BofA Securities analyst Ebrahim Poonawala completed a series of interviews with top Canadian bank executives and concluded that for institutional money managers, U.S. banks provide better value.
The analyst, who’s the head of North American banks research at BofA, is primary concerned that provisions for credit losses (PCLs) will remain elevated. These provisions, funds set aside to protect bank balance sheets from consumer and corporate credit defaults, are subtracted from earnings and limit profit growth.
Higher PCLs are a direct result of Bank of Canada rate hikes that have increased borrowing costs. Mr. Poonawala notes that domestic consumer insolvencies are up 23 per cent year over year and business insolvencies jumped 60 per cent, albeit from extremely low levels.
BofA forecasts that higher rates will also drastically slow mortgage lending, from a 2021 peak of 11 per cent year over year growth to below 4 per cent by the end of 2024.
The S&P/TSX Banks Index has underperformed the S&P/TSX Composite Index over the three-month, year to date, and three-year average annual return periods. This was not easy to achieve since the major banks make up such a large portion of the benchmark. Not only have the banks lagged the TSX, they have also trailed their global peers. Year to date, Japanese, Australian, European, U.S. and Nordic banks have all outperformed Canadian lenders.
Despite the underperformance, bank stocks are not cheap. BofA notes that the forward price to earnings ratio of 10.4 times (a 5 per cent discount to U.S. banks) and 1.4 times book value (a 15 per cent premium to U.S. banks) are close to historical averages.
The year-to-date underperformance of the banks is all the more surprising in that earnings revisions were significantly positive for Royal Bank, TD Bank and CIBC. Positive earnings revisions would historically have translated into sharp price rallies in previous periods and the lack of response now implies skeptical investor sentiment.
Mr. Poonwala’s research report emphasizes the better risk-reward dynamic of U.S. banks relative to Canadian banks but in truth, they are not viable options for most Canadian investors – familiarity and the tax treatment of dividends keep them in domestic stocks. The comparison does, however, underscore the substantial hurdles facing the banks that will likely limit profits in the months ahead.
-- Scott Barlow, Globe and Mail market strategist
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