Proactive Investors - Canadian banks are entering the third quarter of 2023 facing headwinds tied to persistently higher interest rates, Bank of America (NYSE:BAC) has warned.
As the major Canadian financial institutions get set to report their quarterly earnings at the end of the week, a new report from Bank of America (BofA) highlighted concerns over rising interest rates and regulatory scrutiny for Canadian banks.
Concerns loom as the five-year government bond yield, a proxy for mortgage pricing, reaches post-Great Financial Crisis (GFC) highs at approximately 4.1%, analysts noted.
“Investors (and we) are rightly cautious given squeeze to consumer pocketbooks from mortgage re-pricing, especially if no let-up in rates,” BofA analysts wrote. “This is likely to weigh on growth, credit quality and thereby challenge ROE profiles.”
Bank stocks have already felt the pressure, down 6% month-to-date, reflecting these concerns. Bank of America expects earnings per share (EPS) growth for 3Q23 to be -4% year-on-year, compared to a more optimistic -2% to +3% for the full year 2023 and 2024 estimates.
Factors contributing to the anticipated slowdown include moderating lending activity, increased funding costs, and ongoing expense pressures, with major restructurings expected to be more prominent in the fourth quarter, according to analysts. Lower EPS estimates are also driven by a tempered margin outlook and subdued capital market activity, with credit potentially normalizing and the possibility of reserve builds.
Elsewhere, regulatory changes are another area of focus, as the report highlights the impending increased Domestic Stability Buffer (DSB) requirements, changes to market risk (FRTB), and the Basel floor factor increase.
Despite these challenges, Bank of America pointed out that Canadian bank stocks are currently trading at discounted valuations, with a 2024 price-to-earnings (P/E) ratio of 8.7x compared to a pre-pandemic five-year median of 10.4x.
“We see limited potential for multiple expansion given macro concerns and with EPS revision risk skewed to the downside,” analysts wrote. “A decisive break lower in inflation would reduce probability of tail-risk events, potentially boost sentiment.”
As for specific Canadian banks, BofA highlighted Toronto Dominion (TD (TSX:TD)) as an attractive option due to its relative positioning on capital, deposits, and scale.
However, Royal Bank faces scrutiny regarding expense growth and the HSBC Canada deal, while Bank of Montreal (CSE:TSX:BMO)’s performance will be closely watched, particularly regarding US margins and Bank of the West (BoW) deal synergies.
Scotiabank ({{TSX:BNS) could see signs of a turnaround under CEO Scott Thomson, but CIBC (TSX:CM) faces questions about recent regulatory matters related to its mortgage lending business, BofA wrote.