Surprises Could Be Coming from Big 6 Canadian Banks

Includes: BMO, BNS, CM, LRCDF
by: Streetwise Blog

By Andrew Willis

As a rule, investors don't like to be shocked by corporate news.

But, if analysts are reading the tea leaves correctly, Canada's banks will be offering some surprises to the upside when they start reporting their financial results next week by reporting better-than-expected profits.

Buoyed by strong capital markets performance, the six big banks are expected to exceed expectations as they roll out fourth-quarter and year-end results. Bank of Montreal (NYSE:BMO) kicks off the earnings parade Tuesday and Bank of Nova Scotia (NYSE:BNS) finishes up on Dec. 8. Regional rivals Canadian Western Bank and Laurentian Bank (OTCPK:LRCDF) also report during this two-week stretch.

In recent days, analysts began to bump up their forecasts in advance of these releases, with CIBC World Markets' Darko Mihelic recently raising his fourth-quarter profit forecast for the sector by 4%.

"Capital-markets-related revenues, including trading, are expected to support our earnings-per-share estimates and may also be a source of positive surprise," Mr. Mihelic said in a report. Year over year, the CIBC World Marketsanalyst expects fourth-quarter earnings at the banks to be up by 7%.

In addition to an increasingly upbeat view on the sector, there are analysts predicting the worst performer of last quarter will shine this time around. And if you haven't guessed, we're talking about Canadian Imperial Bank of Commerce (NYSEARCA:BCM).

The most accident-prone of domestic banks, CIBC turned in shocking large loan-loss provisions in the third quarter, and now trades at a valuation well below that of its peers. Barclays Capital analyst John Aiken pumped out a report that characterized the third-quarter provisions as a one-time hit, rather than "the start of a trend of deeper deterioration."

There is a "reasonably solid likelihood that CIBC could report lower formations and provisions, generating the possibility of a positive surprise," Mr. Aiken said.

Now, not everyone is this bullish on the banks. BMO Nesbitt Burns analyst John Reucassel previewed the quarterly numbers by sticking with profit forecasts that are well below those of peers, and explained: "Our below-consensus earnings outlook reflects higher loan-loss estimates (9% above consensus) and most likely a more conservative outlook for trading revenues."

But even with this relatively muted take on the sector, Mr. Reucassel predicted the banks will post an "impressive" 14% to 15% return on equity in the fourth quarter, and "despite higher loan losses, we believe that this level of profitability is sustainable over the medium term."

While one quarter of earnings that exceed expectations would buoy these widely held stocks, or at least justify the rally in Canadian banks since their stocks bottomed out in March, it would take an optimistic view of 2010 and beyond to really light a fire under these stocks.

That kind of upbeat guidance is expected to be lacking. Analysts say bank brass will offer minimal guidance on issues such as loan losses, because they simply can't forecast how the North American economy will perform over the next year, much less predict the environment in 2011. Mr. Aiken warned: "Given that the fourth quarter is typically rife with non-recurring charges and restructurings, core earnings should once again be obscured."

The same sentiment came from Mr. Mihelic, who said: "We expect subdued (hazy) fiscal 2010 target discussions. Still, we believe banks' outlooks will be more positive than our estimates." However, CIBC World Market's analyst is telling clients to overweight the banks in their portfolios, concluding his report by saying: "Our thesis for the group is unchanged: a meaningful rebound in earnings will occur in fiscal 2011 driven by further margin recovery and declining loan losses."