The Case For Confidence In Canadian Banks

Includes: TD
by: Streetwise Blog

By Tim Kiladze

Canadian banks surprised everyone last quarter. Given Europe's meltdown, almost everyone expected the banks to suffer, translating into rough earnings to end the fiscal year.

Turns out the joke was on us. For the most part, the banks had strong fourth-quarter earnings, driven by stable retail arms and surprisingly modest capital markets divisions, despite a dearth of deals and trading.

Since then, people have piled up against the banks once again, expecting household borrowing to slow in fiscal 2012 and for that to hit their bottom lines. But analyst Peter Routledge at National Bank Financial believes these claims could very well be exaggerated.

"There is simply no empirical evidence to support the notion that Canadian households have begun to de-leverage, or have even slowed their borrowing," he notes. The latest data from November shows that households grew their credit balances by 1.6 per cent quarter-over-quarter. "Until interest rates rise appreciably, we see no reason why households would slow the expansion of their borrowing which is currently running at 6 per cent year-over-year."

Business borrowing, on the other hand, slowed in November. Mr. Routledge attributes that to management teams paying much more attention to the European crisis than Canadian households. Despite this, he doesn't think the Big Six will get hurt because their balance sheets are more heavily weighted toward Canadian households.

For that reason, "investors should look at the Big Six banks as yield plays in which they will be adequately rewarded for taking transient valuation risk with reasonably attractive dividend yields." Of all the Canadian banks, he likes Toronto-Dominion Bank TD the best because of its deposit-heavy balance sheet, which ties it to the strong retail banking sector.

However, it's not as though the Canadian banks get off scot-free and are totally immune from what's going on in Europe. As everybody knows, funding stresses across the Atlantic can have knock-off effects on counterparties, and then counterparties of counterparties. "No large bank with a sizable capital markets trading platform, therefore, is truly immune from the European sovereign debt crisis," Mr. Routledge notes.

Disclosure: None