Banks to benefit from lower rates

One standout among Canada’s Big Six

Canadian bank earnings have been somewhat disappointing. The non-inspiring results for the full year 2023, ending Oct. 31, were due largely to the sharp increase in their provisions for credit losses (PCLs). In many cases these more than doubled from a year earlier, although some of the loans affected were still current and paying interest. This was due to the economic models the banks employ, which, given the almost 5% (500 basis points) increase in Canadian short term interest rates over the last 18 months, understandably are indicating a big jump in financial stress and probable bankruptcies or restructuring of loans.

CIBC’s CEO Victor Dodig said economic growth is expected to continue to slow, and its Chief Risk Officer, Frank Guse, commented that “absent a more rapid shock to unemployment or a larger than expected decline in GDP,” the bank expected losses on impaired loans to settle in the mid-30s basis points range (0.30%). That was up from the previous guidance of 0.25%-0.30%.

Mixed operating results for 2023

The actual operating results were mixed, with some banks reporting strong investment, for example, BMO, RBC, and National. Others booked restructuring charges as they cut staff. Between them, the Big Five banks (RBC, TD, BMO, BNS, and CIBC) announced almost 10,000 job cuts. Scotiabank cut 1,500, TD 3,000, RBC 2,300, BMO 1,500, and CIBC more than 1,000, accounting for between 2% and 5% of their workforces at the beginning of the year. The other major factor affecting earnings was restructuring charges due to takeovers (BMO’s acquisition of Bank of the West in the U.S.) or corporate reorganization (Scotiabank).

The largest bank, RBC, earned $4.1 billion ($2.90 per share) against $3.9 billion ($2.74 per share) in the same quarter the previous year, or $2.78 per share adjusted for certain items. It reported $720 million in PCLs against $381 million in 2022.

The second-largest bank, TD, reported earnings of $2.9 billion ($1.49 per share) against $6.67 billion ($3.62 per share). The decline was due to exceptional items such as the termination fee on its failed First Horizons acquisition and the settlement of legislation over jailed financier Alan Stanford. Adjusted earnings per share were $1.83. PCLs were $878 million against $617 million.

BMO, whose market capitalization is now over $10 billion more than Scotiabank, earned $1.6 billion ($2.06 per share). That compared with $4.5 billion ($6.51 per share) last year, or $2.81 per share, adjusted for exceptional items such as restructuring charges and costs of acquiring Bank of the West. PCLs were a lower-than-expected $446 million, including a very low $38 million against loans that are still being repaid. That compared with $226 million in 2022.

Scotiabank, in the middle of a major restructuring under its new non-bank CEO Scott Thomson, saw its earnings down by one third at $1.4 billion ($1.02 per share) against $2.1 billion ($1.63 per share) last year, or $1.26 per share, adjusted for $590 million in exceptional items. These included a writedown on its holding in Bank of Xian in China, trimming 3% of its workforce, and selling some of its real estate portfolio.

Finally, CIBC had better-than-expected results, with earnings of $1.48 billion ($1.53 per share) against $1.19 billion ($1.26 per share) in 2023, and $1.57 per share adjusted. PCLs were $541 million, up from $282 million but lower than analysts expected, especially given the losses the bank has been experiencing in US offices.

National Bank, the smallest but best-performing of the Big Six chartered banks, reported earnings of $768 million ($2.14 per share) compared with $738 million ($2.08 per share) last year. Adjusted earnings were $2.44 per share, up 17%. PCLs were $115 million against $87 million.

Perhaps the most impressive aspect of the banks’ results was that everyone except Scotiabank increased its dividend, by between 3% (BMO) and 6% (TD). With dividend yields ranging from 4.5% for RBC to a remarkable 6.8% for Scotiabank, investors can buy Canadian banks at yields that have not been available since the depths of the Great Financial Crisis in 2008-09, and with a much healthier financial and economic outlook now as opposed to then.

CIBC’s Frank Guse estimated that 10% of its fixed-rate loan book (primarily residential mortgages) would reset next year and another 20% each in both 2025 and 2026. Given approximately the same profile for other banks, their strong capital ratios (CET1 of 13%-14.5%) and proactive actions on provisioning should enable them to weather the downturn successfully. Dividends are a very good indicator of management's confidence in the outlook, as companies hate to reduce dividends. No Canadian bank has done so in the last 40 years, with the exception of Laurentian Bank.

Rising rates and bad debt fears

Rising rates and fears of a spike in bad debts have contributed to the big banks’ lacklustre performance over the last year. National Bank, for example, is flat, while TD, BMO, and Scotiabank are down more than 10%. However, National Bank remains the top-performer of the Big Six.

National Bank of Canada (TSX: NA), based in Montreal, is the smallest of the Big Six Canadian chartered banks and has been known for its focus on Quebec. But it has expanded in the last decade, building a major investment banking and asset management business to complement its strong position in retail banking, as well as a growing U.S. specialty finance subsidiary.

Personal and Commercial (P&C) business saw a 12% increase in earnings before PCLs in the year ended Oct. 31, climbing to $2 billion. Net income was reported at $1.28 billion with a rise in net interest margin (NIM) to 235 bps from 215 bps.

Wealth Management pre-tax income rose 3%, to $987 million, and net income climbed 2%, to $714 million. Financial Markets (capital markets) pre-tax income rose 4%, to $1.49 billion, and net income was down 2%, to $1.06 billion, largely due to PCLs switching from a recovery of $23 million to a loss of $39 million.

Finally, its U.S. Specialty Finance and International (USSFI), with its subsidiaries Credigy and ABA Bank, saw pre-tax income down 1%, to $694 million, due to PCLs at Credigy rising from $35 million to $81 million and net income falling 2% to $548 million.

National had profits of $768 million ($2.14 per share), or $2.44 per share adjusted for exceptional items. For the year to Oct. 31, its net income was $3.35 billion ($9.38 per share) down 1%, while adjusted net income rose 1% to $3.4 billion ($9.60 per share).

National has successfully delivered growth by expanding from its Quebec base to become a major player in both wealth management and capital markets, with net income of over $700 million and $1 billion respectively. Meanwhile it has also built a US specialty finance business without running into many of the issues that have caused problems for Canadian banks expanding south of the border. Its net income, while flat over the last two years as margins have been affected by rising rates, has increased by 50% from 2019. While its price/book ratio is the highest amongst the banks, it is still only 1.44 times. Revenue and earnings have increased by 7% and 10% annually over the last five years.

Consider National Bank if you’re looking for a well-run Canadian bank with excellent organic growth and a reasonable yield of about 4.2%.

Gavin Graham is a veteran financial analyst, money manager, formerly Chief Investment Officer of BMO Financial, and a specialist in international investing, with over 35 years’ experience in global investment management.

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The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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