The banks always win in the end
Lucky for us shareholders of CDN chartered banks, they always seem to sail intact through stormy seas. Contrary to my prediction, bank shares actually rose today. I had assumed that the removal of the profitable income trust biz from next year’s i-banking revenue would lead to a trimming of forecasts. Instead, we seemed to experience a “flight to quality”, or else Genuity Capital Market’s Research Analyst made the right call on multiple expansion in his a.m. note (probably a bit of both):
“The announcement by Finance Minister, Jim Flaherty, that the Federal Government will implement a tax on the distributions of income trusts is likely to introduce considerable uncertainty and volatility into the performance of these high-yielding entities for the foreseeable future. As a result, we believe investors will look to allocate at least a portion of their trust holdings into other “alternative yield” assets, such as the Canadian banks.
· The commitment of the banks to the “return of capital” strategy has continued to increase in F2006. Excluding CM and LB, the growth rate in dividends declared YTD (18%) exceeds the growth rate of core EPS (14%) by a good margin. Additionally, the average 3.1% dividend yield of the eight largest banks compares favourably to the 4.0% yield on the Government of Canada’s (GofC) ten-year bond, and we expect at least four members of the group to increase the quarterly payment during Q4/06 earnings season.
· The only potential negative we see for the banks from the announcement is the possibility of lower investment banking revenue as a result of a halt in trust conversions. That said, we should also note that 1) the contribution of trust-related fees to total IB revenue has not been quantified by the banks; and, 2) the strong top-line performance for the group in F2006 (total revenue up 6%) has been achieved despite underwriting and advisory fees declining by 5% versus the first nine months of F2005.
· The big six banks are trading at 12.7x consensus 2007E EPS, below their March high of 13.0x, and well-below their peaks versus the U.S. banks. We believe the combination of 1) a strong earnings performance in Q4/06; and, 2) a “flow of funds” toward the high yielding banks leaves the banks well-positioned for multiple expansion, similar to the strong run enjoyed by the group following the announcement of the proposed dividend tax cut in late-November 2005 (the big six traded at 12.9x consensus 2006E EPS prior to the Goodale statement on November 23, 2005; the multiple preceded to expand to 13.5x by the end of the fiscal year in January 2006).”
BNS and CM both hit new highs. But so did Constellation Software and Duke Energy. Now figure out the correlation there.
The reality is that investment banking fees are a fraction of what the more stable retail and wealth management business earn that you won’t see a impact on the banks EPS with the loss of trust business.