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Streetwise Why investors aren’t buying the banks’ earnings headlines

The logo of the Royal Bank of Canada (RBC) is seen on a building in Toronto June 11, 2015.

© Chris Helgren / Reuters

If there's one theme running through bank earnings so far this reporting season, it's this: No one is quite buying the numbers the banks are reporting.

The headlines look good, of course. Royal Bank of Canada on Wednesday said that its profit for the full 2015 fiscal year topped $10-billion, and its profit in the fourth quarter rose 11 per cent, year-over-year, to nearly $2.6-billion.

The problem? One of the profit drivers in the fourth quarter had little to do with RBC's banking operations, but rather a favourable tax adjustment estimated at about $190-million. That fed some skepticism on the part of analysts that RBC's profits during the quarter reflected its true growth.

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"The bottom line for us is that RBC's results are quite a bit weaker than they seem," said Meny Grauman, an analyst at Cormark Securities, in a note. Robert Sedran, an analyst at CIBC World Markets, said in his note that RBC shares "will likely not react well to this result."

He was right: RBC shares fell 0.3 per cent in early trading on Wednesday.

No doubt, the analysts' headlines might be dismissed as defensive, given that their targets have been off this quarter. According to data from Bloomberg, the consensus among analysts for RBC earnings in the fourth quarter was $1.64 a share; RBC trounced that estimate with earnings of $1.77 a share – or 13 cents higher – marking the bank's biggest "beat" in 14 quarters.

Bank of Montreal, which reported its fourth quarter results on Tuesday, showed a similar spread between estimates and results: Analysts had pencilled in earnings of $1.74 a share but BMO reported $1.90 a share – 16 cents more. Bank of Nova Scotia's results were closer to the mark but also topped estimates.

In an environment where the big banks continue to note the headwinds from low interest rates, slow economic activity and weaker mortgage growth – along with the need to spend big bucks on technology – how can they be surpassing expectations by a wide margin?

The answer from analysts: The banks are reporting numbers that make their operations look considerably better than they really are.

In the case of RBC, the bank benefited from a tax adjustment that was larger than in previous years, lowering the bank's effective tax rate to the low end of its target range of 22 per cent to 24 per cent. If you factor this adjustment into the bank's profits, RBC's per-share earnings slip back towards analysts' consensus estimates – and that double-digit rise in quarterly profits looks more like 4 per cent.

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Analysts raised similar objections to BMO's results, which were driven higher to some extent by unusual items. "There were legal reserves and releases, gains on sale of businesses, even gains on sales of OREO (not as tasty as they sound … it means other real estate owned, or foreclosed property)," Mr. Sedran said in a note. "For a better read on the quarter, we are forced down into many of the underlying trends, which had a more in-line-with-expectations feel to them."

Even Scotiabank's results, which were close to analysts' estimates, were met with some concerns due to a sizable pension adjustment.

"Despite the headline earnings-per-share beat, we consider this quarter to be a miss on an operating basis," said Peter Routledge, an analyst at National Bank Financial, in a note.

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