Monday, August 21, 2017

Preview of Banks' Q3 2017 Earnings

Scotia Capital, 21 August 2017

• Despite the favourable combination of strong operating performance (13% YoY EPS growth in 1H/17) and a resurgent domestic economy that underpinned the first rate hike from the BoC in seven years, Canadian bank stocks have run in place for much of 2017, with the TSX Bank Index having moved a grand total of 1% (to the downside) 7.5 months into the year. While we expect that the upcoming Q3/17 results from the sector will continue to show solid financial performance, in our view the stall of the stocks has more to do with questions regarding the health of the Canadian housing market, particularly as sales activity in Toronto has moderated in recent months.

• The group enters reporting season trading at 11.2x our 2018E, down a full-point from the 12.2x peak that was seen in early-March. With the housing conversation remaining at the forefront, we think the key area of focus for investors will be the ability of the group to demonstrate EPS offsets in other parts of the business (net interest margin [NIM] expansion, operating leverage, growth in US / International segments), an important consideration given that 2018E revisions have been limited to ~1% so far this year.

• Given that the dispersion between the individual stocks has been limited (8% band between the best-and-worst performers within the 'Big Six' YTD), the combination of relative valuation and potential inflection points in key fundamental trends has taken on greater importance in our stock selection process. Accordingly, we are upgrading our rating on TD to a SO, and balancing this move by lowering RY to a SP.

• Bank of Montreal (BMO, $91.53, SO, $103.00) – Target priced decreased from $104.00
• Canadian Imperial Bank of Commerce (CM, $106.94, SP, $120.00) – Target price increased from $118.00
• National Bank of Canada (NA, $55.29, SO, $61.00) – Target price increased from $60.00
• Royal Bank of Canada (RY, $92.25, SP, $100.00) – Rating cut from Sector Outperform and target price decreased from $102.00
• TD Bank Financial Group (TD, $63.73, SO, $73.00) – Rating raised from Sector Perform and target price increased from $71.00

Friday, June 30, 2017

CIBC’s Pricey PrivateBancorp Deal

The Globe & Mail, James Bradshaw, 30 June 2017

For the second summer in a row, there will be little rest for the weary at Canadian Imperial Bank of Commerce. Executives will be rolling up their sleeves to complete a long-delayed U$4.9-billion acquisition of PrivateBancorp, Chicago’s third-largest bank. CIBC tabled its first offer in June of last year, but U.S. bank stocks surged last fall and winter, and CIBC had to sweeten its bid twice before PrivateBancorp shareholders voted to accept it in May. CIBC CEO Victor Dodig was clearly relieved. “This merger is a major milestone for us,” he said in a statement. “The transaction creates a strong platform for us to serve our clients’ needs throughout North America.”

In many ways, however, CIBC has just cleared a first hurdle. The deal marks a return to territory that was a minefield for the bank: the United States. Starting in the late 1990s, John Hunkin, who was CIBC’s head of investment banking before he was appointed CEO in 1999, tried gambits that included a push into Wall Street investment banking and the U.S. launch of the Amicus electronic banking network, which operated mini-banks for U.S. grocery store chains.

None of them worked, and when Gerry McCaughey succeeded Hunkin in 2005, he reversed course and ushered in a new risk-averse era. CIBC agreed to pay U$2.4 billion to settle a class-action lawsuit with Enron investors, and the bank retreated from the U.S. market. When CIBC later swallowed billions of dollars in writedowns on exposure to U.S. subprime mortgages during the financial crisis, that pullback seemed eminently sensible.

But since then, caution has been costly. CIBC’s share price growth has lagged behind the other Big Six banks over the past decade. When Dodig assumed the top job in 2014, prospects for expansion in Canada were limited. He needed to look abroad.

On its face, Dodig has reasons to be bullish about the PrivateBancorp deal. Larry Richman, who became PrivateBancorp CEO in 2007, has cleaned up troubled assets and built a solid Midwestern lender with operations in 13 states. He is a respected relationship banker, and the deal gives him access to CIBC’s much larger balance sheet—PrivateBancorp has just $28 billion in assets, compared to CIBC’s $529 billion.

But history is littered with examples of Canadian banks’ missteps in the U.S. market. Any boost to CIBC’s earnings will likely take years to materialize. Darko Mihelic, an analyst at RBC Capital Markets, is taking a wait-and-see approach. “How exactly does [CIBC] stitch together its U.S. businesses to form a coherent brand presence in the U.S.?” he wrote in a research note. That’s a key question that remains.

The Big Six Canadian banks’ profits by geography. Royal Bank has operations in about 40 countries around the world and often wins headlines for its overseas expansion plans. But RBC, like the other Big Six banks, still generates an overwhelming majority of its profits here in Canada. The portion from foreign operations is slowly growing at RBC, but surprisingly, when you look at the Big Six as a group, it’s the domestic portion that has climbed.

Sunday, August 28, 2016

Analysts Question Why TD Bank Lags Behind Canadian Peers

Bloomberg, Doug Alexander, 28 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

Toronto-Dominion Bank’s own analyst is wondering why the lender is becoming a laggard in Canadian banking, underscoring concerns that prompted two stock downgrades.

"We’re all collectively scratching our heads on why this premium domestic retail bank isn’t keeping up with its peers," TD analyst Mario Mendonca asked Teri Currie, the head of Canadian personal banking, on a conference call Thursday after the company reported quarterly results.

Profit from Canadian banking rose 1.4 per cent in the third quarter, less than half the pace of the country’s largest lender, Royal Bank of Canada, and a quarter that of Canadian Imperial Bank of Commerce.

TD Bank posted a 4-per-cent increase in quarterly profit from a year earlier as gains from its U.S. bank and capital-markets business offset declining domestic retail operations.

Ms. Currie told Mr. Mendonca, who rates the shares a buy, that lower interest rates, competitive pricing and the cost of funds for mortgages were to blame, along with repricing on fee-based products.

Other analysts are highlighting TD Bank’s problems at home.

CIBC Capital Markets’ Robert Sedran downgraded the stock of the Toronto-based company to the equivalent of hold from buy on Thursday.

“As much as we’re heartened by the stronger U.S. performance, we expect and need better from the Canadian business relative to its peers,” Mr. Sedran said in a note to clients.

Canaccord Genuity Group Inc.’s Gabriel Dechaine also cut the stock to hold, saying the Canadian personal and commercial-banking business “is falling short of peer results and the bank’s own targets.”

TD Bank has a medium-term objective of 7-per-cent growth for its Canadian banking division, a goal Ms. Currie reiterated Thursday.

The division is the bank’s largest and generates about half the company’s profit.

Weak margins – with low rates, competition and lower mortgage-backed securities funding – along with a higher tax rate and provisions “are likely to drive below-average domestic banking earnings next quarter,” Mr. Mendonca wrote Friday in a note.

On Friday, TD Bank shares closed down 0.2 per cent to $57.29, on pace for a second day of declines.

TD Bank has nine buy recommendations, eight holds and one sell, according to data compiled by Bloomberg.

Analysts including Bank of Nova Scotia’s Sumit Malhotra and Barclays PLC’s John Aiken have suggested the bank may be easing up on Canadian growth on purpose, given concerns about sluggish economic growth and overheated housing prices.

“They’re putting the brakes on domestic growth,” said Mr. Aiken, who rates TD Bank stock a sell, in an interview.

“They’re consciously growing slower than peers because they’re worried about what’s going on with the economy.”

Canaccord’s Mr. Dechaine also noted the discrepancy, despite his downgrade.

“To be fair, it seems odd to criticize TD for its low growth in Canadian retail banking at a time when market concerns over consumer indebtedness and late-cycle credit growth in certain segments (e.g. housing in overheated markets) are elevated,” Mr. Dechaine said in his note.

“However, we also believe it is fair to compare TD’s actual performance to targets it communicated to the Street.”

Friday, August 26, 2016

Why Are Hedge Funds Shorting Canadian Bank Stocks So Confident?

The Globe and Mail, Scott Barlow, 26 August 2016

Foreign investors betting against Canadian bank stocks continue to swell in numbers while stock prices in the sector grind higher. The result, for now, is considerable financial pain for the doomsayers.

The short positions on Canadian banks have almost uniformly resulted in losses and this had me all ready to write a “foreigners don’t understand the Canadian banking system” column. But I’m worried I’m missing something now.

The early year concern for domestic bank stocks focused on energy industry exposure. The banks repeatedly stated, however, that potential losses were minimal as a percentage of total business operations and wouldn’t affect earnings too much. With help from a partial recovery in the oil price, this has proven correct.

If oil losses were the main reason for the short positions, we’d expect the number of bearish bets on bank stocks to have decreased as the oil price recovered. This has not been the case.

Profits for Canadian banks have also been more reliant on capital markets activity – trading and investment banking operations – and in industry terms this is what’s called a “lumpy” source of profits. Capital markets profits are inconsistent on even a quarter-over-quarter basis and can double or dry up with little notice. Perhaps part of the short thesis is that this profits generator will fade, but on its own such a scenario doesn’t seem a big enough reason to short a bank.

One U.S. hedge fund manager I contacted who holds a short position on Canadian banks believes that transaction activity is about to decline significantly. They believe that corporate and household clients will repay loans early, thanks to low rates, and growth in new loans will be extremely slow. In this scenario, profits from the banks’ basic business of lending will fall.

We’ve covered the energy sector, capital markets and credit demand, which leaves the domestic housing markets. National Bank economist Warren Lovely wrote in a report released on Tuesday that real estate markets have been 'surprisingly sturdy' in recent years, but that 'cracks in the foundation are nonetheless visible,' notably in regions dependent on oil revenue. Vancouver housing sales, viewed as unstoppable until very recently, have cooled considerably as the Vancouver Sun reported that sales in the metro area have 'frozen solid.'

It has been fashionable for domestic pundits, including me, to write that foreign managers’ short positions on Canadian banks were a negligent mistake because they did not understand the Canadian Mortgage and Housing Corp.’s role in protecting major banks from losses on mortgage defaults.

But too much time has passed for that to be the case, at least in general. The U.S. hedge fund companies that hold the bulk of the short positions have analysts looking deeply into every trade and I refuse to believe they don’t understand the CMHC’s role at this point. In the majority of cases, they make too much money to be that dense.

I’ve written at least three bullish columns on Canadian banks in recent months and still lean that way. But it’s a bad idea for any investor to get so locked into a market view that they consider anyone betting the other way as stupid or uninformed. I won’t be as comfortably bullish on domestic bank stocks until I have a clearer idea what the hedge funds are thinking.

Monday, August 17, 2015

TD Bank Warns of Impact of Oil’s Fall on Canadian Economy

Financial Times, Ben McLannahan, 17 August 2015

Bharat Masrani, the chief executive of Toronto-Dominion Bank has warned of the chilling effects of lower oil prices on the Canadian economy, which could check the lender’s ambitions in the US, its most important growth market.

The Toronto-based bank, the country’s joint largest lender by assets alongside Royal Bank of Canada, has expanded more quickly in the US than any other big foreign bank since the crisis. But in an interview with the Financial Times, president and chief executive Bharat Masrani said the latest drop in the oil price could hurt consumption in certain parts of Canada that are highly reliant on energy exports — and by extension, affect the bank’s earnings power.

Mr Masrani said that while he does not worry about the bank’s direct lending to energy companies — which at about 1 per cent of total assets of C$1tn, is less than the peer-group average of about 2.5 per cent — he is concerned about the indirect exposures for a bank with dominant shares in retail markets across Canada. “If there is a knock-on effect on consumer confidence, then obviously that is something not to take lightly,” he said.

TD Bank has been building US presence since 2004, when it bought Banknorth Group, based in Portland, Maine. But since 2008 — when it added Commerce Bank of New Jersey — TD has accelerated the pace of expansion, taking advantage of tactical retreats by overextended US and European rivals. The bank was more or less unscarred by the financial crisis, benefiting from a decision to exit structured products in 2005, well before detonations in mortgage-related markets.

TD’s assets in the US have doubled since December 2008 to $317bn at the end of last year, according to Federal Reserve data, as the bank has built out an east coast network centred on wealthy urban areas. By doing so, says Moody’s, the credit rating agency, TD has “effectively addressed the core strategic dilemma of the Canadian banks”, which is how to deploy the capital they generate in their mature, oligopolistic home market.

“We took the view 10 years ago that the US retail market would be our next growth platform,” said Mr Masrani. “We are one of the best-rated banks in the world, and we are highly liquid. Obviously we are looking to expand where appropriate.”

But oil’s renewed slide could give the bank a less stable platform. TD has about C$52bn of consumer loans in the oil-producing provinces of Alberta, Saskatchewan and Manitoba, estimates Moody’s, second only to RBC. The rating agency warns that losses could multiply in the event of a prolonged downturn in crude, which has hit a six-year low.

“If our customers suffer, we suffer; that is how we take it, but from a financial perspective, it is a manageable situation,” said Mr Masrani.

TD Bank Bets on US Branches as Rivals Cut Back

Financial Times, Ben McLannahan, 17 August 2015

If you are idling away time in a TD Bank branch, try throwing some change in the free TD coin-counter. If your children are nagging, let them play on the jukebox-like quiz machine. If your dog fidgets, toss it a TD biscuit.

It is all part of the service at TD, the Toronto-based lender that is still a big believer in the power of bricks and mortar. In the 12 months to the end of April, TD opened more branches across the US than it closed, defying an industry-wide trend. Across the five boroughs of New York City, the lender with C$1tn in assets recently eclipsed Bank of America by branch count — a strategic goal it had set at the annual meeting in 2012 — and is closing in on the top three of Chase, Citi and Capital One.

“The physical presence continues to be central to our customers’ needs in many ways,” says chief executive Bharat Masrani, during an interview in a flagship branch opposite Sony’s headquarters on Madison Avenue.

He describes an “omni-channel experience”, where a person could start a loan application in the morning on an iPad, pick it up again on an iPhone on the train, then walk into a store at lunch to close the deal. “How can we make that experience seamless?”

TD’s belief in the branch is not unusual. Unlike in the UK and parts of Europe, for example, where banks have spent years slimming down networks, US banks have tended to want to “put branches on every street corner”, says David Haber, chief executive of Bond Street, an online lender to small businesses.

It is only recently, in fact, that the tide has turned. Data from the Federal Deposit Insurance Corporation shows the total US branch-count falling each year since a peak of 99,550 in 2009, dropping to 94,725 as of June 2014.

But for many of the big banks, the pace of closures is beginning to pick up. JPMorgan Chase wants to cut about 6 per cent of its retail footprint by the end of next year, eliminating a net 300 branches in the process. Citigroup reduced its US branch count by 7 per cent in the 12 months to June. It is now focused on six cities, down from 14, pulling out of markets such as Dallas and Houston altogether.

Analysts say that some lenders are eyeing a gradual return to more normal monetary policy from the US Federal Reserve, which could catch banks with big branch networks on the hop.

“We suspect that when [interest] rates do rise, technology will allow depositors to move their money to high interest rate accounts with a speed never before seen,” wrote Frederick Cannon, global director of research at Keefe, Bruyette & Woods, in a recent report.

Bob Meara, a senior analyst at Celent in New York, says that simple pressure from shareholders for higher returns should result in faster shrinkage of costly branch networks. “There’s no two ways around it — banks do not need the densities they used to. The scales will have to tip.”

Mr Masrani, whose rise to chief executive last November capped a 35-year career with TD, does not worry that his network-building puts him out of step with the industry. He notes that, with 1,302 US branches in April — a slight increase from 1,297 a year earlier — TD is still 10th by total branch count, well behind the likes of Chase, with 5,504.

He also sees plenty of scope for “optimisation” of TD’s US network, which after acquisitions in 2004 and 2008 stretches down the entire East Coast, from Maine to Florida. TD is now experimenting with “five, six or seven” different formats for its branches, Mr Masrani says, up from just one or two a few years ago. In Baltimore, for example, it recently opened its first teller-less branch, about one-third smaller than the previous default size, featuring three high-tech cash machines and a handful of “financial services associates” to help customers use the machines.

The important thing is to “wow” the customer, says Mr Masrani, 59, who ran TD divisions in India and Europe before overseeing the bank’s expansion in the US. He notes that every new employee does at least one course at TD University, a purpose-built campus in Mt Laurel, New Jersey, to learn the TD way. All staff are encouraged to use the phrase, “TD Bank, America’s most convenient bank” like a mantra. (The chief executive does so himself about half a dozen times during the interview.)

That is why the openings will continue. When it cut the ribbon last month on a new branch on the corner of Grand St and Allen St on Manhattan’s Lower East Side, TD brought its New York branch tally to 127. It has committed to opening another 10 by the end of the year, and may consolidate a few others. However, its chief executive cautions that the pace of expansion in the US may be held back as the falling oil price could affect the bank’s earnings power in its home market.

“We may build a new location and bring business to that location if there is a better look and feel to it, and it has better technology,” says Mr Masrani. “But that doesn’t mean we are not committed to our physical presence, because that is central to what we do.”