O Canada: Bank stocks for 2013

They had a strong fourth quarter, but can they keep it up next year?

By InvestorPlace Dec 10, 2012 2:09PM

Image, Canada copyright Royalty-Free, CorbisBy Will Ashworth


iplogoBefore buying a Canadian bank, every investor should read commentary about Canada from Connor, Clark & Lunn -- a Canadian money manager. It will provide a sobering reminder that Canada has its own set of problems (see excerpts from a recent report here).


Just because you can get better yields north of the border doesn't necessarily mean they're a better buy. While the U.S. continues to slowly get its act together, Canada has failed to deal with personal debt -- the repercussions of which could be felt by its banks in 2013.


Of course, I'm not saying you shouldn't invest in Canadian banks. Just that you go in with your eyes wide open.


With that in mind, how do picks in the sector stack up heading into 2013? Let's take a look:


The Bank of Montreal

From a purely numbers standpoint, the clear winner of Q4 is The Bank of Montreal (BMO). It saw earnings increase 38% year over year to C$1.65 a share. Leading the charge was the capital markets division (including trading and investment banking), which posted a 30% increase in revenue and a 95% increase in net income. CEO Bill Downe also believes its capital markets division is perfectly positioned for organic growth in 2013.


The company's U.S. banking operations have been totally transformed over the past 24 months, too, thanks to the acquisition of Marshall and Ilsley last year. BMO Harris Bank increased its market share for deposits in the Chicago area to almost 12% in the fourth quarter -- the second highest in this major metropolitan market. The Midwest has definitely become BMO's core market in the U.S. and 2013 looks promising for its all its businesses south of the border.


The company's personal and commercial lending in Canada, which represents approximately 44% of annual revenue, is still the company's bread and butter and remains steady. But the U.S. division should add in some nice growth. All in all, I like BMO's prospects.


Bank of Nova Scotia

Bank of Nova Scotia (BNS) is actually my personal favorite, though, because of its focus on non-U.S. markets. But despite the bank's push into Latin America and other emerging nations, its biggest splash in the quarter was the purchase of ING Bank of Canada for C$3.13 billion -- a brilliant acquisition that strengthens its domestic banking operations moving forward into 2013.


I tend to think of the Canadian banking segment as the weak link in a very strong operation, but the truth is it contributes its fair share. Year over year, the fourth quarter saw revenues and net income increase 6% and 15% respectively, while its net income of C$481 million represents 32% of its overall profits. The addition of ING solidifies its position as the third biggest bank in Canada, while big things should come from Latin America as well -- especially in personal and commercial lending growth.


In 2013, BNS expects its earnings per share to grow 5% to 10% with its net interest margin holding steady around 2.3%. With a current yield of 4.1%, you're getting a very stable bank that beats any of the big American outfits.


Toronto Dominion Bank

The biggest Canadian bank in terms of its operations in the U.S. is Toronto Dominion Bank (TD), which just purchased Epoch Investment Partners (EPHC) for $668 million. The move adds $24 billion in assets under management to its existing asset base of $207 billion, but more importantly, gives it a stronger team in U.S. and global equities. Bill Priest, Epoch's founder, has been a successul investment manager for almost 50 years. This is a great pick-up for the bank.


However, its overall business leaves a lot to be desired. It's adjusted diluted earnings per share in the fourth quarter were C$1.83 compared to C$1.75 Q4 2011. That's a 4.6% increase year-over-year, making it the only bank to deliver single-digit earnings growth.


So what went wrong? Barclays (BCS) analyst John Aiken noted that TD's domestic loan business experienced increased provisions for credit losses in the quarter -- something to be aware of because other Canadian banks are experiencing similar activity.


Still, I see this quarter as a rare time when TD has taken its foot off the gas. Expect it to fix that in 2013.


The final three

Royal Bank (RY), Canada's largest bank, continues to perform as well. Its fourth quarter earnings per share (EPS) increased 23% to C$1.25, while its return on equity was 160 basis points higher year-over-year. Personal and commercial banking, which accounted for 54% of its overall net income in Q4, delivered a 9% increase in net income year over year. The only fly in the ointment was a higher provision for credit losses in its Canadian business lending operation. Other than that, this is one rock-solid bank.


Canadian Imperial Bank of Commerce's (CM) enjoyed a 15% increase in Q4 net income to C$2.04 per share -- nothing to sneeze at. The only downer in CIBC's report was the 5% or C$28 million decline in its retail and business banking division, which accounts for two-thirds of its overall profit. Otherwise, 2013 looks to be another strong year for the bank.


Finally National Bank (NTIOF) is the smallest of the six. Its goal is to grow its business outside its home province of Quebec through acquisitions and organic development. Its fourth quarter earnings per share gained 15% year-over-year. More importantly, it was the only bank of the six to raise its quarterly dividend, hiking it 5% to 83 cents per share. It now yields 4.3%, putting it in the middle of the dividend pack.This could be the bank that surprises in 2013.


As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.


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