Amid increasingly unpredictable loan losses and rising acquisition risk, Canadian banks are facing intensifying market volatility, says Hamilton Capital Partners Inc.
In a research note, the Toronto-based investment firm said it expects Canadian banks to experience higher volatility over the next two years, pointing to U.S. merger and acquisition activity and a shift in the accounting rules as the primary reasons.
In particular, banks with U.S. commercial banking platforms, including Bank of Montreal, CIBC, Royal Bank and TD Bank, face rising acquisition risk, the firm said.
“Recent high profile bank mergers south of the border suggest that, after several years of limited activity, U.S. bank M&A is poised to accelerate,” the report said.
Canadian banks with significant U.S. platforms “will likely feel pressure” to participate in the M&A action, it added.
“Today, we believe TD is most at risk, given its lower quality Southeast platform (largely built through the acquisition of failed/failing U.S. banks), higher capital ratios (signalling preparation for a deal), and the fact it has not done a U.S. commercial bank acquisition in the region since 2010. However, BMO, CIBC and [RBC] are also potential acquirers thereby increasing acquisition risk,” the firm said.
Additionally, a change in how loan losses are accounted for “is likely to create additional volatility – both upside and downside,” the firm said.
Under the new approach, “banks now need to estimate the potential loan losses in their existing loan portfolios based on their expectations for changes in the broader economy,” it noted.
“Reduced visibility in this critical expense will very likely make it more difficult for analysts to forecast quarterly [earnings], increasing the probability of beats/misses and resultant share price volatility,” it said.