Ruth Saldanha: With the large Canadian banks all beating estimates in their quarterly result announcements last week, how should you play the space right now? Morningstar analyst, Eric Compton, covers this space and he is here today to give us his views.
Eric, thanks so much for being here today.
Eric Compton: Thanks for having me. Great to be here.
Saldanha: How are you reading the quarterly results for the big banks right now?
Compton: Yeah, like you said, they beat consensus pretty much all around. So, results were really good. There's no doubt about that. Provisioning was down. So, credit costs remained well-controlled. You even saw some reserve releases. Trading revenues continue to remain strong. A lot of wealth revenues were actually good as assets under management hold up with rebounds in the markets. You're even seeing some of the core personal and commercial banking units start to turn the corner again as well. Those had generally seen a bit more pressure in the midst of the pandemic. So, yeah, I mean, results were really good all-around just like you said. So, I think that's really the big takeaway that I saw. A lot of the analysts and consensus also agree. You saw a lot of upgrades in future projections, things like that. So, the analyst community definitely noticed.
Saldanha: Now, the one thing that's worrying all Canadians are real estate prices. How much of a risk are these sky-high real estate prices for banks?
Compton: Yeah, so it's a good question, and it I think it's understandably, kind of, on everyone's mind. I think that you're probably going to have some buyers' remorse once things open back up again. I mean, there's definitely like a lot of momentum right now for moving out of the cities or bidding on homes, things like that. And when things open back up, there will probably be some reaction the other way. The cities will probably still be around after this is over. People will still want to live there to some degree. So, you'll probably have some level of buyers' remorse on these, but I don't think it will be to the degree that it's going to cause some sort of housing crisis or something like what you saw in the U.S. in 2007. I think in the hottest markets, you still have natural supply constraints that are still going to be there going forward. You don't see I don't think quite the risky underwriting that you saw in the U.S. I still think there is some control there, although prices are getting to kind of unaffordable levels for a lot of people and so that does stretch some of the underwritings too in some certain situations.
I think the biggest thing is, one, you're going to have a situation where can you raise rates again and the central banks are going to have to think about what kind of burden does that put on the Canadian consumer and then two is, it could just be a drain on future consumption, which would be bad for future growth. But I don't think it will result in some sort of housing or financial crisis in its current state. But definitely something to keep an eye on.
And another thing I'll point out, the last thing, is just that more and more of the balances are moving to the uninsured market. And so, the banks are more and more exposed to uninsured mortgages in which they would have to take the losses. So, again, the risks are increasing, but I think something to keep an eye on right now, but not something that I would lose too much sleep over just yet.
Saldanha: Finally, with all this said and done, what's your top Canadian bank pick and why?
Compton: Yeah. So, I would say that – the first thing I would say is that the banks have traded up quite a bit in the last couple months. As some of that recovery thesis has started to gain some more steam, we had I think the whole Canadian bank coverage list at 5 stars for a brief period in the depths of March and really, at 4 stars for most of 2020. But with the recent trade up in shares, they're all back to pretty close to fairly valued again. So, I think that's something to keep in mind. It's going to be a lot harder to find, I think, that excess performance now, now that the market is kind of buying into this cyclical recovery.
Now, if you are still looking for some greater exposure to the Canadian banks, there are two names I would highlight. First one is Bank of Montreal. So, they have – two things I would highlight that I like about them. One, they've got good U.S. exposure. And so, in the U.S., to the extent that this sort of reflation, higher interest rates coming about maybe sooner than people previously expected, good economic recovery, to the extent that that plays out in the U.S., Bank of Montreal is going to have good exposure to that and that can drive future earnings growth. So, I like that. I also like their continued exposure to ETF market and the wealth market in general, which I think is also a good future tailwind for them. And then, the final thing is, management talked about on the last earnings call that they think they can keep expenses roughly flat for another year. So, I think you've got potential growth drivers combined with expense control which could drive, I think, some upside in some estimates and even some of our estimates going forward. So, that's what I would think about.
And then, the other one I would highlight would just be National Bank of Canada. So, this is one that kind of flies under the radar for a lot of people. A lot of times you talk about the Big 5 Canadian banks and they're kind of most left off the list. So, they're the smallest of the Big 6. And I think because of that they can – they're not always top of mind for some people, but they produce the best ROEs of any of the Canadian banks we cover, and they've got a really solid growth story I think that people need to be aware of. And so, they've got this specialty lending unit called Credigy and also an international banking unit with ABA Bank that's driving huge growth for them. Management thinks they can get double-digit growth again in this upcoming year. I think you combine that with just the best return profile, and I think it's another bank where you could see some potential upside going forward. So, yeah, Bank of Montreal and National Bank of Canada would be two that I would consider.
Saldanha: Thank you so much for joining us today with your perspective, Eric.
Compton: Yeah, thanks for having me.
Saldanha: For Morningstar, I'm Ruth Saldanha.
