Monday, November 27, 2006

Banks Q4 Profits Seen Strong

  
Financial Post, Don Vialoux, 27 November 2006

The Canadian financial services index has a history of moving higher in late November/early December prior to release of final earnings reports for the year by Canada's top six banks.

Chief executives of the banks like to offer encouraging news to shareholders when they release fiscal fourth-quarter results for the period ended Oct 31. The chart shows performance of the TSX financial services index in late November/early December during the past five years.

Technicals

Technicals for the TSX financial services index are encouraging. Late last week, the index closed at a record high.

The index remains in a three-year uptrend. Recent changes in Canada's tax laws have contributed to recent strength. Income-oriented investors have been encouraged to prefer high-yielding, dividend-paying bank stocks rather than income trusts.

Fundamentals

Chief executives from the banks have lots of good news to give their shareholders when they release fourth-quarter results this year.

- Fourth-quarter earnings per share for the top six banks are expected to improve by 10.6% on a year-over-year basis. Gains will come from strong loan demand, rising fee income (thanks partly to strong equity markets and a robust new-issue calendar) and a growing contribution from international operations.

- Dividends are expected to rise. Banks likely to raise their quarterly dividend when fourth-quarter reports are released include CIBC, Scotia Bank, National Bank and Bank of Montreal.

- The quality of bank loans is expected to remain high. Loan loss provisions are expected to remain relatively stable.
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The Globe and Mail, Andrew Willis & Roma Luciw, 26 November 2006

The financial forecast calls for the banks to rain dividends on investors over the next two weeks, as Bank of Montreal kicks off the annual earnings season on Tuesday with the first in a series of projected double-digit increases in dividend payouts.

Bank of Montreal is expected to bump up its annual dividend by up to 12 per cent to $2.78, a move that's expected to continue the market's recent love affair with the sector. Yield-hungry investors have embraced banks this month as they search for new sources of income in the wake of the federal government's Oct. 31 decision to tax income trusts.

With banks enjoying a near-perfect combination of solid economic growth and minimal loan losses, analyst Darko Mihelic at CIBC World Markets Inc. expects four of the big six banks will raise their dividends, with an average increase of 11 per cent. The two banks unlikely to move — Royal Bank of Canada and Toronto-Dominion Bank — are only constrained by the fact they recently raised dividends.

Banks have been star performers, with the S&P/TSX capped financial subindex up 14 per cent this year, outperforming a 12.2-per-cent gain by the S&P/TSX composite index. The question of just how much higher the sector can soar now preoccupies analysts.

Robert Wessel of National Bank Financial Inc. said in a report: “The banks continue to report strong EPS growth. This fact, combined with (still) attractive valuations, low risk, and most importantly, our expectation of another two years of double-digit EPS growth, supports our continued bullish stance, although a short-term correction is possible.” He forecasts bank profits will increase 9.8 per cent in 2007 and 10.9 per cent in 2008.

However, this year's rising prices mean the bank stocks are now relatively expensive, compared with historic valuations. The price-to-earnings ratio of the group is 13.3 times forecast earnings, near the 10-year high of 14 times earnings that was seen at the height of bank-merger mania in 1998.

A number of analysts are warning that with bank stocks commanding premium prices, there is the potential for unpleasant surprises in annual earnings over the next two weeks. Mr. Mihelic said: “While banks may trade at high multiples due to dividend yields, the stocks are at risk should earnings or outlook disappoint.”

While the banks are expected to report higher year-over-year profit, with 13-per-cent annual growth in earnings per share — results from the fourth quarter of fiscal 2006 are expected to show profit growth slowing as the credit cycle darkens.

“We believe credit quality and equity markets are unlikely to be as good for the banks in upcoming years as in the last five years,” said Merrill Lynch analyst Andre-Philippe Hardy. While year-over-year growth will be impressive, Mr. Hardy says fourth-quarter numbers will likely be weaker than what was seen in the third quarter, with share profit dropping 2 per cent on a 25-per-cent projected rise in provisions for credit losses.

Merrill Lynch's forecast has Royal Bank of Canada leading the way on profit growth, while Canadian Imperial Bank of Commerce is likely to come in at the back of the pack, “mainly driven by lower merchant banking gains,” Mr. Hardy said.

However, CIBC is expected to restart dividend increases, with Mr. Mihelic calling for a rise of up to 17 per cent on what's currently a $2.80 annual dividend. CIBC has rebuilt its balance sheet after taking a $2.4-billion (U.S.) hit to settle Enron-related lawsuits early last year.

Bank of Montreal will be the first of the big six to report earnings, followed by RBC and National Bank of Canada on Nov. 30, CIBC on Dec. 7, and TD Bank and Bank of Nova Scotia on Dec. 8.

Bank of Montreal earned $1.30 (Canadian) a share in the third quarter of fiscal 2006, when capital markets revenues hit record highs. The consensus forecast from analysts calls for earnings of $1.25 a share in the fourth quarter.
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Canadian Press, David Friend, 26 November 2006

Canada's big banks are certain to ring up strong year-over-year net profit growth as they begin to report fourth quarter earnings this week — mainly because the fallout from the Enron scandal won't drag down their books as it did in fiscal 2005.

Overall, the six biggest banks — the Royal, CIBC, Bank of Montreal, TD, Scotiabank and National — earned a net profit of $10.4 billion last year, a figure already surpassed in the first nine months of fiscal 2006, when the banks earned cumulative profits of $13.6 billion.

Analysts are forecasting the banks as a group will complete the fiscal fourth quarter, which runs from August until October, with median earnings per share growth of around 10 per cent.

"These are not rocketship returns in terms of EPS. It's more a matter of steady as she goes and no potholes on the horizon," said Ian Nakamoto, director of research at MacDougall, MacDougall and Weir.

RBC Capital Markets analyst James Keating said the Bank of Montreal is the only big bank he expects to report lower earnings than a year ago.

"It's not so much that they had a weak quarter, but more that some of their prior quarters have been unsustainably strong," he said, citing past gains on securities and tax credits.

Other analysts are more optimistic about BMO, on average predicting a three per cent rise in its earnings per share.

Earnings this year will look especially good, considering some of the banks were pummelled by billions of dollars in charges last year for liabilities in lawsuits connection with the Enron scandal.

Retail banking "has been pretty friendly," according to Keating who equates it with abuot 50 to 60 per cent of the banks' profits. Capital markets have also seen good results, though "the arrows are pointing down a bit."

He noted that bank shares, with their steadily increasing dividends, have benefited from investors' flight from income trusts since Finance Minister Jim Flaherty's Oct. 31 announcement that trust distributions will be taxed at corporate rates in 2011.

"Some of the money that was in income trusts has found its way over to banks. We were predicting a five or six per cent lift as a result of that, and I'd argue that's what we've seen."

Caldwell Securities portfolio manager John Kinsey said low interest rates have helped sustain bank profits.

"The bank earnings have been slowing from two or three years ago, when they were gangbusters, but they're still going to be in the high single-digit or low double-digits," he said.

Kinsey predicted four banks will increase their dividends this quarter, in line with Keating's expectation that Scotiabank will lead by boosting its payout by eight per cent.

Keating also targets dividend increases of five per cent at BMO, four per cent at National Bank and three per cent at CIBC.

Royal Bank and TD boosted their dividends in the third quarter and are unlikely to do so in this period, analysts said.

The fourth-quarter earnings season begins Monday and runs until Dec. 8, with BMO the first to report.

It will be followed by the Royal and National Bank on Thursay, then CIBC on Dec. 7 and both TD and Scotiabank on Dec. 8.

The Royal and TD have been putting their increased cash to use as they attempt to boost their U.S. presence.

RBC, aiming to "re-accelerate" its U.S. presence in 2007, paid US$456 million in August for Flag Financial Corp. and Flag Bank in Georgia.

Last week, TD announced plans to acquire the rest of its majority-owned Portland, Me.-based TD Banknorth Inc. for C$3.6 billion.

But more generally the Canadian banks have been hesitant to expand stateside, given high bank-share valuations, a slumping housing market and indications of a slowing American economy.

Looking into the new financial year, RBC's Keating says earnings estimates "may prove conservative again . . . as the benign credit and interest rate conditions prevail, and stability in the U.S. dollar and Canadian dollar stabilizes non-domestic earnings contribution."

He said the main risks would be credit problems related to unemployment, a sharp drop in the Canadian dollar, or surprise inflation and interest rate increases. None of these is particularly likely, he added.

Nakamoto said next year's loan losses will put the banks to the test after a healthy five-year showing.

"People are going to focus more on the credit quality because the general sense is that the economy is softening," he said.

"Let's see if there are any sins of the past, loans that were made in 2003 and 2004, that will haunt them in 2007."
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