Why solid earnings might not matter for Canadian banks this quarter

Barclays hit three banks with ratings downgrades, while price targets for all lenders were cut

TORONTO, CANADA - NOVEMBER 16: A Canadian flag flies in a plaza in the center of towers representing two of Canada's five major banks, the Toronto-Dominion Bank and the Bank of Montreal on November 16, 2018 in Toronto, Ontario, Canada. (Photo by Gary Hershorn/Getty Images)
Barclays senior analyst John Aiken says economic uncertainty and U.S. banking sector woes are likely to overshadow solid financial results from the Canadian banks in the second quarter. (Photo by Gary Hershorn/Getty Images)

Even if Canada's banks come out swinging when they report quarterly earnings later this month, it might not matter much to investors as they focus on what the deteriorating economic outlook will mean for the lenders, analysts at Barclays say.

"While we continue to believe that the second quarter will be reasonably solid from an earnings perspective, we recognize that economic storm clouds are looming on the horizon in terms of potential spikes in credit losses and ongoing uncertainty regarding global banking liquidity," said John Aiken, head of Canada research at Barclays and lead author of the lengthy 77-page report, which was released on Tuesday.

"We would argue that the Canadian banks are less impacted on a relative basis by most of the pending concerns, but we also concede that these concerns are likely to affect their valuations."

We do anticipate near-term pressures will continue to mount and weigh on sentimentJohn Aiken, Barclays

Aiken downgraded his ratings on three banks: Bank of Nova Scotia (BNS.TO) (BNS) moved to "underweight" from "equal weight," Toronto-Dominion Bank (TD.TO) (TD) moved to "equal weight" from "overweight" and Royal Bank of Canada (RY.TO) (RY) was hit with a double downgrade to "underweight" from "overweight."

He is maintaining his ratings on Bank of Montreal (BMO.TO) (BMO) at "overweight," Canadian Imperial Bank of Commerce (CM.TO) (CM) at "equal weight" and National Bank (NA.TO) at "underweight."

Aiken also cut his 12-month price targets on all the lenders he covers.

The lenders could see bad loans climb with a potential recession looming, Aiken says, and capital markets activity could wane in the coming quarter.

He also gave various company-specific reasons why he downgraded three of the banks, including investors waiting for Scotia's new CEO to release his strategic plan for the company, and TD investors needing to assess the bank's next move after its First Horizon deal was called off. RBC's downgrade was largely valuation based, he says.

On the positive side, the banks overall are set to benefit from better margins thanks to the high interest rate environment and a rebound in mortgage volumes from a stronger spring housing market, he adds.

"While we continue to see long-term value in Canadian banks and are not concerned with their solvency, we do anticipate near-term pressures will continue to mount and weigh on sentiment. Thus, our rating changes could be short term in nature, should the economy prove to be more resilient than we anticipate, or if a recession is reasonably shallow and the outlook shifts to a more 'normalized' 2024 than the concerns of credit on 2023 earnings and capital," Aiken said.

Buy banks on the dips?

Despite all the uncertainty at home and emanating from the U.S. regional banking sector, Aiken says dips in Canadian bank stocks might be a buying opportunity.

"Given that our base-case scenario does not anticipate an extended recession, any incremental pressure on valuations could represent a solid longer-term buying opportunity, as a P/E multiple below 8.0x has historically been an attractive entry point for investors with sufficient patience and a long enough investment horizon," he said.

Investors will also likely be treated to dividend hikes in the second quarter, Aiken says, but share buybacks will be on the back burner in order to rein in expenses.

"Looking ahead, amidst the ongoing macro/geopolitical uncertainty, along with the likelihood of a recession on the horizon and still fairly elevated inflationary pressures, we anticipate market volatility will continue to persist," he said.

"That said, we maintain that the Canadian banks' reputation as a relative safe haven, along with their strong capital and reserve levels, will continue to enable the group to ride out some market volatility but not completely avoid the pressure."

Bank earnings release dates:

  • Bank of Montreal: May 24

  • Scotiabank: May 24

  • TD: May 25

  • Royal Bank: May 25

  • CIBC: May 25

  • National Bank: May 31

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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