Canadian bank investors looking for better days ahead

The majority of Canada's big banks are heading into fourth-quarter earnings this week riding high as fears around mortgage defaults and a recession ease.

The majority of Canada’s big banks are heading into fourth-quarter earnings this week riding high as fears around mortgage defaults and a recession ease.

But analysts say the banks will have to show there’s enough earnings growth ahead to justify current valuations that are on the high end of historic trends.

“We believe that the banks now must prove out the thesis,” said Canaccord Genuity analyst Matthew Lee in a note.

The S&P TSX bank index is up around 12 per cent since last quarter’s results, including a 19 per cent gain for Scotiabank and 17 per cent climb for CIBC.

The exception is TD, which was hit with a US$3 billion fine and growth limits in the U.S. because of its anti-money laundering deficiencies. Its stock is down slightly this quarter amid these struggles.

Lee said, overall, the banks are now trading at a “lofty” 12.1 times earnings, a level justified by a constructive growth environment, robust capital positions and loan books that look reasonably healthy, but they will need to show improved margins ahead to maintain their stock prices.

“With sector valuations full, we believe the next leg of upside will have to come from earnings growth,” Lee said.

Investors that have propped up bank stocks are already looking past the still-worsening credit fundamentals and sluggish loan growth to the turnaround ahead, said Scotiabank analyst Meny Grauman.