Canadian Bank Q3 Results

Here's how the banks did this quarter

Eric Compton 26 August, 2020 | 8:30AM

Bank Locker

CIBC Sees Middle-of-the Pack Profitability
But capital is still strong

Capping off a strong quarter of earnings for the Canadian banks, narrow-moat-rated Canadian Imperial Bank of Commerce (CM), also called CIBC, reported decent third-quarter earnings, with EPS down 13% year over year and an adjusted return on equity of 12.9%. The EPS decline was roughly middle of the pack for peers, as adjusted preprovision revenue was up 1% year over year and provisioning declined to $ 525 million, from $ 1.4 billion in the second quarter, although provisioning was still elevated compared with $ 291 million in the third quarter of 2019. Net interest income was up 2% despite declining net interest margins, and fee income was down 3% year over year. The bank’s common equity Tier 1 ratio improved to 11.8% from 11.3% last quarter. Overall, the theme this quarter for the Canadian banks, CIBC included, is that credit costs are already receding, while revenue is generally holding up well. Pressure on retail and commercial banking revenue has been offset by strength within capital markets and wealth operations. While we don’t expect record capital market activity to continue indefinitely, depending on future economic developments, fee income could continue to recover, and provisioning could continue to recede. CIBC appears to have a manageable level of what we would consider higher-risk lending exposures, namely energy and industries most affected by COVID-19, at just under 5% of total loans, while the bank’s reserve levels are relatively in line with peers who have similar exposure levels. As we incorporate third-quarter results into our projections, we do not plan to materially change our fair value estimate of $ 117 ($85).

As we have seen with peers, the initial deferral stats generally look promising, although we are admittedly still in the earlier stages of the process. We'll know a lot more by the end of the year. Deferral balances have decreased materially for CIBC’s Canadian personal lending and business banking loan portfolios, and the bank reports that nearly all credit card accommodations that have been completed and have returned to normal payments. Impaired loans have continued to trend higher, but the increases have been within a predictable range, while write-offs haven’t really materialized just yet, although we would expect writeoffs to trend higher for the foreseeable future.

On a segment level, personal and business banking saw year-over-year declines in net income as provisioning continued to eat up profits. Lower net interest margins helped spur a decline in net interest income of 6% while lower economic activity helped drive fees lower by 13%. Lower rates are likely here to stay, and while there are mixed economic signals, there are some positive signs within that mix, which could aid a continued recovery in fees. Provisioning affected the U.S. commercial and wealth segment, driving net income down 64%, although top-line revenue is generally holding up, up 1% year over year, while expenses were controlled, down 4%. The Canadian commercial and wealth segment had a similar story, with preprovision earnings up 1%, and higher provisioning helping drive a decline in net income of 7%. The capital markets group recorded another record quarter, and net income was up 67% year over year. As we have said, record quarters can’t continue indefinitely, but the segment has provided a nice cushion while other segments have come under pressure.



Provisioning Still Eating Into TD’s Profits
But costs are receding and capital is solid

Capping off a strong quarter of earnings for the Canadian banks, wide-moat rated Toronto Dominion (TD) reported less robust third-quarter results, with EPS down 30% year over year and return on equity coming in at 10.4%. The earnings decline was the second worst result we saw this quarter, behind Scotiabank. TD's provisioning remained a bit more elevated than peers, and revenue, while growing 2% year over year, didn't come in as strong as some of its peers. The bank's U.S. retail segment reported a 7% year-over-year decline in revenue, while the Canadian retail segment was down 2% year over year. The bank also disclosed that 7%-8% of its loan book is within industries (including energy) that are more likely to be negatively affected by COVID-19, which is a bit higher than peers, although still a manageable level in our view (especially as many of the U. S. banks that we cover are closer to the 10% range).

While there was some relative weakness in results, the overall theme this quarter for TD and the other Canadian banks was that credit costs are already receding while revenue is generally holding up. Meanwhile, what pressure there has been on retail and commercial banking revenue has been offset by strength within capital markets and wealth operations, and the ratios for provisions for credit losses have declined across the board. While we don't expect what has been a record level of capital market activity to continue indefinitely, fee income should continue to recover and provisioning should continue to recede (assuming a return to a more normalized economic environment). TD's reserve levels are some of the highest among its peers, and the firm has a good underwriting history along with the highest relative capital levels, leaving the bank well positioned, in our view, to manage through the pandemic-driven downturn. As we work to incorporate third-quarter results into our model, we do not anticipate materially changing our fair value estimate of $ 80.

As we have seen with TD's peers, the initial deferral stats generally look promising, although we are admittedly still in the earlier stages of the process. We'll know a lot more by the end of the year. Deferral balances have generally declined for TD, although they still remain at roughly 6% of total loans. Impaired loans have continued to trend higher, but the increases have been within a predictable range, while write-offs haven't materialized just yet, although we would expect write-offs to trend higher for the foreseeable future. Many management teams have commented that impairments and write-offs will largely be a 2021 event, with current reserves hopefully enough to absorb these future credit costs.

On a segment level, Canadian retail banking saw a yearover-year net-income decline of 33% as provisioning continued to eat up profits. Lower net interest margins also led to a 7% decline in net interest income, while the wealth and insurance units within the segment helped drive fees higher by 3%. Lower rates are likely here to stay, and while there are mixed economic signals, there are some positive signs within that mix, which could aid a continued recovery in fees.


Earnings Stabilize for Royal Bank of Canada in Q3
Thanks to lower provisioning and top-line growth help

Wide-moat Royal Bank of Canada (RY) reported good fiscal third-quarter results, all things considered. The strain from provisioning was much lower in the third quarter compared with the second quarter, and adjusted diluted EPS was only down 1% year over year, at $ 2.23 per share. Pre-provision net revenue growth was 6%, showing the resiliency of core revenue, while provisioning came in at $ 675, up roughly 60% year over year but down significantly compared with the $ 2.8 billion second quarter provisioning charge. Return on equity was a strong 15.7%. The trend in provisioning was better than what we saw for BMO and Scotiabank, and more in line with what we have seen with National Bank of Canada, which reported on the same day as RBC and also saw its provisioning decline materially in the third quarter. We were largely expecting the high-water mark for provisioning to be in the third quarter for most banks, so this has been a pleasant surprise, and management called this out last quarter, predicting second quarter would be the high point. Of course, the ultimate question remains, “is RBC adequately reserved?” With roughly 6%-7% of total loans estimated to be more sensitive to the impacts of COVID-19, the bank has a slightly higher estimated exposure here, while the ratio of loan loss reserves to gross loans is a bit above NBC’s and BMO’s ratios and behind Scotiabank’s (not unexpected given Scotiabank’s unique international footprint and loan exposures), so we don’t see an obvious imbalance. RBC’s common equity Tier 1 ratio remained strong, increasing to 12% from 11.7% last quarter. Internal capital generation was the primary driving factor, and lower risk weighted asset amounts also helped. Given RBC’s strong earnings profile and current reserve levels, we think it remains well positioned to weather the COVID-19 storm. As we incorporate third-quarter results into our projections, we do not plan to materially change our fair value estimate of $ 112 (USD 81).

Deferral stats are generally encouraging, but are admittedly still in their early stages, as the majority of deferrals still have yet to expire. Most deferral balances will have had a chance to expire by the end of fiscal 2020. Still, with roughly $ 23 billion of deferrals having expired so far, out of the roughly $ 57 billion offered, roughly 80% of deferrals that have expired have resumed regular payments, 19% have extended their deferral arrangement, and only 1% moved into delinquency.

On a segment level basis, personal and commercial banking saw net income decline roughly 18% year over year, as lower net interest margins and fee income weighed on top-line results, provisioning remained higher year over year, and expenses were up roughly 1%. We wouldn’t be surprised to see fee income gradually recover, and data shows debit and credit card volumes gradually improving in certain categories, such as dining and entertainment. Wealth management also saw the impact of lower rates and higher provisioning, as net income was down 12% year over year. Assets under management still saw good growth of 13% year over year, and we would expect earnings to improve for this segment. Insurance net income was up 6% year over year, and capital markets saw net income increase 45% year over year. The record volumes in capital markets can’t continue forever, but they have been a nice offset as other segments have faced pressure.



National Bank of Canada Stabilizes EPS in Q3
Top-line growth and lower provisioning help

Narrow-moat National Bank of Canada (NA) reported good fiscal third-quarter results, all things considered. The strain from provisioning was much lower in the third quarter compared with the second quarter, and diluted earnings per share came in flat year over year at $1.66. Flat EPS is a remarkable feat considering the economic backdrop. Preprovision net revenue growth was 5%, showing the resiliency of core revenue, while provisioning was $143 billion, up roughly 66% year over year but down significantly from the $504 billion provisioning charge in the second quarter. Return on equity was a strong 17% as NBC turned in a performance that will once again likely be at the top of the Canadian banks.

The trend in provisioning was better than what we saw for BMO and Scotiabank and more in line with Royal Bank of Canada, which reported its third quarter on the same day as NBC and saw provisioning decline materially. We were largely expecting the high-water mark for provisioning to be in the third quarter for most banks, so this has been a pleasant surprise. Of course, the ultimate question is whether NBC is adequately reserved. With roughly 4% of total loans estimated to be more sensitive to the impacts of COVID-19, the bank has one of the lowest estimated exposures here, and its ratio of loan-loss reserves to gross loans isn’t far behind peers, so we don’t see an obvious imbalance.

Given NBC’s resilient earnings profile, current reserve levels, and the more limited higher-risk credit exposures, we think the bank remains well positioned to weather the COVID-19 storm. As we incorporate third-quarter results into our projections, we do not plan to materially change our $74 fair value estimate. The market price has moved back to within a couple of dollars of our fair value estimate, reducing the likelihood of future outperformance, in our view, after gaining over 80% since the bottom in late March.

NBC’s common equity Tier 1 ratio remained steady at 11.4%. NBC was still seeing risk-weighted asset expansion during the quarter, something peers did not have to deal with; otherwise, NBC’s CET1 ratio could have increased. Deferral stats have generally been encouraging, with 98% of expired retail real estate-related deferrals resuming regular payments upon expiration of their deferral. Deferral balances have also been declining materially, particularly in the retail lending programs, dropping from over $9 billion in the second quarter to roughly $3.7 billion in the third quarter. Roughly 5.6% of total loans remain in some state of deferral, and nonretail deferrals have remained at roughly the same level since last quarter, but the initial stats have been encouraging.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Bank of Montreal97.76 CAD0.44
Bank of Nova Scotia66.40 CAD0.38
Canadian Imperial Bank of Commerce110.32 CAD0.24
National Bank of Canada72.08 CAD-0.70
Royal Bank of Canada105.84 CAD-0.52
The Toronto-Dominion Bank70.67 CAD-0.16

About Author

Eric Compton

Eric Compton  Eric Compton is an equity analyst for Morningstar,

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