Canadian bank profits vulnerable, analyst says

VANCOUVER, British Columbia (Reuters) - While it may be tempting to argue that the worst is over for Canadian bank stocks, several factors could still put pressure on earnings growth at the banks, an analyst said on Thursday.

"We maintain our cautious view on Canadian bank stocks," RBC Capital Markets analyst Andre-Philippe Hardy said in a research note.

Rising credit losses, slower growth in wealth-management businesses, slowing retail loan growth and a greater dependence on wholesale funding, among other factors, could crimp profit growth, Hardy said.

"Our expectations for a decline in profitability are not unique on the street but we remain concerned that our expectations for profitability could still be too high," he said.

The Toronto Stock Exchange's S&P/TSX banks index rallied 19 percent between July 15, when many Canadian bank stocks hit a 52-week low, and Wednesday.

But the group gave back some of those gains on Thursday, with Toronto-Dominion Bank shares down C$3.18 at C$60.04, and Canadian Imperial Bank of Commerce off C$3.71 at C$59.58.

In his report, Hardy estimates that CIBC will take wholesale-bank writedowns of C$1.5 billion in the third quarter, which ends July 31. He sees Royal Bank of Canada writing down C$500 million, a figure that is lower than some other analyst estimates.

Hardy said he prefers the Canadian life insurance sector to the bank sector, because the macroeconomic environment should not hurt life insurer profits as much, and their market valuations already reflect investor concerns.

As of Wednesday's close, the stocks of Canada's big six banks -- CIBC, Royal, Bank of Montreal , Bank of Nova Scotia , National Bank of Canada , and TD Bank -- traded at an average of 10.3 times their expected 2008 earnings, which is not expensive, Hardy noted.

But the stocks trade at 2.0 times their book value per share, which he thinks is a more appropriate measure in the current environment, and that is "not overly cheap."

Only six years ago, weak credit and shaky equity markets pushed bank share prices down to 1.65 times book value, the RBC analyst pointed out.

Canadian banks will probably continue to raise capital by issuing preferred shares and hybrid securities, but Hardy said he does not expect any of them to issue new common shares.

Even at CIBC, the likelihood of a common equity issue is low, he said.

CIBC has been hit hard by the U.S. subprime mortgage market's collapse, and raised C$2.9 billion early this year in a common share issue.

"For CIBC to raise additional equity, we believe writeoffs would need to be close to C$5 billion taken over a short period of time," Hardy wrote.

($1=$1.01 Canadian)

(Reporting by Lynne Olver; Editing by Peter Galloway)