Big Six banks ‘cautiously optimistic’ after solid earnings season.
“Overall, most banks were adopting a cautiously bullish tone on the economy,” said Craig Jerusalem, senior portfolio manager for Canadian equities at CIBC Asset Management, in a recent interview. The exception was the Royal Bank, which Jerusalim said began raising the yellow flags for growth and warned of an economic slowdown in 2023.
RBC CEO Dave McKay said in announcing the bank’s results that markets are struggling to predict how the economy will evolve in response to the central bank’s tightening.
“Are we going to get it with a mild recession? And our message today is it could go either way, it’s 50/50,” he said.
Overall, Jerusalem noted that the Big Six banks “rather successfully” weathered a difficult second quarter – which saw stock and bond markets decline.
Lower credit reserves are a key factor, he said.
“One of the main reasons the banks beat earnings expectations this quarter was that the group collectively reduced its loan loss provisions,” he said.
The release of provisions for loan losses boosts earnings per share, Jerusalem said, but also reduces the bad debt cushion. Banks could afford to release provisions after realizing they were “too conservative at the height of Covid fears,” he said, and after coming to grips with the aftermath of the Russia-Ukraine conflict.
CIBC and Scotiabank are the most conservative, he said, while TD and Royal Bank are relatively aggressive in their assumptions.
Another theme for the period ended April 30 was higher spending. Jerusalem attributed this to competition for talent and higher labor costs, as well as inflationary pressures across all aspects of the spending line. For example, although business travel is nowhere near pre-pandemic levels, banks are seeing these spending items normalize once the economy reopens.
On the flip side of higher spending is higher growth, which is higher credit growth, Jerusalem said.
Jerusalem said any slowdown in residential mortgage growth will be offset by other types of unsecured consumer credit, particularly very strong commercial credit growth. Additionally, commercial and unsecured personal loans should provide “tailwinds to net interest income.”
Margins have also increased thanks to higher interest rates, which is generally positive for banks.
Net interest margins increased by an average of six basis points during the quarter.
“The net impact of higher spending, but even higher pre-provision pre-tax profit growth, is a positive operating leverage we’ve seen at most banks this quarter,” he said
Even TD, which Jerusalem says is typically the most interest-rate sensitive, has seen particularly strong growth in this regard.
Finally, Jerusalem said that although CET1 ratios for the group fell 20 basis points quarter-on-quarter, capital levels remained strong.
“Levels remain reasonably healthy, well above any regulatory minimums, leaving plenty of ammunition for further dividend increases,” he said.
Five of the big six banks increased their dividends this quarter. The exception was TD as they are instead trying to raise capital to fund their purchase of First Horizon, Jerusalem said.
Still, Jerusalem said there was a clear demarcation between winners and losers this quarter.
National Bank, Scotiabank and BMO delivered the best overall Q2 results, Jerusalem said, followed by TD Bank, CIBC and Royal Bank.
However, he said that CIBC and Royal Bank offer two of the most defensive banking positions in these volatile markets.
Overall, the group trades at about 10 times earnings, offers dividend yields of nearly 4%, and a history of outperforming the market, and as such remains “a worthwhile place for long-term equity investors,” Jerusalem said.
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