Canadian banks' third quarter earnings are likely to reflect the nation’s challenged economy with sluggish loan growth and higher credit costs, analysts at Bank of America believe.
However, the drop in yields has the potential to boost earnings per share (EPS) outlooks.
“The key question for investors is whether the 100 basis points recent decline in bond yields is enough to brighten the EPS outlook for the sector?” they wrote in a note to clients.
The analysts’ revised estimates imply EPS growth of 3.3% year-over-year for 3Q or the same as what banks reported for the second quarter.
Key drivers for this forecast include a projected 48 basis point increase in impaired provisions for credit losses and stable net interest margins.
A bright spot is capital levels, with banks expected to deploy capital through activities such as share buybacks or mergers and acquisitions. Canadian Imperial Bank of Commerce (CIBC) (TSX:CM) and the Bank of Montreal (CSE:BMO) are expected to initiate share buybacks.
The analysts also see the potential for a faster-than-expected decline in interest rates as a positive for Canadian banks relative to their US peers due to better margin defensibility.
“Lower rates should not only alleviate the pressure on the Canadian consumer due to mortgage repricing, but also increase the attractiveness of the dividend yields,” they wrote.
Bank stocks to watch
Royal Bank of Canada (TSX:RY) remains the analysts’ top pick given its potential for EPS upside and Return on Equity (ROE) improvement driven by synergies from its recently closed HSBC Canada transaction. They have a ‘Buy’ rating on the stock.
They also highlighted ‘Buy’-rated BMO, where management credibility has been hit by back-to-back disappointing quarters.
“Despite this, we see risk/reward as attractive given the lowered expectations and what we view as a differentiated franchise, potential for lower US rates to alleviate funding cost pressures and stabilizing credit outlook,” they wrote.
Toronto-Dominion Bank (TSX:TD) is also in focus as the bank works to resolve deficiencies in its anti-money laundering program amid a Department of Justice probe.
“Our investor conversations suggest continued appetite to add exposure to the stock, assuming no major surprises emerge from a potential settlement with US agencies (negotiations ongoing),” analysts wrote. “However, the uncertain outcome of timing of regulatory issues keeps us ‘Neutral’-rated.”