Clean Sweep of Dividends and Buybacks from Canadian Banks

Overall, the results have been a mixed bag, with Scotiabank, TD, and BMO beating expectations, while RBC, CIBC and National Bank missed expectations. The banks all benefited from industry-wide increases in fee revenues but were hit by margin pressures and higher costs.

Here’s what Morningstar Analyst Eric Compton thinks of the banks’ performance:

Scotiabank (BNS)

Narrow-moat-rated Bank of Nova Scotia reported solid fiscal fourth-quarter earnings. Adjusted earnings per share were $2.10, beating Factset consensus estimates for $1.92 and representing solid year-over-year growth compared with adjusted EPS of $1.45 in the same period a year ago and higher than last quarter’s EPS of $2.01. Provisioning continues to be a major driver of improved earnings, coming in at a cost of $168 million this quarter, a multi-year low and materially lower than the $1.1 billion charge the bank took in last year’s quarter. We would expect reserve releases to be much lower going forward. Revenue growth continues to be lacklustre, down roughly 1% compared with last quarter, while adjusted expenses ($188 million in restructuring and other provisions) were roughly flat.

We think revenue growth will reach a turning point in 2022. The two steady sources of growth so far have been the Canadian banking segment and Canadian wealth management, while global markets and international banking have generally trended lower compared with the pre-pandemic period. We expect that interest rate hikes within the international segment (Mexico, Peru, Chile) and upcoming hikes within Canada, along with decent loan growth should drive growth in NII in 2022 and 2023. We also expect a healthy economic environment will drive continued growth in fees, overcoming any potential headwinds for trading and investment banking fees as we lap tough comps in 2021.

Royal Bank of Canada (RY)

Wide-moat-rated Royal Bank of Canada reported solid fiscal fourth-quarter earnings. Adjusted earnings per share were $2.71, coming in slightly below Factset consensus estimates for $2.81. It was a small miss, and given that loan loss reserves are still moving around, we wouldn’t read into it too much. In fact, we were generally encouraged by the results and management’s commentary on the call. Net interest income was relatively stagnant quarter over quarter, however, we expect this to change in 2022 as rate hikes in Canada and the U.S. are very likely to play out, and we also expect some decent loan growth in 2022.

The one item that may have given investors pause was the expense guidance, which was for the high end of low-single-digit percentage growth, with management citing inflation and growth investments. We’re pencilling in a 4% growth rate in 2022, which still allows the bank to achieve roughly 100 basis points in operating leverage as revenue remains strong. We wouldn’t get too hung up on the higher expense run rate, as we think RBC remains in a unique position to continue to invest in growth, and we wouldn’t be surprised if the bank pursued some additional wealth-related acquisition in the future. We think solid revenue growth will be the story, helping unlock some additional value. We are increasing our fair value estimate to $141 from $132, implying a roughly 11% upside.

CIBC (CM)

Narrow-moat-rated Canadian Imperial Bank of Commerce reported decent fiscal fourth-quarter earnings. Adjusted earnings per share were $3.37, coming in below Factset consensus estimates for $3.54. Revenue slightly missed consensus as underwriting and advisory fees and trading fees dropped a bit, but this is something we’ve seen for the industry. We think expenses were the biggest disappointment, which came in above our projections as they increased 7% on a reported basis and 5% on an adjusted basis. We think this was the biggest question mark from earnings and the call.

Management admitted that operating leverage might be negative for the first half of 2022, largely driven by another step up in expenses as they continue to invest in multiple business lines. CIBC is generally hitting decent top-line growth numbers, but expenses are eating up a good chunk of this growth.

While the first half of 2022 might be a bit tough, we think these growth targets are achievable, and we think decent revenue growth and a return to better margins in the second half of 2022 will be the proof the market is looking for. After incorporating these results, we are increasing our fair value estimate to $156/USD 122 from $153/USD 121 after increasing our NII and fee growth forecasts slightly, while also increasing our expense forecast, leading to roughly a 5% increase in our net income estimates in 2022 and 2023 (mostly driven by higher NII and lower provisioning).

National Bank of Canada (NA)

Narrow-moat-rated National Bank of Canada reported solid fiscal fourth-quarter earnings. Adjusted earnings per share were $2.21, in line with the Factset consensus estimate of $2.22. While the market generally reacted negatively, with shares selling off 3%, we think NBC is in a good position to beat consensus going forward and unlock some additional value. Management guided towards mid-single-digit pretax pre-provision earnings growth in 2022, a level we think is achievable. We think the bank can probably maintain this type of momentum for the next several years as outsized balance sheet growth (ABA, Credigy, smaller base compared with peers), some slight help from interest rate hikes in Canada, and strong continued fee growth for the bank’s wealth-related franchises should all contribute. This should set the bank up for outperformance, and our net interest income and fee income projections are ahead of consensus.

Perhaps the one negative from earnings was management admitting that costs will remain pressured as inflation feeds through wages, however, even accounting for this we think top-line revenue will allow for mid-single-digit PTPP earnings growth.

We are raising our fair value estimate to $109 from $98, making this one of the most undervalued names we see among the Canadian banks. We already have expense growth of 6% in 2022 baked in, along with 5% in 2023, generally above peers. We think the key will be for the bank to continue to see outsize balance sheet growth (roughly 7% in 2022) leading to equal growth in NII, along with decent mid-single-digit fee growth. We’re also cognizant that the bank has been slower to release some reserves compared with peers, but we haven’t seen anything to suggest that negative surprises are lurking here. We expect additional reserve releases in 2022 to confirm this.

Bank of Montreal (BMO)

BMO is not one of the largest or most dominant retail banks in Canada, as we rank it in the lower half of the Big Six. However, with its more commercially focused book, it boasts a good share in its domestic commercial lending market, particularly for loans under $25 million. Additionally, BMO has the lowest relative exposure to residential mortgage loans among its peers, helping to mitigate some of the risks in its loan book, although a true housing crisis could cause a recession and hurt commercial loans indirectly.

Over the past several years, BMO has been building its commercial lending strength in the U.S., although we expect the consistent double-digit loan growth to slow. In general, we like BMO’s presence in the U.S., as it has built up respectable deposit market share numbers, generated material growth, and avoided some of the mistakes other Canadian banks have made in attempts to expand south.

BMO has the second-largest amount of assets under management among the Canadian banks, with the largest proportion of its revenue coming from wealth-management fees among peers, close to 20%. We like the growth and results that the bank has achieved here. Competing against BlackRock in exchange-traded funds will likely get more difficult, and RBC's latest partnership with BlackRock shows that competition will get tougher, however, we expect passive to grow strongly in Canada, supporting future growth for the industry in general.

Bank of Montreal has taken a step up in 2021, improving operating efficiency while growing fees and managing its interest rate exposure. We expect that the bank will remain a more efficient operation going forward.

The Toronto-Dominion Bank (TD)

Toronto-Dominion is one of the two largest banks in Canada by assets and one of six that collectively hold roughly 90% of the nation's banking deposits. The bank derives approximately 55% of its revenue from Canada and 35% from the United States, with the rest from other countries. Toronto-Dominion has done an admirable job of focusing on its Canadian retail operations and growing into a number-one or -two market share for most key products in this segment. The bank also has the number-two market share for business banking in Canada. With roughly $360 billion in Canadian assets under management and top-three dealer status in Canada, and being the number-one card issuer in Canada, Toronto-Dominion should remain one of the dominant Canadian banks for years to come.

Toronto-Dominion has also established a significant presence in the U.S. by having the most branches in the U.S. among Canadian banks as well as a 13.5% ownership stake in Charles Schwab (after the TD Ameritrade acquisition). While we like the higher exposure to more growth in the U.S., the segment has lower returns on equity than the Canadian segment, partially because of goodwill but also partially because returns are naturally lower on average. As the U.S. segment grows, we expect returns on equity to be further pressured. We also like Toronto-Dominion’s positioning as a major discount brokerage player because we believe this industry is ripe for growth as investors seek out lower-cost alternatives, and the bank could leverage its knowledge of the industry for future growth in Canada.

The bank has taken several charges (such as integration charges, restructuring charges, and more). Many of these have been related to acquired card portfolios. We expect that as these card relationships mature, the bank should be well-positioned in what is a higher-return business if managed well. We expect decent growth for TD Ameritrade, stable strength in domestic banking operations, good credit quality management, and continued expense control to drive consistent returns on equity and mid-single-digit earnings growth over the longer term.