As Canada’s biggest lenders prepare to report fourth quarter results next week, one analyst says the Big Six banks are likely to be less optimistic than they were in previous quarters as consumer weakness persists.
Mario Mendonca, managing director and bank analyst at TD Cowen, told BNN Bloomberg in a Monday interview that he was surprised by the banks’ messaging around credit losses in the third quarter, saying it was more positive than he expected.
“Since then, I think the environment has softened somewhat… they’ve been a little less optimistic, and I suspect we’re going to hear the banks offer a more pessimistic outlook on credit losses,” he said.
“Where the weakness is coming from is in the Canadian consumer in particular. And if I want to be really specific here, I’d say the unsecured Canadian consumer… credit cards, auto loans and some lines of credit.”
Mendonca said that while he expects credit loss provisioning to be something investors will be looking at closely in fourth quarter results next week, he doesn’t think the banks will go as far as warning about any significant losses related to mortgages, which he said remain “safe.”
When it comes to valuations, Mendonca said he believes the banks as a group are now approaching fair value.
“Within that context, there are some like (Royal Bank of Canada) that is trading at a meaningful premium to the group, probably a 15 or 16 per cent premium… that’s a fairly heavy premium for Royal,” he said.
“Normally, the stock sort of takes a breather when you get to that level and that’s why I’m actually a little more cautious on Royal. I recently downgraded it from buy to hold after a very, very strong year.”
Mendonca said the downgrade reflects “not a view that Royal is going to have a bad 2025,” but rather a view that its current valuation looks full and there are other names within the Canadian banking space that may be more attractive for investors in the near term.
One such lender is Bank of Nova Scotia, which he recently upgraded to buy from hold, despite it being the worst performing of Canada’s Big Six over the past five years.
The bank came under new leadership in 2022 when it named Scott Thomson its new chief executive officer and overhauled its management team in an effort to improve performance. Scotiabank stock has gained more than 30 per cent in the past year.
“Scotia used to be among the most efficient banks in the group. Their efficiency ratio and operating level has been very weak over the last five years, and I argue that this management team is going to reinstitute that focus on efficiency,” he said.
Mendonca said he expects Scotiabank to continue focusing on its high return-on-equity (ROE) businesses such as capital markets next year, which should support a higher share price.
“If that ROE improvement plays out in 2025, my argument is that it’s going to support the stock,” he said.