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DAVID BERMAN

Thursday, May 15, 2008

When you look at Royal Bank of Canada yesterday, two things stand out: It reported an $855-million writedown early in the day and its stock ended up as by far the biggest mover on the S&P/TSX composite index, rising 2.5 per cent.

One potential lesson for investors? Buy bank stocks that have potentially bad news overhanging them, which implies that just about the entire sector is a buy right now, with earnings season fast approaching.

But André-Philippe Hardy, an analyst at RBC Dominion Securities, recommends a more cautious approach, which makes him fairly typical among analysts who have yet to embrace beaten-up bank stocks as an ideal value investment. In a note to clients, Mr. Hardy said that second-quarter results will be weak among the big six names, with earnings per share expected to fall an average of 1 per cent from the second quarter of 2007, thanks mainly to writedowns.

As a result, he believes that the stocks of just two of the big six - RBC and Toronto-Dominion Bank - will see their total returns, including dividends, rise over the next 12 months, and even then only by 7 per cent. The other four - Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce and National Bank Financial - will see their total returns fall between 1 per cent and 5 per cent.

At National Bank, he believes writedowns will total $150-million in the second quarter, which is actually a notable improvement from an earlier forecast for $300-million in writedowns. At CIBC, writedowns will be the largest among the group, at $1.5-billion.

At BMO, the poster child for rebounds now that its stock is 27 per cent above its recent multiyear low, writedowns are expected to be another $200-million. Ditto for Scotiabank, while TD's total "restructuring charges" (the bank is not expected to break out writedowns in a separate number) should hit $420-million.

Meanwhile, Mr. Hardy expects the banks will report that credit losses rose 49 per cent year-over-year, with BMO and Scotiabank reporting the largest increases. Needless to say, these two stocks are among the analyst's least favoured stocks, along with National Bank.

And if you're counting on robust dividend increases, think again: Mr. Hardy expects Scotiabank and RBC will be the only hikers this time around. He believes these banks will raise their respective dividends by 2 cents a share - to 49 cents a share in the case of Scotiabank, and 52 cents in the case in RBC.

Of course, that's the bad news. There is the possibility that bank stocks could bounce back if the writeoffs aren't as large as expected or credit losses aren't as grim or the dividend increases aren't as skimpy (or non-existent).

Yesterday, RBC's bump came amid just such a scenario. Amid fears of spectacular writedowns as high as $1.5-billion, $855-million apparently didn't appear too bad, even though it was toward the higher end of expectations. In RBC's case, at least, bad is a lot better than shocking.

See David Berman's Market Blog at ReportonBusiness.com

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