Canadian bank shares could see a ‘significant price correction’ in 2019, analyst warns

Canadian bank shares could see a ‘significant price correction’ in 2019, analyst warns

Jeff Lagerquist Yahoo Finance Canada March 12, 2019

Shares of Canada’s Big Six banks could be heading for a “significant price correction” in 2019 and 2020 as rising credit losses and slowing economic growth weigh on the largest lenders, according to Veritas Investment Research.

Financial services analyst Nigel D’Souza examined the sector’s performance over 30 years, and found being overweight the banks was a winning strategy about nine-out-of-10 years per decade. Underperforming years had one obvious thing common he said, elevated or rising credit losses.

“The debt-service ratio for households this year, we expect to match or exceed the peak debt-service ratio for 2008. Mortgage interest costs are going up at the fastest rate since 2008 as well,” D’Souza told Yahoo Finance Canada. “Historically, if the debt-servicing ratio, the total amount of principal interest payments by household relative to income is going up, then typically credit losses for the Big Six banks also go up.”

D’Souza said he expected 2019-2020 would be a bad year for the banks before signs of broad-based economic weakness emerged. The slow-growth environment reinforced his recent decision to downgrade five out of six big Canadian banks to a “sell” rating.

The S&P/TSX Capped Financial Index has climbed over 11 per cent year-to-date.

However, the risk of deteriorating credit quality is rearing its head. Toronto-Dominion Bank (TD.TO) and Canadian Imperial Bank of Commerce (CM.TO) acknowledged that in their fiscal first-quarters. Both set aside the highest level of funds to brace against soured loans in at least two years.

D’Souza said while today’s debt-servicing metrics align more closely with the decline in 2008, when consumer loans led credit delinquencies, he expects the impact on bank shares will be more similar to 2015-2016, when the banks’ corporate lending divisions were exposed to plunging commodity prices.

“If there are credit risk concerns, and it is coupled with slow economic growth, that is what happened in 2015-2016, and the multiple for the sector contracted by 30 per cent. The bank space itself could face a significant contraction,” D’Souza said. “We expect it to contract meaningfully over the next 12 months. It should lead to underperformance of the banks relative to other markets.”

The Bank of Montreal (BMO.TO) is the only major Canadian lender to get a “buy” rating from D’Souza, due to its commercial lending focus in Canada, robust U.S. commercial operations, and potential for improved efficiency. He said CIBC is most exposed to the risks he outlined.

D’Souza isn’t the only one betting against Canada’s big banks. U.S. hedge fund Crescat Capital’s global macro analyst Tavi Costa told Bloomberg News in January that, “Canadian banks will be left holding the bag and the ones to suffer from what is likely to be a major economic recession” as the housing market buckles.

Data from S3 Partners, a New York-based financial technology and analytics firm, shows short sellers have increased their positions by almost US$2 billion, or 19 per cent, in 2019.

The largest amount of net short selling in 2019 occurred in Bank of Nova Scotia, with five million shares shorted ($271 million), S3 Partners said. Followed by CIBC, with 4.3 million shares ($361 million) and Bank of Montreal, with 883 thousand shares ($68 million).

Those bets have yet to pay off. That could change, according to S3 Partners’ Ihor Dusaniwsky.

“If we continue to see downward volatility in the Canadian housing market, we should continue to see increased short selling and price weakness in the Canadian banking sector,”  he wrote in a research note last Friday.

He also cited weak fourth-quarter GDP growth, and declining household consumption gains among the factors motivating short sellers.

D’Souza said the hedge funds behind the so-called “Great Canadian Short” have been singing the same tune since the 2008 recession.

“Our thesis is different because it’s about a specific mechanism and specific timing of that mechanism,” he said. “I don’t think the U.S. hedge funds fully understand the difference between our regulatory system, our banking and even consumer behaviour in Canada versus the U.S.”

https://ca.finance.yahoo.com/news/canadian-bank-shares-see-significant-price-correction-2019-analyst-warns-184735353.html