As the Canadian economy shows signs of weakness, it’s never been more dependent on household spending, according to Craig Jerusalim, senior portfolio manager at CIBC Asset Management.
And that could be a problem, with household debt levels at all-time highs. So what does that mean for Canada’s big banks as they prepare to report first-quarter earnings?
Overall, Jerusalim said the Big Six banks are “a good proxy” for the Canadian economy. Even with an uncertain period for economic growth, though, he said key financial indicators point to a strong backdrop for Canadian banks.
An indebted consumer is one potential headwind. Canadians’ household credit market debt as a proportion of disposable income increased to 177.53% in Q3 2018. The Bloomberg Nanos Canadian Confidence Index ended January at 54.2, near a two-year low.
“With mortgage interest-rate payments significantly rising over the past few years, and housing prices stalling out, the Canadian consumer can best be summed up as fatigued,” said Jerusalim, who co-manages the Renaissance Canadian Small-Cap Fund, in a Jan. 18 interview.
“Auto sales have turned negative for the first time this cycle, further questioning consumers’ propensity to consume.”
The situation may not be that bleak, however. Jerusalim noted that “leading credit indicators are not flashing any red or yellow lights as of yet.”
The unemployment rate in December 2018 was a historically low 5.6%, credit-card delinquencies are “benign,” with a delinquency rate (90 days+) for the quarter ending in April 2018 at 0.83%, and consumer confidence is still “relatively high,” he said.
So despite the macro picture, Jerusalim said bank valuations are “still extremely compelling.”
“The banks are trading close to 9x next year’s earnings, despite mid-single-digit earnings growth and sustainable dividend yields in the 4% to 5% range,” he said.
They’re also “extremely well-capitalized,” and not showing signs of stress “outside of some idiosyncratic exposures,” such as General Electric and Pacific Gas & Electric, the California utility that filed for bankruptcy last month.
As Canadian banks gear up to report Q1 earnings, Jerusalim said the key drivers his firm will pay attention to are net interest margins, loan growth and provision for credit losses, as well as updates on those idiosyncratic exposures.
“The banks saw margins expand when the Fed and the Bank of Canada were increasing interest rates. However, no further expansions are being built into expectations at this point,” he said. “Therefore, cost controls will be needed to realize operating leverage in 2019.”
Due to the “fatigued” consumer, he said his team has tempered the outlook for loan growth. However, he said commercial and U.S. loans are still “quite robust.”
“As for the provisions for credit losses, they can’t go any lower, but they can stay benign so long as those leading indicators continue to cooperate,” he said.
Overall, Jerusalim said the banks remain attractive. “The inexpensive starting point [valuations], strong oligopoly within the Canadian banking system, and the high and growing dividends make the group an attractive place to invest from a risk-reward perspective.”
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