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Should You Be Worried About the Big Bank Short?

In March it was revealed that Steve Eisman, the money manager made famous in the book and later film The Big Short, was targeting Canada’s top banks. Eisman reiterated that he was “not calling for a housing collapse,” but rather a “normalization of credit” that would bring shocks to Canada’s top financial institutions.

In April Eisman expanded on his outlook. He said that Canadian banks were “ill-prepared” for a credit cycle. He also revealed the three banks he had targeted, which we will review below. Eisman predicted that another round of disappointing earnings could potentially lead to some second-guessing when it came to forecasts.

Let’s review Eisman’s short targets and determine whether investors should be concerned ahead of the Q2 earnings season.

Royal Bank (TSX:RY)(NYSE:RY)

Royal Bank is the largest financial institution in Canada. Eisman identified Royal Bank as the first of the three short targets. Shares of Royal Bank have climbed 12.4% in 2019 as of close on April 15. The stock is up 9.3% from the prior year.

Royal Bank had a strong first-quarter even in the face of weakness in its Capital Markets segment. It posted net income of $3.2 billion, up 5% from Q1 2018. Royal Bank has been active in preparation for economic headwinds. In the first quarter provisions for credit losses increased $184 million or 54% from the same period in 2018.

Investors can expect Royal Bank’s second-quarter results in May. The stock is trading at the high end of its 52-week range and boasts an RSI of 66, which puts it just outside of overbought territory. This high valuation is something to consider ahead of its Q2 report.

Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM)

CIBC was the second bank identified by Eisman. Shares of CIBC have climbed 8.5% in 2019 so far. The stock dipped sharply in late March, providing value investors with a nice buying opportunity.

CIBC suffered an 11% drop in profit in Q1 2019. This was due to double-digit drops in net income in Canadian Personal and Small Business Banking as well as Capital Markets. The bank still hiked its quarterly dividend by 4% to $1.40 per share.

Shares have waded comfortably out of oversold territory as of close on April 15. Its Capital Markets segment should see an improvement after a good start to 2019, but a slowdown in its mortgage portfolio remains a concern going forward.

CIBC is still trading at the low end of its 52-week range. It carries risk into its second-quarter earnings report, but still boasts a fantastic yield in comparison to its peers.

Laurentian Bank of Canada (TSX:LB)

Laurentian Bank was the third bank stock identified by Eisman. Laurentian is a regional bank based in Quebec. Shares have climbed 9.2% in 2019 so far. The bank has attracted considerable short interest over the past year and remains one of the most shorted stocks on the TSX right now. Shares have dropped 11.9% from the prior year.

Laurentian CEO Francois Desjardins took aim at the short call in an interview with BNN Bloomberg. He defended the resiliency and credit history of Canadian banks. Top CEOs from other top banks have followed suit.

The bank saw net income sink 33% from the prior year to $40.3 million in Q1 2019. This was primarily due to lower capital market revenue. Laurentian is trading at the middle of its 52-week range and is in neutral territory ahead of its next earnings report. The stock also offers an attractive 6% dividend yield.

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Fool contributor Ambrose O'Callaghan has no position in any of the stocks mentioned.

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