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Morningstar | Good Finish to 2018 for National Bank of Canada; Future of Canadian Economy Remains Top of Mind. See Updated Analyst Note from 05 Dec 2018

Narrow-moat National Bank of Canada reported strong fourth-quarter results that fit well with our long-term thesis for the bank. Overall, full-year net income was right in line with our estimates. However, the bank had slightly more diluted shares outstanding than we were projecting, leading to reported earnings per share of CAD 5.94 versus our estimate of CAD 5.99. These differences are not material, and we are maintaining our fair value estimate of CAD 70 per share. If the bank can maintain anything close to this type of performance, we believe our current fair value estimate is well supported, as we have earnings growth slowing and a deterioration of return on tangible equity of over 200 basis points to account for a weakening Canadian housing market and economy over the medium term.

EPS growth was in the double digits for the full year, coming in at 10% year over year. The efficiency ratio improved 130 basis points to 54.6%, and return on equity remained above 18% at 18.5%. This was again the highest return on equity among the major Canadian banks. The bank maintains the second-highest common equity Tier 1 ratio among the Canadians, at 11.7%, and maintains minimal exposure to the oil sector, minimal exposure to Alberta, and also one of the smaller relative exposures to the hottest Canadian real estate markets. With these results, the bank met all of its medium-term objectives.

Results were generally strong across all segments, with positive operating leverage and revenue growth across the board. Rising interest rates have helped the bank expand net interest margins gradually for its personal and commercial banking segment, although this slowed in the fourth quarter. The bank is also seeing decent loan growth, with balances up roughly 7% for the year. While mortgage growth is slowing a bit, the bank is still growing its home equity line of credit balances at a decent clip, and this will be an area to watch as the housing cycle develops over the future. Even so, credit metrics remained pristine, with impaired loans staying steady, the provision for credit losses ratio remaining range-bound for the whole loan book, and PCLs remaining range-bound for the retail mortgage portfolio as well. Uninsured mortgages and HELOC balances in the greater Toronto and Vancouver areas represented only 11% of National Bank of Canada’s total loans. We would also highlight the bank’s strong growth in its financial markets segment, with revenue growth of 8% year over year, where despite its smaller size, the bank still manages to source good financing and corporate banking activity. The bank also saw a 5% increase in assets under management year over year, a strong comp against peers, as it had net sales for the year.