Canada's big banks delivered upbeat third-quarter results, but investors aren't impressed. They should be.
It was a good quarter: Bank profits from the six biggest banks rose 6 per cent over the previous quarter and 11 per cent over the third quarter of last year. That's impressive for a big, mature sector.
The results were also quite clean, which is to say that they reflected what the banks' day-to-day operations can do, in contrast to some of the previous reporting seasons when results were complicated by notoriously volatile divisions or one-off divestments and provisions for credit losses.
And the third reason to applaud the results is because profits beat analysts' expectations, which suggests that the market might not be giving enough credit to the banks.
Robert Sedran, an analyst at CIBC World Markets, summed up the quarter this way: "Very good revenue growth, very good credit quality, very good earnings growth, and very good capital accretion. This combined with a very good valuation setup supports our positive stance on the banks at this time."
Yet, investors aren't keen on bank stocks right now. The sector is down 8.5 per cent from its high earlier this year. On average, the share prices have been flat in 2017, before factoring in dividends.
Bank of Montreal is the laggard, falling nearly 8 per cent this year and Canadian Imperial Bank of Commerce isn't far behind, sliding 5 per cent. Royal Bank of Canada is essentially flat, Toronto Dominion Bank is up all of 1 per cent and Bank of Nova Scotia is up less than 3 per cent. National Bank of Canada is almost 4 per cent on the year.
Worrywarts are no doubt concerned about the usual suspects.
Tighter mortgage regulations and rising mortgage rates appear to be acting as a brake on the housing market. Sales are falling and prices are retreating in key markets, raising concerns about a sharper downturn and its potential impact on the banks' underwriting activities and the quality of their loans.
More generally, the ebullience that greeted the Trump presidency and some of the U.S. administration's promises – stronger economic growth, less financial regulation and lower taxes – has given way to political infighting, another debt-ceiling imbroglio and rising conflict with North Korea.
As a result, U.S. and Canadian stock markets were pummelled on Tuesday, and Canadian bank stocks were caught in the downturn as their strong third-quarter results were swept aside.
However, investors should breathe in and buy.
Let's start with the most obvious selling feature: dividends. With stock prices going nowhere but quarterly payouts heading higher by an average of 7 per cent over the past 12 months, dividend yields look curiously rich. The average yield for the Big Six is an impressive 4.1 per cent.
Next, interest rates are going up. The Bank of Canada raised its key rate by a quarter of a percentage point in July, amid strong economic growth and as part of a global move toward unwinding the monetary stimulus that followed the financial crisis a decade ago.
Higher rates might cool the need for bank loans, but they are undoubtedly good for bank profits: Margins expand because banks can charge a higher rate of interest than they pay on deposits.
We'll hear more about the Bank of Canada's plans for rate increases on Wednesday morning, when it makes its next interest-rate announcement – but most observers believe that higher rates are coming this year.
And lastly, bank-stock valuations are compelling. According to Mr. Sedran's calculations, the stocks trade at 11.3 times his fiscal 2017 per-share profit estimates, which is cheaper than the historical average.
You can worry about North Korea or the latest tweet from the White House. And yes, Canadian consumers have a lot of debt and home prices in Vancouver and Toronto are still bubbly.
But these issues will simmer for some time, while the buying opportunity might not.