Banks pricing in a 'more dire' economic situation, which is good for future stock price: Investor

The economy isn’t as bad as Canadian banks are pricing in and this is a good sign for the future of the sector, according to one Bay Street investor.

In an interview with BNN Bloomberg on Wednesday, Gordon Reid, president and CEO of Goodreid Investment Counsel Corp., said the fact that some banks are reporting a contraction in net interest margins tells you that the economy and consumers remain “stronger than I think many thought.”

“That allows for loan growth, which I think the great fear out there was that we would see a contraction perhaps resulting in a recession,” Reid said.

“I think that the banks by and large are priced for a more dire outcome than is appearing and I think that bodes well for the future of financial stock prices.”

‘NEAR-TERM VOLATILITY’ FOR SCOTIA

So far, five out of six of the big Canadian banks have reported earnings in the latest quarter.

Only Bank of Nova Scotia missed analyst expectations, with total revenue falling to $7.98 billion, from $8.05 billion in the same quarter a year ago.

In a note to clients on Tuesday, Scott Chan, analyst at Canaccord Genuity Corp., said he expects to see “continued margin pressure near term relative to peers” for net interest income.

Chan added that on Scotiabank’s quarterly results conference call “management acknowledged that certain countries within the segment (i.e., Colombia, Central America) have not generated returns commensurate to the capital deployment.”

“Further, management alluded to taking steps to enhance the return profile of the segment including increasing penetration within commercial, affluent, and HNW [high-net worth] clientele,” Chan said.

“While these strategic changes could enhance the segment ROE [return on equity] longer term, we suspect there could be near-term volatility at International.”

As a result of the earnings miss, Chan reduced his target price for Scotiabank to $74 a share, from $82, and changed his stock recommendation to a hold, from a buy.

‘BMO CAN ACHIEVE ABOVE-AVERAGE EARNINGS GROWTH’

While Scotiabank fell short in the latest quarter, Bank of Montreal topped analyst expectations.

In a note to clients on Tuesday, Chan said after closing the Bank of the West acquisition, he thinks the deal will continue to push BMO’s earnings growth higher.

Last month, the Canadian bank announced it closed the US$16.3-billion acquisition of Bank of the West (BOW), which will add around 1.8 million customers and 500 branches to BMO, as well as expand its U.S. presence.

“With BOW closed, we believe BMO can achieve above-average earnings growth over our forecasted period,” Chan said.

“For the quarter, BMO’s P&C [personal and commercial banking] segments performed solidly on both sides of the border with loan growth and margin expansion.”

Chan maintained his price target for BMO at $151 a share and his buy stock recommendation.

ROYAL BANK BEAT DRIVEN BY CAPITAL MARKETS

Royal Bank of Canada also benefited from a boost in revenue in its latest quarter.

On Wednesday, Canada’s largest bank reported revenue rose to $15.09 billion, up from $13.07 billion a year ago.

A surge in Royal Bank’s trading business helped the company top analyst estimates.

In a note to clients on Wednesday, Chan said the bank’s global markets teams benefited “from higher fixed income (particularly Europe and U.S.), complemented by record macro trading.”

Chan has a hold rating on Royal Bank of Canada with a price target of $137.

ROUNDING OUT BANK EARNINGS

TD Bank Group will be the last of the big Canadian banks to report earnings this season and it’s expected to post results tomorrow before the opening bells.

While investors are awaiting earnings, they are also watching for any additional news on the First Horizon Corp. deal, which was brought into question on Wednesday.

The Tennessee-based bank was told by TD that it doesn’t think it will have the necessary regulatory approvals by May 27 and it can’t give a new projected closing date, according to a regulatory filing Wednesday.

In a note to clients on Wednesday, Gabriel Dechaine, analyst at National Bank Financial Inc., said while the closing date has already been pushed back from the original date of Feb. 9, 2023, the “deal falling apart might be a positive for TD”.

“Some may speculate that TD could be negotiating for a better price, given the big correction in U.S. bank stocks since the deal was announced,” Dechaine said.

“However, we believe regulatory approval uncertainty is legitimate, especially considering the TD/FHN [TD and First Horizon] transaction has already faced some political backlash.”

Dechaine said the “market wasn’t enamoured” by the First Horizon deal with TD shares falling two per cent when it was first announced, and if the deal were to be dropped he doesn’t “believe any break fee would apply.”

He added as it relates to accretion, if First Horizon’s 2024 contribution estimate was eliminated, their earnings per share outlook for TD would decline by seven per cent. 

“We note that figure is gross of any offsetting actions (e.g., earnings on excess capital, DRIP [dividend reinvestment plans] elimination, buybacks). Moreover, if the market truly didn’t like the deal, we could see TD’s valuation multiple expand [if the deal was dropped], further offsetting any EPS adjustment required.”