Canadian Bank Earnings Q2 Recap

Solid interest income, but rising expenses marked second-quarter earnings for the big six banks in Canada.

Michael Miller 31 May, 2024 | 2:11PM
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Toronto Financial District

It was a pretty mixed quarter with some firms like Royal Bank of Canada performing quite well while other struggled, most notably Bank of Montreal.

Credit costs continue to rise with provisioning expenses increasing materially sequentially. The quarter also featured higher impaired loans as a percent of total loans nearly across the board as credit performance continues to deteriorate. We expect this to be an ongoing theme in 2024, though we don’t think losses will become that severe and the banks are in a strong financial position.

Higher credit costs were partially offset by strong capital market revenue as higher equity and debt origination activity drove stronger corporate and investment banking results. That said, capital market revenue can be volatile quarter to quarter, so we generally caution against reading too deeply into the growth rates seen in these business lines.

Net interest income for Canadian banking was generally solid across the board but the U.S. operations of some firms faced tough competition for deposits which compressed net interest margins. This was particularly noticeable in BMO’s results, which were impacted by a 26% decline in net income from its U.S. personal and commercial banking business.

Interest rate cuts would likely put downward pressure on the banks’ net interest income. While net interest margins have been facing some pressure from competition for deposits, the banks do broadly generally benefit from higher interest rates. The stated interest rate sensitivities of the bank’s point to lower interest income in the event of a BOC cut. That said, lower interest rates could alleviate some of the pressure on borrowers, which would help some of the credit quality deterioration we are seeing.

 

Morningstar’s Key Stats for Bank of Montreal

Narrow-moat-rated Bank of Montreal reported second-quarter earnings that were a bit worse than we had expected, as rising credit costs and weakness in the firm's US banking business placed downward pressure on bottom-line results. Adjusted net revenue increased 2.5% from last year and 1.8% from last quarter to CAD 8 billion. Meanwhile, adjusted earnings per share was CAD 2.59, 10% lower than last year. While these results were moderately disappointing, they do not change our thesis for the firm, and we do not expect to materially alter our CAD 134/USD 101 fair value estimate.

Like last quarter, the bank’s credit results were poor, with provisioning for credit losses increasing 12.4% from last quarter and 122% from last year to CAD 705 million. Unlike last quarter, most of the increase came from higher allowances on impaired loans, reflecting a deterioration in credit performance. Gross impaired loans increased 14 basis points from last quarter to 0.79% of total loans, which is nearly double what it was last year. New impaired loan formations during the quarter were CAD 1.99 billion versus CAD 843 million last year, with the bank’s US business being responsible for most of the increase. That said, we were projecting a material increase in credit costs in 2024, so this was not entirely unexpected, though the rate of deterioration is a bit faster than we had anticipated, which will bear monitoring.

The bank’s US personal and commercial lending business reported weak results, with revenue falling 7% from last year. The primary driver behind the decline in revenue was lower net interest income, which was affected by both lower loan balances and a narrower net interest margin. Loan balances fell 3.6% from last year, and we expect loan origination to remain constrained while credit results continue to deteriorate. On the other hand, the division’s net interest margin fell 10 basis points to 3.76%, primarily because of continued pressure on deposit pricing.

 

Morningstar’s Key Stats for Bank of Nova Scotia

Narrow-moat-rated Bank of Nova Scotia reported solid fiscal second-quarter results that were largely in line with our expectations. Net revenue increased 5% year over year and decreased 1% from last quarter to CAD 8.3 billion, with fees and net interest income both contributing to the growth. Adjusted net income fell 3% from last year and 5% from last quarter to CAD 2.1 billion. The annual and sequential decreases were primarily driven by the bank’s credit provisioning expense, which was CAD 1.01 billion versus CAD 709 million last year and CAD 962 million last quarter. As we incorporate these results, we do not plan to materially alter our CAD 70/USD 52 fair value estimate. We see the shares as only slightly undervalued.

We still expect credit to remain a headwind for the bank’s earnings growth in 2024, in line with management's updated guidance for higher credit costs in the remaining quarters of 2024. The second quarter’s sequential increase in provisioning was mostly driven by impaired loan balances and, to a lesser extent, performing loans. Provisioning for impaired accounts increased to CAD 975 million from CAD 942 million last quarter. The increase in impaired loan provisioning was mostly driven by the Canadian retail portfolio of variable-rate mortgages and auto, as high interest rates continue to pressure the bank’s Canadian business as well as its international business. Net write-offs increased 61% from last year and 11% sequentially to CAD 889 million. That said, economic expectations for Scotiabank’s core markets have improved, and the bank has a strong balance sheet, with a common equity Tier 1 ratio of 13.2%. While we do expect credit costs to keep increasing in the near term, we project that the bank will be able to handle this in stride.

 

Morningstar’s Key Stats for Royal Bank of Canada

Wide-moat-rated Royal Bank of Canada reported solid second-quarter earnings as strong results, particularly in the bank’s capital markets segments, offset rising credit costs. Net revenue increased 13.7% from last year and 5% from last quarter to CAD 14.15 billion, though this does include CAD 245 million in incremental revenue from the acquisition of HSBC Canada at the end of March. Meanwhile, adjusted diluted earnings per share increased 9% from last year to CAD 2.92, which translates to a return on equity of 15.5%. As we incorporate these results, we do not plan to materially alter our CAD 134/USD 101 fair value estimate.

Unlike last quarter, the bank enjoyed solid net interest income growth, with net interest income increasing 9% from last year to CAD 6.6 billion, inclusive of CAD 179 million in incremental income from HSBC Canada. The increase was mainly driven by high loan balances, with average earnings assets rising 10% from last year. On the other hand, the firm’s net interest margin was relatively stable, falling 3 basis points from last year to 1.5%, though this was a 9-basis-point improvement sequentially.

Credit remains a headwind as Royal Bank of Canada's provisioning expense increased 53% to CAD 920 million from an unusually low-level last year. This does include CAD 217 million of provisioning associated with acquired loans. The increase was primarily driven by provisioning on impaired loans as, like its peers, the bank is seeing deterioration in credit metrics. Gross impaired loans rose to 0.55% of total loans from 0.48% last quarter and 0.34% last year. Additionally, new formations of impaired loans were CAD 1.7 billion, solidly above normal levels. We continue to expect credit costs to be a headwind for the bank and its peers as high interest rates put pressure on credit quality. That said, Royal Bank of Canada's balance sheet is well provisioned, and the firm should be able to take rising credit losses in stride.

 

Morningstar’s Key Stats for The Toronto-Dominion Bank

Wide-moat-rated Toronto-Dominion Bank reported solid underlying second-quarter results that were marred by a variety of restructuring- and acquisition-related expenses, as well as a CAD 615 million provision for potential losses as the bank's anti-money laundering, or AML, practices are investigated by regulators. Revenue increased 11% from last year and 1% from last quarter to CAD 13.8 billion. Meanwhile, diluted earnings per share decreased 20% to CAD 1.35. However, adjusted for the AML provision as well as other restructuring and acquisition expenses, adjusted earnings per share increased 7% to CAD 2.04. As we incorporate these results, we are reducing our fair value estimate for Toronto-Dominion bank to CAD 90/USD 66 from CAD 92/USD 69 as we incorporate higher losses and more ongoing compliance expenses into our model. Even with the decrease, we still see the shares as undervalued at the current price.

The decrease in our fair value estimate primarily comes from a CAD 5.5/USD 4 negative adjustment from our new base assumption of CAD 1 billion in losses from the bank's AML issues as well as an incremental CAD 300 million in ongoing expenses as the firm hires new personnel and improves its compliance. This negative adjustment was partially offset by earnings since our last update and other small adjustments to our model.

Net interest income was effectively flat from last year at CAD 7.5 billion. That said, the Canadian banking segment continues to show strong performance, with interest income increasing 12.9% from last year to $3.8 billion. The increase came from both solid loan growth and net interest margin expansion, which increased to 2.84% from 2.74% last year. Stagnant companywide net interest income was offset by strong noninterest income, which increased 27.9% from last year to $6.3 billion.

 

Morningstar’s Key Stats for National Bank of Cananda

Narrow-moat National Bank of Canada reported decent fiscal second-quarter results. Net revenue increased 12% year over year and 1% from last quarter to CAD 2.8 billion. The bank also delivered positive operating leverage, as expenses increased 8% year over year. Adjusted net income increased 9% from last year and decreased 2% from last quarter to CAD 906 million. Credit provisioning expenses increased 4% to CAD 138 million versus CAD 120 million last quarter. As we incorporate these results, we do not plan to materially alter our CAD 105 fair value estimate. We see the shares as moderately overvalued and think some of the bank's larger Canadian peers present more-attractive opportunities.

Despite relatively better provision costs this quarter than some larger peers, we still expect credit to be a headwind for National Bank's earnings growth in 2024. Provisioning for impaired loans increased 15% sequentially to CAD 114 million from CAD 99 million last quarter. On the other hand, provisioning on performing loans decreased 19% year over year and 27% sequentially. We view changes in provisioning on performing loans as typically driven by changes in projections or economic assumptions, not credit results. Gross impaired loans went up 44% from a year ago to CAD 1.7 billion, driven by the 89% increase in commercial gross impaired accounts. Management commented on lumpy impaired loan new formations in transportation, wholesale trade, and the commercial real estate sectors. Moreover, net write-offs increased 232% from last year and 55% sequentially to CAD 146 million, as there are clear signs that high interest rates are having an impact on credit quality in the bank’s Canadian and US businesses. That said, we already expect credit costs to keep increasing in the near term, and we project that the bank will be able to handle this in stride. National Bank also has a strong balance sheet, with a common equity Tier 1 ratio of 13.2%.

 

Morningstar’s Key Stats for Canadian Imperial Bank of Commerce

Narrow-moat-rated Canadian Imperial Bank of Commerce, or CIBC, reported decent fiscal second-quarter earnings that were largely in line with our expectations, as solid fee results helped total revenue. Adjusted net income, which excludes the benefit of a CAD 51 million income tax recovery related to a dividend-related tax change proposal, increased by 6% from a year ago to CAD 1.7 billion. Adjusted earnings per share were CAD 1.75, representing an increase of 3% year over year and a decrease of 3% quarter over quarter. Given that second-quarter results and management's outlook all largely align with our previous views of CIBC, we maintain our current fair value estimate of CAD 64/USD 48, and we view shares as fairly valued.

Credit costs were better than peers, as CIBC's provisioning expense increased 17% year over year but decreased 12% from a quarter ago to CAD 514 million. The sequential decrease in provisioning was mostly driven by a 9% decline in impaired loan provisioning. This was partly due to the bank selling a US office commercial real estate, or CRE, loan portfolio that contained seven impaired loans and one performing loan. CIBC reduced its US office CRE loan exposure by 11% from a quarter ago to CAD 3.1 billion, representing below 1% of the bank's total loans.

On the other hand, provisioning on performing loans increased 14% year over year and decreased 28% sequentially to CAD 93 million. Net write-offs increased 171% from last year and 40% sequentially to CAD 621 million, as there are signs that high interest rates are having an impact on credit quality in the bank's Canadian and US businesses. That said, economic expectations for CIBC's core markets have improved and the bank has a strong balance sheet, with a common equity Tier 1 ratio of 13.1%. While we expect credit costs to keep increasing in the near term, we project that the bank will be able to handle this.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Bank of Montreal114.97 CAD0.10Rating
Bank of Nova Scotia63.65 CAD-0.08Rating
Canadian Imperial Bank of Commerce65.15 CAD-0.24Rating
National Bank of Canada106.21 CAD-0.21Rating
Royal Bank of Canada142.28 CAD-0.41Rating
The Toronto-Dominion Bank73.88 CAD-0.87Rating

About Author

Michael Miller  is an equity analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

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