Decoding Q1 Canadian Bank Earnings

This podcast was published on March 72024

Mar. 7, 2024

Daniel Stanley: Welcome to the 14th episode of our deep dive series on Canadian bank earnings. Today we’re covering the first quarter 2024 bank earnings announcements and we’re going to be returning each quarter on this channel to update you on the latest financial results. My name is Daniel Stanley I’m an ETF specialist at BMO Exchange Traded Funds. And I’m joined today by my friends and colleagues Chris Heakes, Portfolio Manager for all of BMO’s equity and multi-asset ETFs and Sohrab Movahedi Managing Director, Financials Research at BMO Capital Markets. Today, we’re going to cover the recent bank earnings announcements and what they mean for investors and the Canadian economy, as well as looking at different ETF strategies that give you exposure to the Canadian banks. So without further ado, gentlemen, Chris and Sohrab thank you for taking the time to join me. And Sohrab as we often do, I want to start with you. Look, the Canadian economy-well, no one’s talking about being in recession, growth certainly doesn’t seem to be there. And that seems to be setting some expectations for the banks fairly low-and in particular, heading into this earnings season. How, how did the banks do this earnings season?

Sohrab Movahedi: So I’d say we started fiscal 2024-so we would have just reported the first quarter results-in a little bit better than worried. How does that sound? So what I mean by that is, we were probably looking for the system wide earnings, year over year to be down around 10%, they reported actually something in the order of magnitude of $14.1 billion for the quarter and after tax earnings. And that was down about 8% from a year ago. So a little bit less than what we would you know, a little bit better, I suppose. Still $14 billion in earnings. I mean, I think sometimes we lose sight of the fact that they are profitable. And I suspect, we are lapping I’ll call it more difficult comps. You know, when we look at these growth, we’ll compare them to prior years, I think we’re coming close to lapping these more difficult comps. In the next quarter, I’m gonna I’m gonna stick my neck out here a little bit and say probably another quarter where we may see negative earnings growth still positive, obviously earnings, but from a comparability perspective, but likely to see that turn now and probably turn positive. Certainly by Q3, when we look at the year over year stuff and into into the year end and certainly into 2025. I’d say that, you know, when we when you look at our reaction, let’s say to the results, you know, we tweaked estimates a little bit up and down, generally up down for TD, but on, you know, in totality, we didn’t really think of the quarter as material in terms of revisions to estimates, nor did we view it as material in terms of revisions to valuation multiples.

Daniel Stanley: Now, thanks for that, Sohrab. I mean, I love that emphasis on the fact that they still had $14 billion of earnings, which, you know, as Canadians who are invested in banks, whether it’s through the individual securities or through the ETF or through mutual funds, that those dividends that are turned out from that are in a good position. Chris, I want to transition over to you because, you know, we tend to spend some time watching the individual bank stocks maybe can you talk a little bit about how the individual bank stocks reacted to those Q1 earnings announcements. And how did that compare to you know, the performance of ZEB which is the BMO EqualWeight Bank ETF?

Chris Heakes: Yeah, for sure. Thanks, Dan. And, yeah, 14 billion. That’s a lot. As our good friend Brian Belski at Capital Markets says billions with a B”. So that’s big numbers. Yeah, in terms of the price action, it was generally positive. So you know, as a reminder, last quarter, we saw really around earnings, the best kind of price action we’ve seen in terms of upwards price action on banks and kind of a few quarters. The average bank on the under earnings announcement day moved about 1.7% in Q4, and there were several that were 3, 4, or 5%. A little more muted this quarter, but still positive. So you had commerce and National both moved up 2% Bank of Nova Scotia moved up 3%. And they were the big laggard in Q4. They’ve look like, you know, the markets becoming more receptive to some of the changes that are happening there. Unfortunately, for us, on the call BMO list the lagger down three, you know, and we have been up 2% in the last quarter, but, you know, net, the average bank was up about approximately 1% on the quarter. And, you know, just a little more on the price action, you know, ZEB now, which is, as you mentioned that BMO Canadian Equal Weight Banks ETF were up about 1.6% for the year, it had really rallied into the earnings announcements as well as out of so I think that’s a nice thing to see from from a price perspective. Banks kind of started the year a little bit, little bit negative. But from mid February, we’re up about 5%. And so mid February was about two weeks before earnings, and then now we’re a couple of weeks on the other side of earnings. So you know, in general, I think these trends are pretty positive. It’s nice to hear what Sohrab said in terms of, well, we don’t like being down 8% at a bank, but being down eight is better than down 10. So that’s certainly nice to hear. You know, I think there’s been some favorable macro trends, which are really been the difference makers to equities in general, you know, going back to last November, where, you know, the Fed started talking about interest rate cuts a little bit more, and then the market really became more constructive around a no landing or a very soft landing scenario. So certainly that’s helped broad markets and banks, you know, north and south of the border as well. So, you know, that’s part of it. But, you know, always great to see positive momentum, and a lot of times in equity investing positive momentum, you know, momentum tends to carry through. So we’ll see how that evolves. But a good start to the year.

Daniel Stanley: Yeah, no, that’s great, Chris, thank you. And you’re right about the macro. And it certainly helps being a neighbour to the United States with the growth in their US economy. And that sort of bodes well for the Canadian banks, for sure. Sohrab I want to come back to you here, because you know, your thesis last quarter was that the Canadian banks were at this inflection point. And that 2023 was going to be that year that everyone wants to forget. And you’ve kind of alluded to that. But maybe, given what you saw on heard last week, does this 2024 look to be a better year? And if so, why?

Sohrab Movahedi: Look I think 2024 certainly with the benefit of the first quarter results, actual results, and obviously management commentary here and the outlook that they’re providing. I think I think the thesis we shared with you is still intact, we are probably, you know, it’s always hard to say, well, December and you know, January started. So we’re in 2024. You know, I would say there’s always a little bit of a, these don’t shift the transition, what did we get this quarter, which I think is encouraging supportive of the thesis we had provided? Number one, for example, a number of the banks have discounts on their dividend reinvestment programs as a way of issuing shares, to basically shore up their capital levels for regulatory requirement purposes. And for obviously, for when your downside focused, you want to have higher capital levels. Well, they’ve indicated, at least three of the four banks have given us the actual dates, they’re going to turn those discounts off, and the fourth one is likely to do it. When they report their results next quarter, as far as giving us a date, that’s a net positive because we’re now you know, capital levels are not continuously grinding higher. Certainly we’ve had, and we talked about this last quarter that the regulator is not pushing the domestic stability buffer any higher. That’s a net positive, you know, in the context of regulatory peer pressure. I mean, yesterday, we got a sense out of the US, that maybe the the suggested Basel III Endgame is not going to be implemented with the same kind of veracity and severity as it was implied in the US. I think that takes a little bit of regulatory peer pressure off. So I think capital levels just over here in Canada, we’re targeting 11 and a half from a regulatory minimum perspective. The banks were well clear of that 12 and a half to I would say 12 and a half to 13 and a half percent even after you pro forma. For example, Royal Bank for the pending HSBC acquisition and you take a placeholder for some of the charges that are penalty that the TD is likely have to go into have to pay for its issues. So I would say capital, not a concern. And, you know, we got indications that we may be near the peak of reserve building in anticipation of future credit losses. Now remember that under IFRS 9, which was implemented in 2018, the banks are now on a pro-active or pro-cyclical basis, adding to their reserves. Whereas, historically, credit may have been more of a lagging indicator, we may have seen reratings on the banks, after we had seen the peak of the provisioning, I think we’re starting to see the peak of the provisioning. And I think investors should take note that those provisioning are happening probably on average a year earlier than they would have historically because of some accounting changes. You know, CIBC as an example would have been a leading indicator of commercial real estate and office commercial real estate in the US, in particular, they were early reserve builders, and they would be the one of the ones that suggests that, you know, knowing what they know about their portfolio, obviously, it’s idiosyncratic to their portfolio. They believe that reserve building is materially behind them, for example, as far as the US office, commercial real estate portfolio is concerned. So this doesn’t mean to say that we won’t see headlines around bankruptcies or Canadian consumer leverage or what have you. But if we are indeed in a bit of a soft landing type scenario, which I think has become consensus, and we are going to have rate cuts, and we believe our economics department has a June kind of as a first rate cut in, so call it back half of the year, we see the pressures around credit quality and reserving in anticipation of impairments lessening. Okay, so we then think you can start transitioning your views into top line growth into revenue driven pre-tax, pre-provision growth, and ultimately start talking about higher Return on Equity (ROE) again. And, you know, I can’t promise you were there yet, I think everything we’ve seen, which suggests we’re very close to that point. And in fact, we would argue that investors should start thinking about the transition towards more offense, less defense, so to speak, as it were, with respect to their bank holdings in their portfolios.

Daniel Stanley: Or to use, I guess, another analogy Sohrab. It’s the headwinds of reserve building the headwinds of regulatory issues that I know when we spoke roughly around this time last year, after what happened to us, you said that one of the worries was that the hangover of regulatory peer pressure. So it sounds like what you’re saying, in effect is that the headwinds of these two issues are sort of possibly behind us and that we can focus on the tailwinds of looking at that top line growth which is, which is really exciting. Chris, I want to come over to you now because in addition to ZEB, we also have ZWB, the BMO Covered Call Canadian Bank ETF for those who want income. We’ve also got ZBI, the Canadian Bank Income Index ETF for those who want bonds and perhaps shares. And then more recently, we launched ZEBA, which is the Canadian Bank Accelerator ETF, for those who are basically bullish on the Canadian banks and want a little bit of greater upside with a with a cap. So I’m curious, Chris, given the conditions that you’ve sort of heard sort of describe, is there any one of those particular ETFs or a mix of ETFs that you look to given what you’ve heard?

Chris Heakes: Yeah, thanks, Dan. And I thought I thought it would, you know, I thought it would be interesting and productive to talk a little bit about ZBI, the Canadian Bank Income ETF, because this is really more of a fixed income tool. And we’re obviously talking about equities when we’re talking about banks. But, you know, as investors, you know, we generally have fixed income as well as equities to diversify, you know, the overall portfolio. We launched this fund about two years ago. You know, I think it’s fair to say it hasn’t been a huge star to the gate, but what I would argue now is we’re starting to see the value of the strategy. And we’re seeing a much more constructive, you know, banks movement in the last few months, and is translating on the fixed income side of the portfolio as well. So just to kind of very briefly, you know, what is what is in the portfolio, it’s all big six banks bond and some preferred shares. So it’s about 60% bonds. And they tend to be tilted towards the shorter end. So kind of between zero and 10 years and maturity. And then 40% hybrid instruments like preferred shares. So, you know, what the hybrid instruments do is they allow that income to increase, there’s higher yield on the preferred shares versus the bonds. You’re looking at a yield to maturity on this project about 5.6%. And for a couple bond comparables ZAG our BMO Aggregate Bond Index ETF. So the aggregate bond universe in Canada are about 4.3%, YTM. If you just look at corporate bonds, you know, banks are obviously corporate bonds, you know, you get a bit of a pickup, you’re at 4.9. But again, with the Canadian Bank Income ETF, you’re at 5.6. You know, what are the advantages of bonds, obviously, bonds in general, carry less volatility than equities as well. So the one year volatility of this bond ETF is about 5%, it’s kind of in line with fixed income, right? It’s a fixed income exposure, ZEB would have 50%, that’s an equity level of risk. So it’s about a third of that mark to market risk. And, you know, I found it quite interesting on a one year perspective, which obviously, there’s been a lot of, you know, so it’s hard to remember everything that’s happened in a year, but there’s been, you know, certainly lots of ups and downs. And we kind of expect that going forward. You know, Canadian banks were on the equity side, doing pretty poorly to start the year, last year and into the middle of the year, and then really have that kind of renaissance in Q4, and then kind of carrying over into this year. But on a one year basis, the return of ZBI is almost 8%, 7.9. And if you look at ZEB, it’s about 5%. So I’m not going to suggest the bonds, you would expect them to give more return over the long period of time, but in certain environments, they can be very effective, especially when equities aren’t doing as well. So, you know, for arguing for the benefits of banks, I think, as an investor, you can consider, okay, obviously, we’re considering banks on the equity side of the portfolio, you know, what can they do on the fixed income side of the portfolio, as well. So, you know, I think it’s actually a very good product is really showing, showing some merits, you know, now as we get into are going into their third year of this product, being out into the market. And so I think that’s a very interesting one to have on your portfolio, you know, I, in general, would advocate for a tilt to banks over time, because of, you know, that it tends to give a better a richer return over time. And again, that can that can help on the fixed income as well as the equity. And so I just want to spend a bit of time there, you know, on the equity side, just just to echo, you know, given the conditions, you know, Sohrab outlined in terms of playing offense, you know, I think that’s ZEB is your is your best tool. It’s simple, it’s effective, equities, very low management fee, all in one package, rebalances twice a year. And so that’s, that’s going to be a very effective tool to play offense. You know, of course, if you are an income investor, income oriented investor ZWB is always a great tool that gives you more income, a little less growth. But you know, I think for a lot of investors still playing in the total return space, you know, keep keep it simple, as they say, and ZEB is a great tool to do that on the equity side.

Daniel Stanley: Thanks for that, Chris. I think it’s timely, certainly with the next question, I want to ask Sohrab. But again, I think we tend to forget that the banks are big bond issuers, and it’s high quality corporate debt, in effect, and, you know, at a 5.6% yield to maturity, it can be attractive. Sohrab, it’s a great segue into my next question for you, because we’ve talked about the different, you know, the difference between risks to the balance sheet risks to the income statement, and I’ve seen this talked about a little bit more in the news lately. Can you just give us a quick overview of those risks, and which are sort of more or less serious when it comes to the Canadian banks at this point in this cycle?

Sohrab Movahedi: I think, you know, whenever we’re going through a bit of a downturn, and I’m talking about an economic downturn, I mean, these are balance sheet intensive businesses, we all know that they make money by taking deposits and making loans. So you know, when economic risk increases when risk of, you know, economic contraction increases, they’re like, you know, the worry is, not every loan made under certain assumptions is going to be, you know, be made good, right. So what we worry about usually with a balance sheet risk is, hey, do they have enough good loans? Have they adequately allowed for potential loan losses? And do they have the earnings to absorb because earnings and income statement will be your first line of defense really, when you have hits coming at you. So when you think about that, you know, obviously Canadian consumer leverage is a concern, a very large portion of the system wide balance sheet is Canadian mortgages, we certainly have had to absorb, or when I say we clients or investors or sorry, mortgage holders have had to absorb a relative rate shock, right. In other words, if you were in a variable rate mortgage and your rates are going up, there’s a tendency to feel the pain of that now, some banks would have had the feature that allowed you to adjust your amortization period, to maintain your monthly payments, a couple of the banks would not have had that feature. But long and short of it is the the measures that are in the system, ultimately, I think, in place from a bank shareholder perspective, for the banks to get their money back, right, like we’re not in a rush to write off loans, if we can, you know, rehabilitate the borrower, if we could work with that bar. And when I say we, I mean, the banks, obviously, to work with the borrowers. And it certainly looks like those measures have gone, according to plan, right. So we’ve extended the banks have extended amortizations, but clients have been able to then also make good on the promises they’ve made as far as their reject kind of long loan terms. I mean, I think the saving grace, let’s be honest, here has been that the employment picture has remained still constructive. So, you know, reminder, again, that if people are working, they don’t want to, they’re not looking to default on their debt. And so, as I say, like when we look at some of the broad stroke stuff, and it’s been a tough year, right, like, I mean, when you think about this increase in rates and the pressure it would have put on on the business of lending, at the same time, that it would have put pressure on the business of deposits, right, like in squeeze some of the margin that some of the banks are making, like, some of this has been largely absorbed. And, you know, for people like me, people, like you guys that are in the capital markets, we also know that we have experienced a prolonged period of subdued activity in capital markets, businesses, these are important parts of the revenues for the bank. So when you think about the income statement, we’ve had a little bit of pressure, if you will, on credit, provisioning, probably not enough support coming from fi businesses, when you think back over the last call it 12 months, or 12 to 24 months. And you’ve had this you know, economic contraction, worry, which probably has subsided, subdued loan growth, demand, or loan demand, which kind of weighs on loan growth, we’ve had some we’re going through this transition in rates, which has implications for cost of borrowing and credit spreads. Much of that, I can’t say 100% of that is done, but we’ve absorbed a lot of that. And as we look ahead, we will not we expect loan growth is going to remain subdued, but we expect fee businesses, whether it’s wealth, whether it’s capital markets, some of those things we’re going to start picking picking up and ultimately, a bit of a more favorable rate environment, consistent maybe with a bit of a more favorable economic backdrop, if you want to call it a soft landing type scenario, something that avoids the, you know, the infamous kind of recession or, you know, the big leg down, I think all of that lessens the risk on balance sheet lessens that concern on the downside and starts to transition the focus to the upside. And so if some of these revenues we’re talking about, come through the banks obviously took restructuring charges late last year, some of the benefits are of those are going to come through probably towards the second half of this year and into 2025. So that will manage expenses, you should be able to get operating leverage without the headwinds of credit reserve building coming at you. You have a reasonably good setup, and obviously easier comps. I know it’s 14 billion but it’s down right so you know easier comps will allow for a bit more growth. And so, like I said, I don’t want to pound the table. But I think there are reasons consistent with the thesis. We are talking you know, probably over the last quarter as well. To start feeling a little bit more optimistic on the outlook.

Daniel Stanley: You know, it’s great, because the news tends to be less focused on the optimistic side. But again to go I go back to that these are companies that have $14 billion of earnings, they pay a healthy dividend. And so it’s nice to hear that we’re a little bit more optimistic in the future. So guys, I want to finish up. Normally, I asked both of you one question, but I’m, I’m going to close things off. Chris, I want to start with one question for you. Because it was almost exactly a year ago that we had all those problems with the US regional banks, you know, how does fast forward a year, you know, how does that US banking sector look, one year later? And, you know, what, has there been any spillover to Canada, if any?

Chris Heakes: Yeah, thanks. I’ll start with the US. And I’ll put some comments in. Ya, Sohrab can can add on and talk about the spillover to Canada. But, you know, in terms of what we’ve seen in the US certainly better. I mean, to start with that it’s a lot better than it was a year ago. You know, obviously, that was a significant drawdown in US banks, and they’ve been digging out of the hole. So ZUB which is the BMO US Bank Hedged to CAD ETF was up about 39% since mid-March, a year ago, when all that was happening. I think it’s worthy to note that there’s another bank, that’s, that’s going through some stuff, but you know, it looks like the market has jumped through it and contained it. So this was the NYCB New York commercial bank. I understand mostly commercial loans, perhaps real estate, I’m not sure the exact nature. But hedge fund came in and bailed them out. So that looks isolated, you know, in general, much more constructive, I think those macro tailwinds, you know, that were mentioned, I think, you know, have obviously been super, super constructive, and then, you know, just to echo on Sohrab, you know, in terms of risks, you know, the, the economy is the largest risk to the banks, and especially south of the border, I think. So this, you know, idea that we’re getting a soft landing or no landing is certainly constructive. Given they sold off a lot, you know, a lot of times that gives room on the upside, after a large sell off, like we saw last year, so generally constructive. You know Sohrab also mentioned the regulatory easement that the Powell speaking about yesterday. Obviously, that’s always, that’s always constructive as well. So there’s, there’s some constructive trends, you know, the rest of that remain, you know, obviously, it’s the economy, I think, is the big one. And that’ll have to be gauged and monitored going forward. We’re seeing a little bit of a higher for longer in terms of interest rate policy that’s being messaged by by the Fed now, now, equity investors haven’t reacted overtly to this. But you know, you wonder if that persists, you know, does that take some of the shine off about possible no landing, because I think, you know, higher for longer will naturally play into more of a landing in a harder landing, right, potentially. So I think that’s the risk people to watch. But lots of constructiveness to, you know, that we’ve seen in the past year.

Daniel Stanley: Excellent. Thank you. Certainly, they’ve got that the advantage of the US economic growth engine, which just seems to be trucking along. It’s impressive. Sohrab, I want to end off with you. Your thoughts on an issue that has been top of mind for a lot of people, you know, we’re hearing about from the Canadian banks and just talk to us about Canadian banks and their outlook for commercial real estate.

Sohrab Movahedi: Yeah, I mean, I think commercial real estate has a broad theme. You know, I think all the banks, whether north or south of the border, certainly Canadian banks with disaggregates commercial real estate between at least you know, office, multifamily, industrial. And I think the pocket of commercial real estate that has been obviously attracting a lot of the attention has been the US office, commercial real estate. Just to put things into kind of some perspective, broader commercial real estate portfolio of the Canadian banks, this would be their global portfolios, primarily US and Canada, maybe represents about 10% of their overall loan book. And of that, maybe one, depending on the bank, one to 2% of the loan book may be in office, US office commercial real estate. So I think and as real estate, I think usually goes you know, it’s location, location, location, I think a lot of the banks will tell you that, you know, two buildings across the street from from each other, could have different, you know, capital structures different you know, the age of the building will matter. There’s a variety of things that will factor in that I think what matters is what I kind of alluded to a little bit earlier that if CIBC was the leading indicator here, they are now in telling us that for their portfolio, which probably had enough of the regionals, the risky regions of the US in it, they’re telling us that having gone through the renewal cycle, like I said, for most of it, and nearly half of it, they feel like they have been able to assess the risks in a way that they feel comfortable that they’ve reserved and provided for them. So I think commercial real estate office, commercial real estate, for example and generally speaking, again, I’m not trying to declare victory on credit but I think as far as the implications of credit quality, the aggregation in credit portfolio and need for reserve building is going to increasingly become a rearview mirror item for the banks. If it’s not next quarter, then it will be the quarter after that. But for the most part, the reserve building, whether it’s for consumer credit in Canada, whether it’s for negative amortizing mortgages, or whether it’s for credit cards, or whether it’s for auto loans, or whether it’s for commercial real estate, I think the Canadian banks have been reserving at a pace that makes us feel comfortable. They are-I’m not suggesting they’re over reserved, which suggests they’re adequately reserved for the economic backdrop that we are planning on which is this kind of call it softish landing type scenario.

Daniel Stanley: That’s a great way to end at the end of the day, they’re doing a good job of managing those reserves and irrespective of the the environment that they can’t control, and I think that’s a great way to close off our discussion today. Chris and Sohrab thank you very, very much. I’ve like I said I always love these sessions, we get some true facts on what’s going on on the ground with the banks. As a reminder to the audience you can get exposure to the Canadian banks via ZEB which is the BMO Equal Weight Banks Index ETF, you can get exposure to our US banks ETF, which is ZUB, ZBK the BMO Equal Weight US Banks Index ETF. If you have any questions, please visit the ETF Center at That’s all for today, folks, thank you for tuning in. Please join us for our next session when we update you on Canadian bank earnings.