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.