The big Canadian banks declared their second quarter results this week. Results generally fit within the overall pattern we expect for the Canadian banks this year, as we looked for slowing loan growth, an increase in credit strain, and some pressure on net interest income, or NII, growth. Here is what we think of each:
Bank of Montreal (BMO)
Narrow-moat Bank of Montreal (BMO) reported OK fiscal second-quarter earnings. Overall, we see slowing revenue growth in both Canada and the U.S. segments, largely driven by rising funding pressure and slower balance sheet growth. The bank also recorded a one-time provision related to the Bank of the West, or BOTW, portfolio, which lowered earnings. On an adjusted basis, BOTW contributed $317 million to preprovision pretax earnings, or PPPT, in the quarter. If we remove that, on an organic basis the bank would have seen a decline in PPPT of roughly 4% year over year. Results remained quite messy with one-time charges and adjustments, and it appears that they may not fully clean up until 2024.
The bank announced a quarterly dividend of $1.47 per share, a 4 cent, or 3%, increase from the prior quarter.
While net interest income is stalling out, certain fee items also remain under some pressure, most notably capital markets and securities commissions. The bank still has some integration charges to work through, in addition to cost savings from the acquisition that will not be fully realized until the second quarter of 2024. By 2024, we would expect PPPT to start moving in the right direction again, but for now the bank faces a more difficult environment. We plan to decrease our fair value by roughly a mid-single-digit percentage as we incorporate these results, driven largely by lower revenue assumptions.
Risks within the mortgage industry are increasing for the Canadian economy and for the banks. Higher interest rates are increasing the rates paid on mortgages when they reach their renewal date, and for mortgages that haven't reached renewal, amortization periods are being extended. We still do not think this will break the Canadian banks, but slower growth and potentially some losses are likely in the future.
Current results fit with our overall thesis at the start of the year, where we expected this year to be a bit of a transition period, with loan growth likely to slow, more credit strain likely to emerge, and net interest income likely to come under some pressure.
Canadian Imperial Bank of Commerce (CM)
Narrow-moat-rated Canadian Imperial Bank of Commerce (CM), or CIBC, reported OK fiscal second-quarter earnings. Adjusted earnings per share were CAD 1.70, representing a decline of 4% year over year and a decline of 12% quarter over quarter. Results generally fit within the overall pattern we expect for the Canadian banks this year, as we looked for slowing loan growth, an increase in credit strain, and some pressure on net interest income, or NII, growth.
The bank announced a 2 cent dividend increase to $0.87 per share.
Indeed, net interest income declined sequentially and provisioning for loan losses ticked up during the quarter as the banks in Canada prepare for the possibility of a recession by the end of the year. The second half of the year will be a key moment for CIBC as management expects NII growth and net interest margin, or NIM, expansion will accelerate, which would be a change of pace from the current trends. Adjusted expenses were able to decline 1% sequentially, and management reiterated its target for mid-single-digit percentage expense growth for full-year results. Finally, fees are tracking a bit ahead of where we expected as trading income has not come back down as much as we anticipated, but we wouldn’t read too much into this as the trading environment remains volatile and closer to cyclical highs than lows.
Based on these results, we do not expect a material change to our current fair value estimate of CAD 69/USD 50, although we may lower it by a low-single-digit percentage as we incorporate a potentially lower net interest income outlook. We continue to expect the bank will have to prove it can return to margin expansion before investors start to believe in the bank’s longer-term targets.
Bank of Nova Scotia (BNS)
Narrow-moat-rated Bank of Nova Scotia (BNS) reported OK fiscal second-quarter results. Expenses kept increasing at a healthy rate, outgrowing revenue in the quarter, however, management struck a positive tone in the call, suggesting this pattern may begin to reverse for the rest of the year. Expenses came in a bit ahead of our previous expectations, and as we adjust our forecasts we anticipate a mid-single-digit percentage decline in our current fair value estimates of $75. It remains difficult to predict the bank’s future expense levels as we await an updated strategy, which could result in additional repositioning charges.
The Bank announced a quarterly dividend increase of 3 cents to $1.06 per share.
Revenue came in at $7.93 billion, down 1% sequentially, as net interest income declined while fees remained relatively flat. We would not be surprised if net interest income started to achieve growth once again for the rest of the year as moderate balance sheet growth combines with steady to slightly improving net interest margins. We would also hope for slightly lower sequential expense growth for the rest of the year, helping improve profitability.
Risks within the mortgage industry are increasing for the Canadian economy and for the banks. Higher interest rates are increasing the rates paid on mortgages when they reach their renewal date, and for mortgages that haven’t reached renewal, amortization periods are being extended.
Scotiabank does score better than peers on this front. As of April 30, less than 1% of the bank’s mortgages have an amortization period greater than 30 years, compared with over 30% for some peers. Even so, unless rates are cut materially in the medium term, financial stress is going to begin increasing for a large percentage of the Canadian population. We still do not think this will break the Canadian banks, but slower growth and potentially some losses are likely in the future. Relatedly, Scotiabank hinted that their mortgage growth in Canada will be minimal for the rest of the year.
Royal Bank of Canada (RY)
Wide-moat-rated Royal Bank of Canada (RY) reported OK fiscal second-quarter earnings. Adjusted earnings per share were $2.65, representing a decline of 11% year over year and a decline of 15% quarter over quarter. Results generally fit within the overall pattern we expect for the Canadian banks this year, as we looked for slowing loan growth, an increase in credit strain, and some pressure on net interest income growth.
The bank announced it will now pay a quarterly dividend of $1.35 per share, up 3 cents.
Indeed, net interest income declined sequentially and provisioning for loan losses ticked up during the quarter as the bank prepares for an expected mild recession by the end of the year. We would not be surprised to see continued reserve builds across the industry for the rest of the year. The bank’s expenses also came in a bit above where we had hoped, and management admitted on the call that it plans to do more to control expenses going forward and feels it over-hired during the last year, which it plans to address over the coming year. As we highlighted last quarter, we did not feel we were completely out of the woods yet when it came to higher expense surprises. As we incorporate these results, primarily changing our expense outlook, we plan to decrease our fair value estimate for Royal Bank of Canada of $136 by a low-single-digit percentage amount.
Fees performed relatively in line with our expectations. We had expected a dramatic decline in trading and foreign exchange fees after the unusually good performance last quarter, while capital markets fees also came back down in a difficult environment. As the cycle progresses, trading should recede; however, wealth and investment banking fees should arguably do better during the next cyclical upswing, helping balance out some of the potential headwinds in other items.
