Noah Zivitz

Managing Editor, BNN Bloomberg

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An analyst who covers Canada’s banks is warning of choppy waters ahead and is urging clients to take a more defensive approach as economic uncertainty threatens to send shares sharply lower.

Paul Holden from CIBC Capital Markets raised his recommendation of Royal Bank of Canada and National Bank of Canada to outperform (the equivalent of buy) from sector perform (the equivalent of hold). He cited their capital levels, earnings diversification and lower relative credit risk as the basis for his favourable recommendations.

By contrast, Holden downgraded Bank of Nova Scotia, Toronto-Dominion Bank, and Canadian Western Bank to neutral from outperform.

Holden reduced his price targets on all seven of the banks he covers by an average of eight per cent. Canadian Western Bank was singled out with the most severe price-target cut (16 per cent, to $38.00 from $45.00). The most modest price-target reduction was for shares of Royal Bank of Canada (one per cent, to $149.00 from $151.00).

“Our prior investment thesis was primarily premised on strong loan growth and higher interest rates. In other words, we had taken a pro-cyclical stance. That view is now shifting as we look to commentary from the Federal Reserve, warning signs in rate markets and U.S. bank stocks,” Holden wrote in his report to clients.

He noted Canadian bank stocks have fallen by around four per cent on average, outperforming over the last three months as compared to U.S. stocks that have shed about 18 per cent of their value amid growing concern about the economic outlook as central banks look to hike their interest rates.

Holden said his estimates are based on an assumption that central banks will manage to thread the needle as they tighten monetary policy.

However, he acknowledged there are risks to that assumption and that central banks could overshoot by tightening too aggressively and thus tip economies into recession; or they could move too cautiously and allow stagflation to take hold.

Holden’s models show the Big Six banks, excluding CIBC (which he doesn’t cover), could see their Fiscal 2023 earnings per share tumble 33 and 31 per cent, respectively, in the recession and stagflation scenarios.

“Canadian bank stocks are not being priced for the same economic risks that have already been incorporated into the bond market and U.S. bank stocks. We are not calling for a 2023 recession as our base case, but we cannot simply dismiss that possibility as inconsequential. Our analysis shows there could be (roughly) 30 per cent downside should a recession scenario transpire,” he wrote.