Canadian banks vulnerable to global economic slowdown, analyst says

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The cloud of uncertainty hanging over bank stocks is unlikely to lift any time soon as repercussions of the credit crunch continue to rattle the global economy, according to Desjardins Securities analyst Michael Goldberg.

In a research note Mr. Goldberg warned that despite compelling values, Canadian banks are vulnerable to an economic slowdown that, according to many observers, has already commenced.

Share prices across the financial service spectrum have been badly hit since the start of the year even though some sectors such as life insurance enjoyed relatively healthy results.

The sell-off “is another verification of how broad, deep and global the credit crisis is — it is not just limited to large U. S. or global banks,” Mr. Goldberg warned in the note, released in advance of banks releasing third-quarter results, starting with Bank of Montreal (BMO/ TSX) and Bank of Nova Scotia (BNS/TSX) on Aug. 26.

Mr. Goldberg said that Canadian Imperial Bank of Commerce (CM/TSX) is the most at risk. Its main problem is its holdings of asset classes that have fallen out of favour in the wake of the credit crunch.

CIBC is “potentially seriously under capitalized,” Mr. Goldberg noted, speculating that in a worst-case scenario it could be forced to issue more than $300-million in shares to shore up its capital.

One year after the start of the current credit crisis, Canadian regulators are increasing their scrutiny of banks, and there is a strong likelihood they will adopt a new U. S. rule requiring companies to break down their assets in terms of transparency and liquidity. At the top of the ranking are assets that trade frequently and enjoy liquid markets. At the bottom would be non-trading, hard-to-value assets.

“We believe that increased regulation and intensified scrutiny … would eventually benefit bank stockholders, but regulatory changes could be painful in the near term,” Mr. Goldberg said. “CIBC is the most vulnerable of the banks by a country mile.” He named Bank of Nova

Scotia and Toronto Dominion (TD/TSX) as his top picks, with target prices of $57.50 and $84 respectively.

UBS analyst Peter Rozenberg offered a sunnier outlook, arguing in a recent note that the banks will be protected from the economic turmoil south of the border by the comparatively stronger Canadian economy.

“We do expect loan growth to moderate and provisions to cyclically increase [over the next two years] however, we don’t expect a spike in provisions,” Mr. Rozenberg said.

Though the economy continues to chug along in most provinces, signs of trouble have already begun to appear in residential property markets as well as manufacturing, leading Mr. Rozenberg to temper his predictions.

He warned earnings from capital markets will remain weak and that funding costs for have been “higher than average” because of the credit crunch.

Mr. Rozenberg maintained his “buy” rating on Bank of Nova Scotia, TD and Royal Bank of Canada (RY/TSX), noting that Scotia is best positioned due to solid loan growth, at both its Canadian and international operations.


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