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Why Big Six bank stocks have barely moved after an impressive earnings season

Banks tower above pedestrians in Toronto’s financial district.

Kevin Van Paassen/Kevin Van Paassen/The Globe and

The stock market has delivered its assessment on the latest round of quarterly financial results from Canada's biggest banks: Whatever.

Share prices have barely stirred since Bank of Montreal kicked off the reporting season on May 24 and National Bank of Canada concluded it on May 31.

This is a curious response given that the Big Six reported higher year-over-year profits that generally exceeded analysts' expectations. Two banks also boosted their quarterly dividends, leaving investors with little to complain about.

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Yet investors do not seem particularly happy. On average, bank stocks are down more than 8 per cent since early March, and the sector has been underperforming the S&P/TSX composite index this year.

Why? Blame it on concerns about the Canadian housing market and a less optimistic assessment of U.S. economic growth – both of which are dampening enthusiasm for bank stocks, but may provide a good buying opportunity.

The banks' second-quarter results certainly underscored their financial strength. The Big Six reported a combined profit of more than $10-billion, up 22 per cent from a year earlier. Adjusted profit rose more than 15 per cent, according to numbers from Bloomberg.

Admittedly, the second quarter of 2016 makes for an easy comparison, given that the big banks this time last year were wrestling with bad loans to struggling energy companies.

Even so, five of the six banks sailed past analyst expectations for adjusted profit this quarter – BMO missed by a smidgen – and demonstrated that their core operations are still humming.

Royal Bank of Canada's domestic retail-banking division – home to bread-and-butter activities such as mortgages, credit cards and lines of credit – showed profit growth of 6 per cent. Profit at Toronto-Dominion Bank's comparable division rose 7 per cent.

As for those dividend increases, BMO and National Bank both bumped their respective payouts by two cents a share. Expect dividend increases from the other banks in the quarters that follow, given that most banks increase their payouts either once or twice a year.

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Investors, though, aren't impressed.

Some are clearly rattled by Canada's housing market. When Home Capital Group Inc., a lender that specializes in non-prime mortgages to home buyers with spotty credit histories, announced in April that it required a financial lifeline to offset fleeing deposits, skeptical observers saw warning signs and potential contagion to other lenders.

Perhaps this was an early sign that the frothy housing market, particularly in Toronto and Vancouver, was now claiming victims.

Bank analysts, however, point out that Home Capital's problems are likely confined to Home Capital. The lender operates in the non-prime space, while the banks focus on prime loans. And the lender's conflict with the Ontario Securities Commission over allegations that it was slow to disclose information about mortgage fraud – a potential trigger for the run on deposits – has no peer among the big banks.

The reappraisal of the U.S. economy is a more realistic threat. After Donald Trump's U.S. presidential election victory in November, investors were upbeat about the promise of relaxed financial regulations and a pro-growth agenda that would send U.S. interest rates higher, with knock-on effects for Canada.

U.S. banks, represented by the KBW Bank Index, surged 35 per cent between November and March. Canadian banks, on average, jumped nearly 20 per cent over the same period.

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Now, though, the White House is in disarray and the market appears to be losing some of its initial euphoria. The yield on the 10-year U.S. Treasury bond, which had risen as high as 2.6 per cent in early March in anticipation of higher interest rates – a boost to bank profits – has since fallen to about 2.2 per cent.

Similarly, Canadian bank stock prices are now back to early-December levels, and valuations have subsided.

According to John Aiken, an analyst at Barclays Capital, price-to-earnings ratios are now in line with their 20-year average, after being well above the historical average earlier this year.

That's not a bargain sell-off, but it makes banks look attractive at a time when they continue to post impressive results.

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