National Bank of Canada Earnings: Capital Markets Business Segment Slowed Down

Key Morningstar Metrics for National Bank of Canada

• Fair Value Estimate
  : C$153.00
• Morningstar Rating
  : ★
• Morningstar Economic Moat Rating
  : Narrow
• Morningstar Uncertainty Rating
  : Medium

What We Thought of National Bank of Canada’s Earnings

National Bank of Canada NA reported slightly disappointing results in the second quarter, with shares falling around 4.2% following the earnings release. Adjusted earnings per share came in at C$3.23, up 13% year over year.

Why it matters: We think the bank’s capital markets business segment was the market’s major disappointment this quarter, with segment revenue down 2% and earnings down 3% year over year. We note this is against a strong prior-year comparable, and as we have flagged previously, capital markets results can be volatile quarter to quarter.

• Within capital markets, global markets revenue declined 23% year over year, while corporate and investment banking revenue rose 49%. Management also flagged potential near-term softness in client activity, which would be a headwind to global markets revenue.
• Canadian banking balance sheet growth also moderated, with average loans up 8% compared with 11% last quarter, excluding Canadian Western Bank. While the bank has outpaced most of its larger peers on domestic loan growth in recent quarters, paydowns of legacy CWB commercial real estate loans were a headwind to this quarter’s figures.

The bottom line: Following the second-quarter results, we plan to raise our C$153 fair value estimate for narrow-moat-rated National Bank of Canada by a mid- to high-single-digit percentage and lower our Uncertainty Rating to Low from Medium. We continue to view the shares as overvalued.

• The valuation increase is driven by a reduction in our cost of equity assumption and higher near-term fee income growth in areas like underwriting and advisory, and security brokerage fees. We plan to decrease our cost of equity assumption for National Bank of Canada to 9.3% from 9.5%, reflecting an updated view of the bank’s business mix and cyclicality.
• The Uncertainty Rating change reflects both qualitative and quantitative factors, including a more favorable assessment of National Bank of Canada’s domestic earnings quality.