Bank Premium to U.S. Peers Narrows on Earnings: Corporate Canada

Royal Bank of Canada, Bank of Nova Scotia (BNS) and six other large Canadian lenders are trading at the lowest premium to U.S. bank stocks in more than two years, as their American counterparts regain the confidence of investors.

“Canadian banks’ conservatism and sleepiness is not going to be rewarded to the same degree as it has in the past,” John Aiken, a Toronto-based analyst with Barclays Plc, said in a May 8 phone interview. “We’re back in an environment where earnings growth trumps everything else, and the Canadian banks are going to lag over the next year or so.”

As Canadian lenders prepare to report second-quarter results starting with Toronto-Dominion Bank (TD) on May 23, the spread between the Standard & Poor’s/TSX Commercial Banks Index and the KBW Bank Index (BKX) of 24 U.S. banks is at its narrowest since January 2011, based on price to tangible book value per share, according to data compiled by Bloomberg.

By that measure, Canadian banks are now less than twice as expensive as U.S. banks, trading at about 2.49 times versus 1.41 times for the U.S. group, the data show. In October 2011, they were about three times more expensive, at about 2.58 times versus 0.88 for U.S. banks.

Price to tangible book value measures what investors are willing to pay for a company’s equity after removing intangible items such as goodwill and brand names that would have little value if the company went out of business.

No Bargain

Canada’s banks index (TNBHICP) has been unchanged this year through yesterday, lagging the 18 percent rise of the KBW Index. Canadian lenders are still no bargain when compared to global peers, according to Franklin Templeton Investment’s David Tuttle.

“We’re looking for stocks mired in pessimism,” Tuttle, a research analyst at Templeton Global Equity Group, which manages $105 billion in assets, said in a May 10 interview. “Canadian banks -- despite valuations coming off a little bit -- just don’t demonstrate those characteristics of a stock that’s out of favor.”

Spokesmen at Canada’s six biggest banks declined to comment.

Canadian banks, ranked the world’s soundest for the past five years by the Geneva-based World Economic Forum, are facing a slowdown in domestic consumer lending as the housing market cools and Canadians are urged to curb borrowing.

Household Debt

Household debt rose to a record 165 percent of disposable income at the end of last year, according to Statistics Canada. The International Monetary Fund last month cut its 2013 growth forecast for Canada to 1.5 percent, the slowest among Group of 20 countries outside Europe and down from a 2 percent estimate in October.

Canadian banks have about C$518 billion ($508 billion) in insured residential mortgages and home-equity credit lines, mostly backed by Canada Mortgage & Housing Corp., the nation’s housing agency, John Reucassel, a BMO Capital Markets analyst, said in a May 10 note. In a severe housing downturn, banks may need to either recapitalize CMHC or absorb some potential losses on insured mortgages.

Canada’s banking regulator is reviewing its guidance to lenders on mortgages of more than 25 years. The Office of the Superintendent of Financial Institutions is consulting with banks on the risks posed given housing prices and rising debt levels, said Brock Kruger, a spokesman for the regulator.

Mortgage Rules

Canadian Finance Minister Jim Flaherty has tightened mortgage rules four times in the past five years amid concerns that some regional housing markets were overheating. In July, he reduced the maximum amortization period on mortgages the government insures to 25 years from 30 years.

The country’s banks will grow adjusted per-share earnings by 3 percent this year and 6 percent in 2014, Andre-Philippe Hardy, an analyst at Royal Bank, said in a May 3 note. That’s at the low end of growth rates experienced in past periods of economic recovery and below the 8 percent to 15 percent growth rates of 2010 to 2012, he said.

The gap between Canadian and U.S. banks narrowed because investors became more confident about the real estate assets held by American banks as U.S. housing improves, while getting skittish on Canadian banks’ exposure to a slowing domestic housing market, said David Baskin, president of Baskin Financial Services Inc. He expects the gap to continue to narrow, though investors can benefit by holding both.

“The positive on the Canadian banks is that people are overstating the housing problems and therefore undervaluing the earnings,” Baskin, whose Toronto-based firm oversees C$500 million, said in a May 10 phone interview. “The positive on the U.S. banks is that their assets are better than people thought.”

Short Sellers

Fund managers including Toronto-based Friedberg Mercantile Group Ltd. are shorting Canadian banks on concern the housing market will collapse. Emrys Partners LP founder Steve Eisman, who rose to fame betting against U.S. subprime mortgages, said at the Sohn Investment Conference in New York on May 8 that he’s pessimistic about Canada’s housing market, saying rising prices weren’t accompanied by growth in personal incomes.

Canadian home prices over the past 10 years have increased by 83 percent, according to the Teranet-National Bank Home Price Index. That outpaced the 34.3 percent increase in the average weekly wage for full-time employees in that period, according to Statistics Canada.

‘Dirt Cheap’

Investors had a short interest in 3.45 percent of the Canadian bank shares available to the public as of April 30, according to data compiled by Bloomberg. That’s the highest in at least 10 months and above the 2.35 percent at the end of last year. Short sellers profit from price declines by selling borrowed securities and replacing them with stock bought at cheaper levels.

Canadian investors such as Baskin still see a deal when considering dividend yields and share price to future earnings.

“Canadian banks are dirt cheap right now,” Baskin said. “I think the Canadian banks are screaming buys.”

Canada’s six-biggest banks will report a 4.2 percent rise in per-share profit excluding some items in the second quarter compared with a year earlier, according to Barclays’s Aiken.

Toronto-Dominion Bank, the second-largest lender by assets, will increase adjusted profit by 4.7 percent to C$1.91 a share when it reports, according to the average estimate of 13 analysts surveyed by Bloomberg.

National Bank

National Bank of Canada (NA), the sixth-largest lender, will increase per-share profit by 1.2 percent to C$1.97 a share when it reports May 24, according to the average estimate of 12 analysts. The Montreal-based bank may raise its quarterly dividend by 4.8 percent to 87 cents, according to Bloomberg’s Dividend Forecast.

Scotiabank, the third-largest lender, is estimated to have profit of C$1.26 a share, a 6.7 percent increase from the year-earlier period, when it reports May 28. Bank of Montreal (BMO)’s profit is estimated to climb 2.4 percent to C$1.48 a share when it reports May 29.

Royal Bank, the largest lender, and Canadian Imperial Bank of Commerce, the fifth-biggest, report earnings on May 30. Royal Bank’s profit is estimated to jump 12 percent to C$1.31 a share, and CIBC’s profit will rise 3.2 percent to C$2.06 a share, according to analysts’ estimates.

To contact the reporter on this story: Doug Alexander in Toronto at dalexander3@bloomberg.net

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; David Scanlan at dscanlan@bloomberg.net

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