An announcement of mass layoffs at a Canadian bank is bad news for employees. For investors, though, it might not be such a bad thing.
This week, Bank of Nova Scotia BNS-T said it will terminate 3 per cent of its global work force, or about 2,730 jobs based on 2022 payroll numbers. All those severance packages come with a hefty price: The bank will take a $247-million charge (after tax) in its fiscal fourth quarter.
Some of the reasons for the cuts are tied to Scotiabank specifically.
It has a new chief executive officer, Scott Thomson, who took the helm on Feb. 1 amid hopes from investors that he will revive the laggard. Over the past three years, Scotiabank’s share price has trailed its Big Six peers by nearly 19 percentage points, putting pressure on the need for change.
As well, job cuts follow the bank’s approach to reducing its physical footprint as banking becomes more of an online service. Since 2019, the bank has closed more than 700 branches.
But Scotiabank isn’t alone here. Royal Bank of Canada RY-T announced similar cuts in August – 1 per cent out already; another 1 to 2 per cent coming; and some observers expect other banks will follow with cuts of their own.
“I think this is the first round. I think there is more to come,” Laura Lau, chief investment officer at Brompton Corp., said in an interview.
The chief reason for a sectorwide purge? Bank expenses have been rising at a faster clip than revenue, as inflation drives up salaries and rising borrowing costs weigh on loan growth.
Scotiabank offers a clear example of these trends. In its last quarterly financial results, for the three months ended July 31, the bank said that total revenue increased by 3.7 per cent year-over-year. But non-interest expenses, which includes salaries and benefits, increased by 8.9 per cent over the same period.
In the case of RBC, the bank reported that total revenue increased by 19.4 per cent in its fiscal third quarter, but expenses rose by 23.1 per cent. At Toronto-Dominion Bank TD-T, revenues rose 17 per cent, but expenses surged 24.4 per cent.
Bank efficiency ratios – calculated by dividing non-interest expenses by total revenue; lower is better – are deteriorating. Scotiabank’s efficiency ratio, for example, increased to 56.7 per cent in the first nine months of the fiscal year, up from 52.8 per cent in the same period last year.
One of the bullish arguments in favour of Canadian bank stocks is that the biggest banks have improved their efficiency ratios over much of the past decade, as they modernized their operations with beefed-up technology and gave customers more options for banking on computers and smartphones.
Efficiency setbacks challenge this bullish case, and they arrive at a time when banks are facing a number of obstacles this year.
Tougher regulations require them to hold more capital against downturns; borrowers are stretched, pushing banks to set aside more money to handle bad loans; and economic growth is faltering, in terms of gross domestic product, as high interest rates sap activity.
“Banks are basically a play on GDP growth, and if we don’t see much growth then it gets harder for the banks,” Ms. Lau said.
It sounds like a dismal environment, and in some ways it is. Shares of the Big Six banks have fallen more than 11 per cent, on average, over the past three months alone.
But the stocks are historically cheap, based on estimated earnings from analysts. And dividend yields have risen to 5.6 per cent, on average, reflecting how severely these stocks have been beaten up this year.
The announced layoffs – and the strong probability of more to come, as more banks address their rising costs – offer some hope for investors, though.
The job cuts suggest that the banks are getting serious about reversing their deteriorating efficiency ratios, which should put them on the right path when the economy improves.
Investors can look at the recent rebound in the technology sector for an example of what can go right.
After large tech companies, including Google-parent Alphabet Inc. and Shopify Inc., announced sweeping layoffs early this year, the sector found some stability. The tech-heavy Nasdaq Composite Index is up 26 per cent so far in 2023.
Within banking, the Big Six went through a rough patch in 2016, when lenders responded to weak economic activity and rising credit losses with large layoffs. Bank stocks rallied 37 per cent from February, 2016, to March, 2017.
No, job cuts aren’t a buy signal. But they are certainly no reason to sell.