Citigroup’s case for Canadian bank stocks. (Housing fears? Meh)

Briefing highlights

  • Citi boosts outlook for some banks
  • Global stock markets on the rise
  • New York poised to open higher
  • Canadian dollar at about 77.5 cents
  • Shorting of loonie continues to ease
  • What to expect from Poloz on Wednesday
  • What else to watch for this week

Expressing a lack of interest or enthusiasm

Oxford Living Dictionaries definition of ‘meh’

Moody’s has downgraded Canada’s banks, everyone’s fretting over the Toronto and Vancouver housing markets, oil prices are suffering, and the Bank for International Settlements is warning of potential financial stress.

Meh.

No, Citigroup didn’t express it anywhere near like that in a report on Canada’s banks. But it did put it all in perspective, making the case for four of the Big Six: Royal Bank of Canada, Toronto-Dominion Bank, Bank of Montreal and Bank of Nova Scotia.

It raised its stock price targets for each and most of its profit estimates.

“The Canadian banks do face challenges from the low interest rate environment (although this is starting to ease), increasing competitive pressures, and risks in Canadian housing market (particularly Toronto and Vancouver on prices, and Alberta on oil),” said Citi Research analysts Ian Sealey and Stefan Nedialkov.

“The Canadian banks are dealing with this in two ways: Firstly they are allocating capital to higher-return businesses such as auto finance and commercial in order to protect margins, and secondly they are cutting costs in Canada through better technology, and headcount and branch reductions (an ongoing theme for the sector).”

Among their points:

Home prices have surged in Toronto and Vancouver

But both the Ontario and B.C. governments have moved to tame them. Citi expects housing markets to slow, but in terms of volume rather than loan quality: “The secret to the Canadian banks’ success, and their strong capital build and return characteristics, is the Canadian banking market which is a rational oligopoly backed by an efficient mortgage insurance regime.”

True, oil prices are down

But they’re still “significantly above” last year’s lows.

Interest rates are rising

Benchmarks are up in the U.S. and expected to increase in Canada this week: “This should lead to margins stabilizing, then slowly rising as books roll over, and to reduced impairments going forward. US rate rises should be positive for the banks, as we see +25 basis points in U.S. rates boosting [earnings per share] for TD by +3.7 per cent, BMO +1.9 per cent, RBC +0.8 per cent, and BNS +0.4 per cent.”

Results from outside Canada are strong

“[Returns on equity] are starting to improve with TD reaching a 10-per-cent RoE in its U.S. business and BNS’s international business reaching its three– to five-year year efficiency target after only 18 months.”

And in Canada

“Canada is likely to remain a very profitable market for the Canadian banks, as they strive to continually increase efficiency while low risk weights (a consequence of the mortgage insurance regime) mean that the domestic Canadian businesses have very high [return on tangible equity].”

Here’s how Citi sees the banks:

BMO: “Relatively low housing exposure and strong U.S. franchise.” Citi rates BMO a “buy,” raising its target price to $113 (Canadian) from $110, though earnings-per-share estimates were trimmed to $8.32 for the current fiscal year, and raised to $9.41 for next.

RBC: “Strong diversified business model; top pick.” Also a “buy,” with the target price raised to $119 from $112. Citi boosted its calls on earnings per share for both this year and next, to $7.69 and $8.58, respectively.

Scotiabank: “Canada’s international bank.” It carries a “neutral rating,” but Citi boosted its target price to $86 from $82. It raised its earnings-per-share estimates for each year, to $6.34 and $6.98.

TD: “Most efficient Canadian bank.” It’s rated a “buy,” with the target price up to $80 from $76. Citi also bumped up earnings-per-share estimates to $5.28 and $5.77.


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Global markets are on the rise so far as investors prepare for another earnings season.

Tokyo’s Nikkei gained 0.8 per cent, and Hong Kong’s Hang Seng 0.6 per cent, while the Shanghai composite slipped 0.2 per cent.

In Europe, London’s FTSE 100, Germany’s DAX and the Paris CAC 40 were up by between 0.2 and 0.7 per cent by about 5 a.m. ET.

New York futures were also up, and the Canadian dollar was at about 77.5 cents (U.S.).

“This week sees U.S. earnings season kick off once more, with three of the big banks reporting on Thursday,” said IG market analyst Joshua Mahony.

“Amid a period where we have seen a significant degree of direction dictated by monetary policy consideration, there is a good chance that the corporates could be the driver of a recovery following recent declines.”

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Shorting of the Canadian dollar continues to ease, though it’s still well up there.

The net short position against the loonie dipped again last week, by about $700-million (U.S.), according to numbers released Friday by the Commodity Futures Trading Commission.

“CAD remains the second-largest held net short ($3-billion) despite a sixth consecutive week of narrowing in bearish sentiment,” Scotiabank currency strategists Shaun Osborne and Eric Theoret said in a report on the CFTC numbers, referring to the Canadian dollar by its symbol.

“The build in gross CAD longs drove the bulk of the $700-million week-over-week improvement, along with a modest covering of gross CAD shorts.”

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  • Loonie spikes on job surge. (Up next: 78¢, 3 rate hikes, then 80¢?)

What to watch for this week

It’s a big week for central banks in both Canada and the U.S.

In Canada, many observers consider a Wednesday rate hike a done deal, particularly after Friday’s strong jobs report. There are caveats, though, as central bank Governor Stephen Poloz and his colleagues meet.

“We caution that [this]week’s decision is still not quite a sure thing,” said CIBC World Markets chief economist Avery Shenfeld.

“Governor Poloz’s communications policy has not been crystal clear in the past,” he added.

“The market didn’t pick up on a subtle clue by a deputy governor and failed to expect the first rate cut in 2015, got it right in anticipating a second cut in the middle of that year, but priced in a rate cut that didn’t end up happening in early 2016.”

With a rate increase almost a given on Wednesday, what might come next?

Some observers expect the central bank to follow with another increase, also of one-quarter of a percentage point, before the year is out.

“A second hike in the final quarter of the year will likely see the overnight rate back to 1 per cent,” Mr. Shenfeld said.

“Since the Fed will also be hiking in Q4, we should be done with the lift to the Canadian dollar from the change in Bank of Canada policy. In 2018, look for only a slow crawl higher from both central banks, with a hike every six months or so.”

Federal Reserve chair Janet Yellen also takes centre stage Wednesday and Thursday, with semi-annual testimony to Congress.

“We expect she will strike the same tone as during her June post-FOMC meeting Q&A,” said observers at RBC, referring to the Federal Open Market Committee, the central bank’s policy-setting panel.

“The undertones of her responses bordered on hawkish particularly as it related to inflation.”

The rest of the calendar:

Monday

China reports June inflation numbers.

Tuesday

Canada Mortgage and Housing Corp. reports on the number of housing starts in June. The report is expected to show a rebound to an annual pace of about 200,000.

We’re also back into corporate earnings, today bringing the latest from Jean Coutu Group and Pepsi.

Wednesday

This is the big day, of course, with both Mr. Poloz and Ms. Yellen in the spotlight.

But there are also trade numbers from China, and corporate quarterly results from Alimentation Couche-Tard, Aritzia and Omnicom Group.

Thursday

Ms. Yellen again, plus earnings from Cogeco Inc., Cogeco Communications and Delta Air Lines.

Friday

America’s big banks start reporting results, today bringing JPMorgan Chase, Wells Fargo and PNC Financial.

We’ll also get the latest reading on U.S. inflation, with June expected to show an annual pace of 1.7 per cent.

June retail sales will be reported at the same time, expected to show a rise of 0.1 per cent.

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