Big six banks ‘cautiously optimistic’ following solid earnings season

Despite a volatile quarter in the markets, Canadian banks saw another successful quarterly earnings season with higher loan growth and lower loan-loss provisions.

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“Overall, most banks struck a cautiously optimistic tone on the economy,” said Craig Jerusalim, senior portfolio manager of Canadian equities at CIBC Asset Management, in a recent interview. The exception was Royal Bank, which Jerusalim said began raising the yellow flags on growth, cautioning an economic slowdown impending in 2023.

RBC CEO Dave McKay said on the bank’s earnings call that markets are struggling to predict how the economy lands in response to central bank tightening.

“Do we land it with a slight recession? And our message today is, it could go either way, it’s 50/50,” he said.

Overall, Jerusalim noted the Big Six banks navigated a difficult second quarter — which saw stock and bond markets sink — “quite successfully.”

Lower credit reserves was a key factor, he said.

“One of the main reasons why the banks exceeded earnings expectations this quarter was due to the group collectively shrinking their provisions for credit losses,” he said.

Releases of credit loss provisions boost earnings per share, Jerusalim said, but it also reduces the cushion for bad debt. The banks could afford to release provisions after realizing they were “overly conservative at the height of the Covid scare,” he said, and after getting a handle on the fallout from the Russia-Ukraine conflict.

CIBC and Scotiabank were the most conservative, he said, while TD and Royal Bank were on the relatively aggressive side of their assumptions.

Another theme for the earnings period that ended April 30 was higher expenses. Jerusalim attributed this to competition for talent and higher labour costs, as well inflationary pressures in all aspects of the expense line. For example, although business travel is nowhere near pre-pandemic levels, the banks are seeing a normalization in those expense lines following the economic reopening.

On the flip side of higher expenses is higher growth, namely higher loan growth, Jerusalim said. 

Any cooling in residential mortgage growth is being offset with other types of unsecured consumer borrowing, Jerusalim said, specifically very strong commercial loan growth. Further, commercial and unsecured personal loans should provide “a tailwind to net interest income.”

Margins have also expanded thanks to higher interest rates, which are generally positive for banks.

Net interest margins expanded by six basis points on average this quarter.

“The net impact of higher expenses, but even higher pre-tax pre-provision earnings growth, is positive operating leverage, which we saw from most banks this quarter,” he said

Even TD, which Jerusalim said is typically the most rate sensitive, saw especially strong growth in this regard.

Lastly, despite common equity Tier 1 ratios declining 20 basis points for the group on a quarter-over-quarter basis, Jerusalim said capital levels remained strong. 

“Levels remain quite healthy and well above any regulatory minimums, leaving plenty of ammunition for further dividend increases,” he said. 

Five of the six large banks raised their dividends this quarter. The exception was TD, as they are instead trying to build capital to fund their purchase of First Horizon, Jerusalim said. 

Nevertheless, Jerusalim said there was a clear delineation between the winners and losers this quarter.

National Bank, Scotiabank and BMO delivered the best overall Q2 results, Jerusalim said, followed by TD Bank, CIBC and Royal Bank.

However, he said CIBC and Royal Bank offer two of the most defensive bank positions in these volatile markets.

Overall, the group is trading at around 10 times earnings, offering dividend yields close to 4% and a history of outperforming the market, and therefore “remains a rewarding place to be for long-term focused equity investors,” Jerusalim said.

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