Canadian bank stocks look “fully valued” after a sharp autumn rally, leaving little room for disappointment as lenders prepare to report fourth-quarter results, Jefferies said on Tuesday as it downgraded Royal Bank of Canada (TSX:RY) and Toronto-Dominion Bank (TSX:TD) to ‘Hold.’
The brokerage said credit trends should remain broadly stable, with flat Stage 1 and Stage 2 provisions and “likely incremental increases” in Stage 3 impairments, while lending volumes are expected to stay positive but “largely uninspiring.”
Capital markets and wealth management, which Jefferies thinks are areas where National Bank of Canada (TSX:NA) and Bank of Montreal (TSX:BMO) have stronger exposure, should offer most of the top-line support.
Still, with the sector trading near 13 times forward earnings, Jefferies said downside risks now outweigh potential upside. “Any miss on earnings in the fourth quarter could have significant negative consequences for valuation multiples,” the analysts wrote, adding that even modest beats may deliver “constrained” share-price reactions.
Jefferies said it continues to believe in the long-term investment cases for RY and TD, citing Royal’s diversification and TD’s improving sentiment as it advances through anti-money-laundering remediation, but said both stocks already reflect their upside potential.
The firm highlighted National Bank as a name to watch, pointing to expected updates on revenue synergies from its Canadian Western Bank integration and capital relief from migrating loan portfolios to its AIRB framework.
Jefferies also expects banks to emphasize stronger returns on equity, with buybacks likely to play a bigger role in managing capital levels. TD has the most excess capital, but National could “surprise to the upside,” the analysts noted, adding that most banks are likely to raise dividends in line with earnings.