One strong quarterly profit report from a Canadian big bank can be dismissed as an anomaly. Two strong reports from two big banks might be a coincidence.
But when four banks deliver results in the same week, and all four blast through expectations with rising profits in what is supposed to be a challenging environment for the financial sector, it raises the question: Will the widespread skepticism toward Canadian banks start to fade away?
Many voices have been expressing concern about the sector for more than a year. Short sellers, who profit when stocks fall, have been circling Canadian banks, sensing the sector will be throttled if house prices fall sharply.
Analysts who cover the financial sector also have found little to love.
Heading into the current reporting season, which began this week, a consensus of analysts expected the banks to report no profit growth amid a weak economy, indebted consumers and struggling energy companies that are defaulting on their loans.
Even some bank chief executive officers have added to the dour outlook, warning of looming competition from financial technology upstarts, or fintech, and the impact of low interest rates, which make loans less profitable.
No wonder many investors have taken a dim view. Although bank stocks have rebounded from a dip earlier this year when investors clamoured for dividends, most stocks are no higher today than they were two years ago. The pause suggests something has gone wrong.
Yet results from four big banks this week reveal that a lot is going right. If the trend persists, naysayers may be forced to revisit their skepticism.
In the first week of the fiscal third-quarter reporting season, Bank of Montreal, Royal Bank of Canada, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank all surpassed expectations with their quarterly profits. (Bank of Nova Scotia and National Bank of Canada conclude the reporting season for the big banks next week.)
Combined, they reported profits totalling more than $7.9-billion, or $7.4-billion after adjusting for one-time gains such as asset sales. This adjusted figure, which illustrates the banks' underlying operating performance, was up 6.6 per cent from last year – a strong showing at the best of times, but remarkably strong given the low expectations.
In the case of CIBC, a standout, profit rose more than 8 per cent from last year after subtracting a gain from the sale of its stake in American Century Investments. Its profit on a per-share basis was nearly 14 per cent above the consensus estimate from analysts.
"It's nice when everything comes together," said Kevin Glass, CIBC's chief financial officer. "All businesses performed well."
To be sure, some of the profit drivers this quarter might not repeat next quarter. For example, the capital markets divisions of all four banks that reported results this week produced double-digit growth due to a pickup in corporate financing activity. Profits from this area, though, are notoriously lumpy.
The banks also benefited from ongoing efforts to cut costs, which are making them more efficient. BMO, which kicked off the reporting season on Tuesday, said its expenses during the quarter had risen just 2 per cent from last year, excluding the impact of the U.S. dollar.
Recent layoffs contained some costs. But investments in mobile banking services by all the banks is also paying off.
"You can imagine opening an account on a mobile device in seven to eight minutes is pleasing to the customer," Bill Downe, BMO's CEO, said during a conference call with analysts. "It's also a much more efficient way."
Lastly, the banks appear to be clearing the biggest potholes. Brexit, which rattled global markets in June after Britain voted to leave the European Union, had no impact on third-quarter results.
The two-year slump in crude oil prices is affecting the ability of energy companies to repay their loans. Earlier this year, many observers were concerned that the banks could be on the hook for huge loan losses. These concerns are now subsiding. BMO, RBC, CIBC and TD set aside a total of $1.3-billion to cover bad loans in the third quarter. While these provisions for credit losses are up substantially from last year, and the banks are reluctant to declare that the worst is over, things are moving in the right direction.
Provisions declined by nearly 10 per cent from the previous quarter, partly because of stabilizing oil prices. As well, bad loans represent, on average, less than 0.3 per cent of the banks' total loans, which is at the low end of the historical average.
"We're seeing that [energy] clients are managing better," said Janice Fukakusa, RBC's CFO. "Markets are open to them to do things, such as asset sales, they're managing their cash flows and the price of oil is such that there is some economics for these companies to carry on."
Meanwhile, the banks remain confident that their exposure to Canada's housing market is on solid ground.
"We continue to feel good about the quality of our portfolio, about our standards, about the quality of our [loan] originations," Teri Currie, group head of TD's Canadian personal banking, said during a conference call.
Laura Dottori-Attanasio, CIBC's chief risk officer, put the downside risk into perspective. She said that under a particularly bleak scenario where house prices tumbled 30 per cent and the Canadian unemployment rate soared to 11 per cent, the bank would face less than $100-million in additional losses on a residential mortgage portfolio of $172-billion. Within that portfolio, 57 per cent of mortgages are insured, down from 65 per cent last year. The uninsured portion of the mortgage book would be largely unaffected.
Investors are impressed. They drove up bank stocks, as represented by the S&P/TSX commercial banks index, every day since the reporting season began on Tuesday, for a total gain of 2.2 per cent by Friday afternoon. Trading volumes were also heavy, suggesting commitment to their trades.
But the outlook remains skeptical among many others. Short sellers haven't eased up on their bearish bets, given that the level of short interest on bank stocks remains high. And while analysts have been raising their target prices on bank stocks in response to the upbeat quarterly results – they've boosted their targets by an average of more than 3 per cent – most haven't altered their tone.
Of course, the skeptics on Canadian banks have a point: The economy is struggling, tapped-out consumers don't have a lot of room to expand credit card debt and regulators are determined to cool an overheating housing market that has served the banks well in recent years.
But as this week's results demonstrate, the banks are very good at navigating these obstacles. The burden of proof, it seems, has shifted to the skeptics.
The scorecard: The best and the worst of the third quarter
The quarterly reporting season for Canada's largest banks wraps up next week, but clear trends on profit gains, loan losses and dividend increases are already easy to spot, given the results from four banks this week.
Bank of Montreal, Royal Bank of Canada, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank set an upbeat tone with their results – leaving Bank of Nova Scotia and National Bank of Canada facing potentially tough comparisons on Tuesday and Wednesday.
Biggest divvy disappointment: When a bank feeds hungry investors with dividend hikes for seven consecutive quarters, it's bound to create a dependency. Just ask anyone who has enjoyed the steady increases from CIBC, which has boosted its payout by a total of 21 per cent since the fourth quarter of 2014.
But when the lender reported its results on Thursday, the hiking streak ended. The payout, relative to profits, is already near the top end of CIBC's 50-per-cent target. And the bank is bolstering its capital levels in preparation for its $3.8-billion (U.S.) acquisition of PrivateBancorp Inc. early next year.
Biggest profit gain: CIBC takes this prize too. Sure, all four banks posted decent growth amid lacklustre expectations heading into the quarter. But CIBC increased its profit by a peer-leading 8.3 per cent after accounting for a hefty asset sale – and nearly 9 per cent on a per-share basis.
Remarkably, the lender showed gains in a number of areas that had been written off as mature. Its personal and commercial banking division, home to – yawn – savings accounts and mortgages, woke up observers with profit growth of 6 per cent. Loans rose 9 per cent and personal deposits increased 7 per cent.
Biggest stock bounce: There are advantages to being the first bank to report results. Bank of Montreal kicked off the reporting season on Tuesday and was therefore the first bank to brush past dour expectations with rising profits and contained expenses.
It was rewarded: The shares closed the day 2.3 per cent higher, marking the biggest one-day gain since February and the best post-earnings-announcement increase among the big banks so far.
Sharpest decline in loan losses: Yes, decline. It wasn't long ago that observers were marking the rapid rise in losses as Canadian banks set aside money to cover bad loans. Something to do with the price of crude oil tumbling below $30 a barrel in January and February. Oil has since stabilized above $45 a barrel, giving energy companies the ability to meet their debt obligations.
CIBC's provisions for credit losses (PCL) declined by more than 28 per cent, quarter over quarter, leading its peers. But expressed as a percentage of total loans, RBC's PCL ratio was lower, at just 0.24 per cent, down from 0.36 per cent in the previous quarter.