Bank Earnings Overview
Before I get into the individual earnings of each bank, I figure I’d give the lowdown on the trends we’re seeing from the economy and the Big 6 overall.
The most surprising element for me is the resiliency of the Canadian economy. Although particular banks struggled, all six reported exceptional strength in their Canadian segments.
This has surprised many investors and analysts, as the Canadian economy is not in good shape from an overall growth standpoint. However, all 6 banks continue to drive strong loan, deposit, and earnings growth.
The interesting element now is the idea that it is, for the most part, the paths the banks have decided to head down in terms of expansion and growth that are causing them to struggle, or in the case of National Bank, CIBC, and Royal Bank, thrive.
For many years, the assumption made with Canadian banks was that they were the same types of institutions, sheltered by a Canadian oligopoly that made them immune to competition. However, one thing is clear now: the banks with lower levels of Canadian exposure and growth verticals outside the country are struggling.
Whether this remains in the future is impossible to predict. But there is zero doubt this is what is happening right now.
Individual bank earnings
If I could sum up all 6 banks earnings, it would go as follows:
The Good: Royal Bank, National Bank, Canadian Imperial Bank of Commerce
The So-So: Bank of Nova Scotia
The Bad: Toronto Dominion Bank
The Ugly: Bank of Montreal
If you were a member at the start of the year, you likely remember I ended up selling my positions in Bank of Montreal and Toronto Dominion after a few unsettling situations came to light. One is the Bank of Montreal’s continued acceleration of provisions for credit losses, and the other is Toronto Dominion Bank’s anti-money laundering scandals.
Both of these issues have weighed heavily on the banks over the last 3 quarters, and a turnaround, at least over the short term, doesn’t look likely.
For this newsletter, instead of writing a long, drawn-out earnings summary of each institution, I’m instead going to focus on key performance indicators of all the banks and go more in-depth on the areas that matter.
Let’s kick it off with arguably the most important element: earnings.
Earnings per share
Before I begin, an explanation of the chart above. The first row is simple: the company’s 2023 earnings per share.
The middle row represents what analysts predicted the bank’s earnings per share would be at the start of the year.
The third row represents what analysts believe the company’s earnings per share will be in 2024 based on their most recent quarterly report.
Optimally, you want to see green in the chart above, as it represents not only earnings growth over 2023 but also that estimates are guiding upwards since the start of the year, not downwards.
When we look to the banks’ earnings on a quarterly basis, three of them missed expectations, BMO, TD, and Scotiabank, while the other 3 topped expectations.
As explained, the chart above doesn’t necessarily speak on the quarterly earnings from the banks themselves, but more so future expectations. I believe this type of data will be more relevant to investors, as trailing earnings don’t really tell us all that much about future results.
In addition to this, with the Canadian banks being so reliable from an earnings perspective, analysts are able to predict their earnings with a high level of accuracy, barring any significant surprises.
The Bank of Montreal was the only real bank to report a large surprise this quarter, which was much higher than expected provisions for credit losses, which we’ll get to further on in this newsletter.
For this reason, we see the company witness a 9% downgrade in terms of expected earnings per share this year. Initial expectations were for the bank already to report a year-over-year decline in earnings, but with the most recent numbers, the bank is expected to report a 12.5% decline in year-over-year EPS.
In terms of Toronto Dominion and Scotia, flat earnings are expected. This has been a relatively common situation from Scotiabank for a few years now, but Toronto Dominion is surprising.
The anti-money laundering situation is starting to weigh them down. Although operations are relatively strong, I’d expect this situation to persist until the end of the year, at minimum.
The clear standouts operationally through the first 3 quarters are Royal and National Bank. So, it’s really not all that surprising to see that they’ve received material projected earnings upgrades through 3 quarters.
What to take from this information
There is a large-scale trend among Canadian banks thus far in 2024:
The ones with higher exposure to Canada are excelling, while those with larger international growth verticals are struggling.
It is extremely difficult to try to predict why this is happening, but we can make a few assumptions. For one, the Bank of Canada reduced interest rates before the Federal Reserve. This has likely accelerated Canadian borrowing over the short term.
Although this trend will likely end as the Federal Reserve is all but guaranteed to cut rates at their next meeting, we will also likely continue to see the Bank of Canada cut rates moving forward, which could fuel more borrowing amid cheaper rates.
In addition, although Canadians will be receiving a bit of relief regarding mortgages due to the 50 basis points of cuts thus far, renewed pandemic mortgages will certainly still come in at higher rates, ultimately resulting in more interest income from those mortgages.
Provisions for credit losses
In the chart above, I’ve highlighted the company’s provisions in the third quarter of last year and the second quarter of this year, as well as its most recent provisions for credit losses.
The simplest explanation possible for provisions for credit losses: It is money the bank sets aside for loans it expects to go unpaid. These can be either impaired loans (borrower has had some form of missed payment) or performing loans (loan is being paid but at high risk of going unpaid).
Provisions are taken out of a bank’s net income, meaning if a bank reports a net income of $5B and has provisions for $1B, the bank’s reported net income is $4B.
One of the most important guides I can give investors when it comes to provisions for credit losses is to focus on sequential (quarter-over-quarter) numbers and largely ignore year-over-year numbers. In the case of the chart above, it would be the middle row compared to the bottom row.
Year-over-year provisions have somewhat of an impact when we’re in a normal economic environment. However, the difficulty with provisions at this point is how different of an economy we were in just one year ago.
Remember, rates are 50 basis points lower. The banks are also starting to get a much better idea of their overall loan situation. Whereas, in 2023, it was largely unknown whether the Bank of Canada would continue to raise and if inflation would persist.
When we look to quarter-over-quarter provisions, we want to see one thing at this point: stabilization.
Practically every bank outside of Bank of Montreal reported this. You’ll notice that I also highlighted National Bank in red, as they did report a single-digit boost to provisions over the course of the year.
However, because they are in a much better situation relative to total provisions compared to their entire loan book, I still view the provisions on the quarter as a good sign.
As we see from the institutions highlighted in green, they either reported a QoQ decline in PCLs or they at least remained relatively steady, which starkly contrasts the large-scale increases we’ve witnessed for the last 3-4 quarters.
I’ll focus primarily on the Bank of Montreal here, as they posted the most alarming numbers. There is no sugar-coating this one; the bank’s provisions have been borderline ugly over the last 2-3 quarters.
The bank reported a 28% increase in quarter-over-quarter provisions. The next largest increase was National at 7%~.
Not only is the increase concerning, but most analysts pegged the bank’s provisions on the quarter to come in around $705M. This is the third consecutive quarter that Bank of Montreal has reported significantly higher provisions than expected.
What to take from this information
Mostly, the reported provisions on the quarter from 5 of the 6 banks were positive. We’re seeing a bit of stabilization, and in the case of Royal Bank and CIBC, even a quarter-over-quarter reduction in reported provisions.
Many investors may be optimistic the banks could see a recovery in PCLs over the next year, with a recovery meaning they’re taking provisions and adding them back into net income.
Many have this idea because of the COVID-19 pandemic. Banks reported large-scale provisions at the start of the pandemic but inevitably didn’t need all of them, resulting in outsized earnings growth in 2022.
However, the one thing to keep in mind this time is that many of those loans were performing, meaning it was highly cautionary. Whereas this time, the bulk of provisions are impaired.
At this point, it is too early to be talking about recoveries when it comes to provisions. My main focus on the analysis of the banks at this point is stabilization and a reduction in overall provisions.
Outside of the Bank of Montreal, we’re seeing this. With BMO, the struggles in its US segment are certainly real. The company has significant exposure to commercial real estate south of the border, making up a big chunk of its struggles at this time.
As mentioned, I sold my BMO position closer to the start of the year. I need to see more stabilization before I’d ever consider re-entering at this point.
Dividends
The chart above highlights every one of the banks’ payout ratios as of the most recent quarter. Typically, banks aim to pay out anywhere from 40%-50% of their earnings towards a dividend.
Once we see levels start to creep up above 60% for an extended duration, we can begin to worry about the potential lack of dividend growth and, secondly, worry about the potential for a dividend cut.
The dividend section for this quarter will be relatively short. That is because none of the major 6 banks raised dividends on the quarter. In fact, the only bank in the country to raise the dividend this quarter was none other than Bull List stock Equitable Bank.
Instead, I’ll focus on the quality of the dividends from a payout ratio standpoint and give some comments on future dividend growth.
I’d like to first highlight the concerning payout ratio for Toronto Dominion Bank. Because of the extensive fines in terms of the company’s anti-money laundering scandal, it is highly likely the company’s payout ratio will hover around this high until the fines are done with and earnings can begin to normalize.
I do not believe TD Bank is at any risk of a dividend cut. Even if fines continue to escalate and this company does pay out a large portion, or even 100%+ of earnings, the fines are short-term in nature, and the company will find a way to navigate around its current dividend.
However, one thing this could certainly impact is TD Bank’s dividend growth. The company typically raises its dividend at the end of the year, and it will be interesting to see if they do so in Q4 results of this year. I would not be shocked if they didn’t.
Regarding Scotiabank, the company has not raised the dividend since early 2023. If there is any growth in 2024, I’d expect it to be a miniscule raise. The company’s current payout ratio and lack of earnings growth do not warrant any sort of dividend growth.
Outside of that, most of the banks are in a strong position to raise the dividend moving forward. However, I would not be surprised if these dividend raises either don’t happen or come in much lower than historical averages due to banks taking a cautious approach to the current economic environment.
My thoughts on each individual bank’s quarter, summed up in a couple sentences
Royal Bank: A premier performer, and its operations as of late have highlighted why it has been a Canadian Foundational stock for 4 years. Its Canadian arm is strong, it has one of the best underwriting teams in the country, and continued brand strength should allow it to benefit from economic tailwinds in Canada due to rate declines.
National Bank: Much like Royal, the company is in a great position to benefit from rate declines here in Canada and isn’t facing the same headwinds many of the other banks are, that being stalled out US segments. I still believe this is the bank that is best positioned to grow out of the Big 6.
Canadian Imperial Bank of Commerce: A remarkable turnaround for the company. I will admit, even I was worried about CIBC’s situation a year ago when provisions for credit losses were sky-high. However, this looks to be an overly cautious move by the bank. We’re now seeing provisions come in drastically lower than last year, which should provide a tailwind for the company in terms of earnings growth.
Toronto Dominion Bank: The bank is operating fine, but the difficulties of the anti-money laundering situation are likely to stick around for quite some time. Until there is more clarity on the fines and potential penalties for the bank from US regulators, I’m staying away at this point in time.
Scotiabank: A fairly strong quarter in relation to what it is used to posting. However, the difficulty here is the bar has been set relatively low for a bank like Scotia. I’d need to see the company string together consecutive quarters of strong results before I’d ever consider it inside my portfolio.
Bank of Montreal: The company has been going through an extensive rough patch over the last 3 quarters, with provisions for credit losses ballooning and the company facing some tough operating results in the United States. The Bank of Montreal is likely to trade at discounted valuations relative to the other banks until its provisions start to normalize and its US operations pick back up. I’d rate it a firm hold at this point in time.