Veritas Investment Research is expanding its bear-case against Canada’s Big Six banks, slapping a sell rating on shares of Bank Of Montreal (BMO.TO), the only exception to analyst Nigel D’Souza previous downgrades on the major lenders.
Earlier this month, D’Souza warned of a “significant price correction” in 2019 and 2020 as rising credit losses and slowing economic growth weigh on the banks.
BMO’s commercial lending focus in Canada, robust U.S. commercial operations, and potential for improved efficiency saved it from being downgraded to “sell” with Toronto-Dominion Bank (TD.TO), Canadian Imperial Bank of Commerce (CM.TO), Bank of Nova Scotia (BNS.TO), National Bank of Canada (NA.TO), and Royal Bank of Canada (RY.TO).
“Although we hold a favourable view of BMO’s underlying fundamentals, we note that its current valuation is above its historical premium relative to peers and expect shares to come under pressure as the sector multiple contracts over the coming quarters,” D’Souza wrote in a research note to clients.
Financial services has been a rewarding theme for investors in 2019. The S&P/TSX Capped Financial Index has gained over 10 per cent year-to-date. BMO shares have climbed about 17 per cent since hitting a recent low on Christmas Eve.
The Toronto-listed stock fell 0.34 per cent to $100.73 at 2:53 p.m. ET on Wednesday.
D’Souza conducted a 30-year analysis of the financial services sector and found being overweight the banks was a winning strategy about nine-out-of-10 years per decade. Underperforming years had one obvious thing common he said, elevated or rising credit losses.
“The debt-service ratio for households this year, we expect to match or exceed the peak debt-service ratio for 2008. Mortgage interest costs are going up at the fastest rate since 2008 as well,” he said in a previous interview with Yahoo Finance Canada.
“Historically, if the debt-servicing ratio, the total amount of principal interest payments by household relative to income is going up, then typically credit losses for the Big Six banks also go up.”
He notes that economic data for Canada is currently running at a rate below the base-case assumptions used by the Big Six banks to model performing loan losses.
Veritas expects performing loan losses to build materially through 2019 as banks revise their performing credit loss models amid a backdrop of weaker economic conditions.
“If there are credit risk concerns, and it is coupled with slow economic growth, that is what happened in 2015-2016, and the multiple for the sector contracted by 30 per cent. The bank space itself could face a significant contraction,” D’Souza told Yahoo Finance Canada on March 12. “We expect it to contract meaningfully over the next 12 months.”