Ruth Saldanha: With the large Canadian banks all announcing mixed quarterly earnings this past week, how should you play the space right now? Morningstar analyst, Eric Compton, covers this space, and he is here today to tell us his views.
Eric, thank you so much for being here today.
Eric Compton: Yeah. Thanks for having me.
Saldanha: So, how are you reading the quarterly earnings for the big Canadian banks?
Compton: Yeah. So, earnings, they weren't great, they weren't terrible in some ways either. So, yeah, they're kind of mixed, so, like, as you introduced the question. So, some things are going well for them. Balance sheet growth is really good. Loan growth is really good. We've got a lot of the banks seeing quarter-over-quarter growth of 3% to 4%. A lot of the banks are going to turn in double-digit growth for the year. So, those are really solid results and that's driving along with rising interest rates good results for net interest income. So, the banks are seeing good net interest income growth this year, actually for the most part coming in ahead of our expectations.
However, the weakness comes about on the fee side. And so, investment banking has seen a really weak environment. Trading results often haven't been great for most of the banks. Because of lower market levels wealth-related results, which are often driven by asset levels, those are coming in a little bit weaker. And so, you're seeing good strength on the net interest income side, but a lot of weakness on the fee side. And so, that's that mixture you're seeing. And so, they haven't been great, but they haven't been absolutely terrible either. So, I'd say, that's kind of the flavour of earnings this quarter.
Saldanha: One of the things that's worrying Canadian investors is the fact that some of the banks have missed their quarterly estimates entirely. Are you at all worried about this?
Compton: Yeah. So, I don't usually get too caught up in the quarterly fluctuations. At Morningstar, we do try to (queue) to that long-term view. And so, quarterly earnings, they're going to fluctuate a bit. Diving a little deeper, kind of looking under the hood, the long-term trends we're seeing are that we think balance sheet growth is good right now, but we do expect that to slow a bit as rates rise, as the economy slows both in Canada and in the U.S. And so, we were already kind of expecting some of that slowdown. So, it doesn't change our view on that. If anything, things are coming in better than what we thought.
On the fee side, yeah, they're a little weaker than we expected. But again, in our modelling, we've got some of that cyclicality in there. And so, yeah, some of the quarterly misses, not something you want to see. But we think in the grand scheme of things, a lot of the fee misses are going to be cyclical, and then we already have a little bit more weakness economically in our models anyway. So, nothing too crazy just yet.
Saldanha: One of the things that's changed quite a bit from the last time we spoke in is Canadian real estate prices, which have corrected quite a bit over the past couple of months. Are you worried at all about this correction and what impact it might possibly have on the banks?
Compton: Yeah. So, the way we've always looked at it and the way we still look at it is, we look at it as a risk to future growth. And so, real estate prices coming down, it looks like they're starting to come down in the U.S. as well. We always have said there's going to be some buyer's remorse on some of these things. But the way we look at it is more as the consumer in Canada is levered up. They've had to become more levered up to purchase a lot of these properties, especially in these higher-priced real estate markets. And so, there's going to be less spending power in the future, so that's that risk to growth. But we don't view it as some sort of like existential 2008, 2007 style U.S. meltdown. And so, there's actually a lot of disclosure this quarter where the banks were talking about what percentage of loans are going to reprice and when, what that's going to mean for like the average mortgage payer in Canada. And yeah, the people are going to be paying more on their mortgages in the future, but it's nothing that would make me really worried for the safety of the Canadian financial system.
Saldanha: So, with all this said, what's your top Canadian bank pick and why?
Compton: So, we still like – I think we brought this up maybe last quarter – we still like National Bank of Canada. Again, they are one of the smallest banks in Canada we cover. So, they get a little less attention, which I think can lead to some of the discount. And we still like the valuation. They are still the cheapest name under our Canadian coverage, and we think they've got a couple of things that are going to go their way in the future. So, in this last quarter, their Credigy, kind of credit investment unit, its revenues were hit a little more than average just because of the market environment and some of the economic stress that's starting to show up. And so, we think that's kind of a little more cyclical. Eventually, that's going to reverse and go back their way. Assets under management are actually holding up fairly well for them despite the difficult market environment. So, we like the growth profile there for them. And they also have lower exposure to the highest-priced real estate markets. And so, overall, with their high return on equity and a decent, we think, top-line profile for revenues combined with the valuation, we still like how National Bank of Canada is positioned among the big six Canadian banks. So, yeah, I'm sticking with National Bank of Canada as top pick for now.
Saldanha: Great. Thank you so much for joining us with your perspectives, Eric.
Compton: Yeah. Thanks for having me.
Saldanha: For Morningstar, I'm Ruth Saldanha.
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