Proactive Investors - UBS has a cautiously optimistic outlook on Canadian banks, recommending buys on Royal Bank of Canada (TSX:TSX:RY) and National Bank of Canada (TSX:TSX:NA) due to their strong balance sheets and diversified business mix, while maintaining neutral ratings on the other four banks amidst macroeconomic challenges.
In a new research note initiating coverage of the Big Six banks in the country, UBS recognizing their robust financial health, solid capital reserves, and diverse business operations which help them withstand challenges like slow revenue growth and rising credit costs.
With Royal Bank and National Bank top picks for analysts, the other four banks, Toronto-Dominion Bank (TSX:TSX:TD), Canadian Imperial Bank of Commerce ( CIBC ) (TSX:TSX:CM), Scotiabank (TSX:TSX:BNS), and Bank of Montreal (CSE:TSX:BMO), are rated as neutrals.
UBS analysts project an average implied total return of 17% for the buy-rated stocks.
Royal Bank is a favourite due to its size, scale, and diversification, which positions it to maintain a premium ROE of around 15%. The acquisition of HSBC Bank Canada is expected to bring significant cost savings and revenue synergies.
Meanwhile, analysts highlighted National Bank of Canada (TSX:NA) for its strong credit quality, robust top-line growth, and positive operating leverage, supporting a premium ROE of approximately 16%. The recent acquisition of Canadian Western Bank (TSX:CWB) is seen as a growth driver.
Overall, the banks have posted “resilient” earnings amid macro challenges, according to the analysts.
Despite macroeconomic headwinds, UBS forecasts 2% EPS growth for the Canadian banks in 2024, improving to 7% in 2025. Lower interest rates from the Bank of Canada are expected to provide economic relief. The banks' strong capital positions, with an average CET1 (Common Equity Tier 1) ratio of 13.1%, are highlighted as buffers against rising credit costs.
The banks are currently trading at a slight discount to historical averages, analysts noted, with the group trading at 10.3 times 2024E EPS versus the 10-year average of 10.7 times. UBS's 2024 and 2025 forecasts call for adjusted ROEs of 13.4% and 13.5%, respectively.
Meanwhile, UBS expects the Bank of Canada to lower policy rates to 4.25% by the end of 2024 and to 2.75% by the end of 2025.