(Bloomberg) -- Now is the time for equity investors to move out of premium-traded Canadian banks and into discounted banks, analysts at Canadian Imperial Bank of Commerce said, citing lower interest rates and easing of economic risks that give the cheaper stocks more earnings upside.
CIBC said it upgraded Bank of Nova Scotia to an outperformer rating and demoted National Bank of Canada to neutral as borrowing costs ease and fading economic risks mean banks don’t have to set as much money aside for bad loans. That gives Scotiabank an opportunity to catch up to National Bank, with analyst Paul Holden saying valuation spreads are still wide.
“We think these conditions set the stage for a trade out of the premium banks into the discounted banks,” Holden wrote in a Thursday note.
Holden said the switch trade would work particularly well if expectations for provisions for credit losses — the amount banks set aside for loans potentially going sour — start to come down since discounted banks tend to post the highest ratios.
CIBC said it chose Scotiabank as the “right trade,” because it could post the highest earnings growth rate over the next two fiscal years given its unique exposure that could see net interest margin improvements from rate cuts and a tailwind from declining loan loss provisions. The CIBC analysts updated their earnings estimates for Scotiabank in the next fiscal year to be 2% higher, and 5% higher in fiscal 2026.
The team also noted that Toronto-Dominion Bank is trading at a 7% discount to the group. They expect that gap to narrow once anti-money laundering issues in the US are settled by the end of the year.
“TD has been posting solid fundamental results, and we think concerns over future earnings growth have been exaggerated,” Holden wrote. “We also believe the CEO succession signals a global AML settlement is close.”
National Bank has outperformed all of its peers except for CIBC, which soared in late August after it said its US office portfolio problems have eased. National Bank has gained nearly 26% year-to-date, compared to 13% in the S&P/TSX Composite index banking subgroup.
On Friday, Scotiabank shares rose as much as 1.5% in early trading. National Bank, on the other hand, slid by the same amount.
What Bloomberg Intelligence Says
“Scotiabank is counting on its strategic shift to North America from the Pacific Alliance to bring its profitability and risk measures closer to peers. It trails its better-than-14% midterm ROE goal, which is marginally below competitors. International exposure keeps credit-reserve ratios above rivals, while the bank is targeting improved efficiency, along with other large Canadian banks” - Paul Gulberg, BI Senior Industry Analyst
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