considering price swings has faded in the past 12 months relative to its competitors. The Quebec lender’s one-year risk-adjusted return was 1.3 percent, below the 1.7 percent returns of CIBC and Royal Bank, and Bank of Nova Scotia’s 1.6 percent performance.
The bank benefited from strong economic performance in Quebec, Canada’s second-largest economy, compared with other provinces. Since the end of 2007, Quebec’s economy has grown by 4.9 percent, more than three times the 1.5 percent expansion in Ontario and the 4.4 percent growth in British Columbia, according to Statistics Canada.
“They have very loyal customers in Quebec,” said David Baskin, president of Toronto-based Baskin Financial Services, which manages about C$450 million including National Bank shares. “That customer loyalty makes for a less competitive environment in Quebec, which obviously leads to higher margins and better profits.”
National has had missteps. The bank recorded more than C$1.1 billion of writedowns over two years after the August 2007 collapse of Canada’s market for non-bank administered asset- backed commercial paper. National took the costs after buying back about C$2 billion in frozen short-term debt from its clients.
Still, National took fewer writedowns than its larger Canadian lenders during the U.S. subprime collapse in 2008 and subsequent financial crisis. It was the first Canadian lender to raise its dividend in 2010, ending a three-year payout freeze.
“They haven’t blown their brains out doing stupid things in the United States,” Baskin said. “They have less currency risk than the other banks, which also helps. That may tend to reduce the volatility of their earnings a little bit.”
Canadian lenders have been ranked the world’s soundest for the past five years by the Geneva-based World Economic Forum. The eight-biggest banks have outperformed Canada’s benchmark S&P/TSX Composite Index, which has been almost unchanged over five years when accounting for volatility.
Canada’s eight-bank S&P/TSX Commercial Banks Index (STCBNK) returned 1.4 percent on a risk-adjusted basis, outperforming the 0.7 percent decline of the 24-company KBW Bank Index in the U.S. on that basis.
In spite of its returns, National’s stock is the cheapest of Canada’s six-larger banks based on a ratio of its share price to earnings potential in the next 12 months.
“One of the perennial knocks on National’s valuation has been its outsized contribution from capital markets,” Aiken said. “When you take a look at the earnings performance of National, it’s actually been very steady. What you get is reasonably strong growth with a more stable valuation multiple.”
National Bank generated 31 percent of its revenue from financial markets, which includes its investment bank, in the fiscal year ended Oct. 31, more than any other Canadian lender. In comparison, Royal Bank, which has investment-banking operations in the U.S., Europe and Asia, gets 21 percent of revenue from capital markets. Bank of Montreal (BMO) gets 23 percent of revenue from investment banking.
“The financial markets are volatile, but we are less volatile than the others,” Chief Financial Officer Ghislain Parent said in a telephone interview. “We’re trading and client driven.”
National’s track record isn’t enough to convince money managers such as Caldwell Securities Ltd.’s John Kinsey to invest in the stock.
“They have done well, it’s just that it’s more of a regional bank,” Kinsey said in a Nov. 26 interview in Toronto. “With the top five banks, that’s enough for us. You can’t kiss all the girls.”