Noah Zivitz

Managing Editor, BNN Bloomberg

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A Bay Street analyst who hasn’t shied away from going bearish on the banks is doing it again.

Nigel D’Souza, who covers the financial services sector at Veritas Investment Research, downgraded all but one of Canada’s Big Six banks on Wednesday, citing the eventual drag from higher interest rates.

He cut each of Bank of Nova Scotia, Canadian Imperial Bank of Commerce, National Bank of Canada, Royal Bank of Canada, and Toronto-Dominion Bank to a sell recommendation, and also lowered his price targets on each of the banks. He continues to recommend clients buy shares in Bank of Montreal; however, he trimmed his price target to $159 per share from $170 previously.

D’Souza acknowledged that higher interest rates will boost the banks’ net interest margins, or the difference between what they charge for loans and what they pay in interest on deposits. However, he said that those higher rates will eventually drag down economic growth and create renewed risk for the banks’ loan books.

As of Wednesday afternoon, Bloomberg data was showing investors have priced in at least five rate hikes from the Bank of Canada and the U.S. Federal Reserve this year.

“We expect market sentiment to shift over the coming months as investors look past the benefit of higher net interest income and look ahead to the possibility of slowing economic growth and elevated credit risk in a rising rate environment,” he wrote.

D’Souza warned that history shows the banks could be heading for an “inflection point” after investors initially bid up their shares as central banks signalled the days of rock-bottom interest rates are coming to an end.

He pointed to what transpired in the last rate-hike cycle. He noted that before the Bank of Canada started raising its main policy rate in 2017, the Canadian banks’ forward price-to-earnings multiple reached about 12.0x before slumping back to 9.0x. He indicated he expects a similar story to play out this time. As a barometer for the sector, the TSX banks index has surged 16 per cent since the end of November. D’Souza said on Wednesday he cut his forward price-to-earnings multiple estimate for the sector to 10.6x from 11.9x.

“While the rally may continue in the short-term, the sector is likely approaching an inflection point where economic and credit risks related to rising rates outweigh benefits,” he added.