National Bank Of Canada Should Be Able To Offset Weak Mortgage Growth In Canada

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About: National Bank of Canada (NTIOF), Includes: BMO, BNS, CM, FRRPF, RY, TD
by: Ploutos Investing

Summary

National Bank of Canada is the sixth largest bank in Canada.

The bank’s personal loans growth rate continues to decelerate in Q3 2018.

The bank should be able to benefit from Quebec’s strong economic growth due to its higher exposure in the province.

National Bank of Canada should be able to grow its net income through NIM expansion.

Investment Thesis

National Bank of Canada (OTCPK:NTIOF) [TSX:NA] continues to experience a slowdown in its personal loan growth in Q3 2018. Nevertheless, the bank should be able to offset the slowdown, thanks to (1) favorable economic condition in Quebec; (2) net interest margin expansion; and (3) strong growth in its wealth management segment. The company pays a growing dividend with a dividend yield of 3.9%. However, its shares are currently fairly valued.

National Bank of Canada

Source: YCharts

National Bank of Canada’s mortgage growth slowdown

Although still growing, National Bank of Canada’s personal loan volume growth rate has decelerated considerably in 2018 due to the implementation of Guideline B-20. The chart below shows the bank’s personal loan volume and growth rates since 2016. As can be seen, its loan growth rate has decelerated to 3.3% in Q3 2018 from 7.1% in Q1 2016.

National Bank of Canada

Source: Created by author; Company Reports

Reasons why we are not too concerned

Net interest margin expansion should help offset slower mortgage growth

While National Bank of Canada experiences a slowdown in its mortgage loan growth, we believe the bank should continue to perform well. This is because Canada is in a rate increase environment. Since mid-2017, Canada has raised its benchmark interest rate four times. It is also widely expected that another rate increase will happen in October 2018. These rate hikes should help National Bank of Canada improve its profitability. As can be seen from the chart below, its net interest margin of 2.33% in Q3 2018 is much higher than the NIM of 2.27% back in Q3 2017. The benefit of rate hike should help offset the revenue impact from slower loan growth. This is evident in its Q3 2018 net income growth of 6% year over year in its personal and commercial banking segment.

National Bank of Canada

Source: Created by author; Company Reports

National Bank of Canada’s focus in Quebec should be helpful

National Bank of Canada has a strong focus in Quebec. In fact, Quebec represents about 55% of its retail mortgage and HELOC (home equity line of credit) portfolio.

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Source: Investor Presentation

Quebec’s economy is performing well. In fact, Quebec’s economy is expected to continue to expand in 2018 and 2019 above or near the national average. Although lower than the growth rate last year (3%), Quebec's forecasted 2018 economic growth rate of 2.4% would still be the best since 2007. The province’s GDP growth rate in 2018 is also expected to rank second among all provinces in Canada.

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Source: RBC Economic Research

Quebec is near full employment as the province’s unemployment rate of 5.5% in 2018 is the lowest since 1976. This means that families and individuals in Quebec will be able to allocate more resources on housing related costs such as buying a new home, improving its homes, etc. This should benefit National Bank of Canada’s business.

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September 2018 Provincial Outlook (Source: RBC Economic Research)

Despite new mortgage regulation, homebuilders appear to be busy this year. Housing units under construction are the best number in 40 years (see chart below). In fact, Quebec’s housing starts is expected to reach nearly 48 thousand in 2018 (see table above). We believe a combination of strong economic growth rate and population growth will continue to support the housing market in Quebec. This should help support National Bank of Canada’s mortgage volume growth in the province.

June 2018 Provincial Outlook (Source: RBC Economic Research)

Wealth management segment should continue to perform well

As the table below shows, National Bank of Canada’s net income in its wealth management segment grew by 19% year over year, thanks to 7% growth in fee-based revenue and 21% growth in net interest income. We believe the bank should continue to grow its wealth management segment thanks to favorable economic condition in Canada. The company also holds 21% stake in Fiera Capital (OTC:FRRPF), a fast-growing independent asset manager in Canada.

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Source: Investor Presentation

Valuation Analysis

Share price of National Bank of Canada has only appreciated by about 4% in the past year but by about 49% in the past 3 years. We have included in the table below the P/E ratios of National Bank of Canada and its Canadian peers based on the consensus estimates of their 2018 and 2019 earnings. As the table below shows, National Bank of Canada’s price to 2018 EPS ratio of 10.6x is slightly below the 11.1x average of its Canadian peers but slightly above its own 5-year average P/E ratio of 10.0x. National Bank of Canada’s price to 2019 EPS ratio of 10.0x is below the 10.5x average of its Canadian peers. Based on the table, we believe National Bank of Canada is currently fairly valued.

Share Price (C$) on October 10

Consensus 18 EPS

Price to 18 EPS Ratio

Consensus 19 EPS

Price to 19 EPS Ratio

5-year P/E Ratio (Forward)

National Bank of Canada

$63.41

$5.97

10.6

$6.37

10.0

10.0

Scotiabank (BNS)

$74.49

$7.01

10.6

$7.46

10.0

11.1

Bank of Montreal (BMO)

$105.58

$8.95

11.8

$9.63

11.0

11.2

TD Bank (TD)

$76.51

$6.45

11.9

$6.92

11.1

11.6

Royal Bank (RY)

$102.31

$8.50

12.0

$9.00

11.4

11.7

CIBC (CM)

$120.04

$12.21

9.8

$12.56

9.6

10.1

Average

11.1

10.5

11.0

Source: Created by author; Yahoo Finance

National Bank of Canada has an excellent track record of dividend growth. It currently pays a quarterly dividend of C$0.62 per share. This is equivalent to an annualized dividend yield of about 3.9%. As can be seen from the chart below, the bank has raised its dividend twice per year since 2010.

Source: YCharts

Risks and Challenges

National Bank of Canada faces macroeconomic risks related to the credit and debt cycle. Many investors will know that Canada’s mortgage debt levels have increased considerably in the past decade. While debt service ratios are still under control (thanks to low interest rates), Canada’s interest rates are going up. As Canada's central bank continues to raise interest rate, the potential for consumer defaults increases as well. This will eventually negatively impact National Bank of Canada’s business.

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Source: RBC Economics

Investor Takeaway

Despite a slowdown in Canadian personal loan growth, National Bank of Canada should continue to perform well in the next few quarters thanks to rising interest rates and favorable economic condition in the bank’s largest market, Quebec. However, its shares are currently fairly valued. Investors may want to wait for a pullback or research into other Canadian banks that have better growth potential.

Note: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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Disclosure: I am/we are long BNS, CM, TD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.