CIBC Only Bargain Among Canadian Banks

Eric Compton: We are just entering the next earnings cycle for Canadian banks, and we believe two key themes will be housing and interest rates.

On housing, we will be paying close attention to delinquency rates, loss rates, and loan-to-value ratios, particularly on mortgages within Toronto and Vancouver, which remain the hottest markets within Canada. Last quarter, all of these items remained pristine; however, in late April, the Canadian government increased taxes on foreign homebuyers within Toronto, and since then the market has begun to cool. We will be watching the unwind here, and if it is having any negative effects on the quality of the banks' balance sheets.

Second, we'll be watching the effects from the recent rate rise in July. We will be curious how much this rise will have affected the banks' profitability, and also if it will begin to affect borrowing behavior, particularly among potential mortgagors. The key questions will be if the Canadian economy and the heavily indebted Canadian consumer can indeed handle a rising rate regime.

From a valuation perspective, we view the space as mostly fairly valued, with the Canadian Imperial Bank of Commerce being the only standout, trading in 4-star territory. CIBC is the most exposed to the Canadian housing market, and, along with the bank's history of blowing itself up once every decade or so, we think this is what is driving the discount in the share price. However, we do believe the market is more than compensating investors for the risk here, particularly if the housing unwind is anything short of a complete disaster.