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1. Bank of Montreal BMO
Bank of Montreal BMO is the fourth-largest bank in Canada and one of six Canadian banks that collectively hold almost 90% of the nation's banking deposits. The bank derives roughly 60% of its revenue from Canada and 30% from the United States. BMO has a well-established Canadian banking presence, an established U.S. retail operation in the Midwest, and growing commercial and capital markets capabilities. It is also the second-largest asset manager among the Canadian banks as well as the second-largest ETF provider in Canada.
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 good share in its domestic commercial lending market, particularly for loans under CAD 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 eventually 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. The bank's acquisition of Bank of the West closed at the beginning of February 2023.
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 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 continue to grow in Canada, supporting future growth for the industry in general.
2. Bank of Nova Scotia / Scotiabank (BNS)
Narrow-moat-rated Bank of Nova Scotia (BNS) reported fiscal fourth-quarter results that were largely as expected, except for provisioning, which shot up 50% quarter over quarter. While we had expected some increase, this exceeded both our own and FactSet consensus expectations. Provisioning is notoriously difficult to predict and can be quite volatile quarter to quarter, although current results for Scotiabank signal that other Canadian banks are likely to see increased provisioning in the next quarter or two as well.
The majority of the provisioning increase was driven by increases in allowances on performing balances—in other words, on loans that have not gone bad yet. Increases like this are driven by changing assumptions and projections. Net write-offs were largely stable, and gross impaired balances continued their steady climb, up 4 basis points, in line with previous quarters. Bottom line, there is not a true deterioration occurring just yet; rather, the bank is assigning a higher probability to the likelihood of additional deterioration in the future.
We do not want to completely dismiss this—it is a negative signal when banks say they think things will get worse—but we also do not want to read too much into it, either. It has been known that the interest-rate and debt burden situation in Canada was not great and was set to deteriorate further as long as rates stay at their current level. This is the next step in that process, and one that we were already projecting for 2024. Scotiabank was still able to increase capital organically in the quarter, and we think the Canadian banks will be able to handle the upcoming pressure, but earnings growth will not look pretty for the time being. Given that we are already projecting a material increase in credit costs in 2024, these results do not fundamentally change our thesis on Scotiabank or our $72 fair value estimate.
Revenue was roughly as expected, with net interest income and fees both increasing by a low-single-digit percentage sequentially. Expenses were a bit of a question mark heading into the quarter. With the dust settled, the bank recorded roughly CAD 800 million in adjusting items, roughly 15% of total expenses in the quarter, and adjusted expenses increased 4% sequentially, in line with our expectations. 2024 guidance was for continued moderate revenue and expense growth; we’re guessing somewhere in the mid-single-digit percentage range for both, with expense growth just below revenue growth to allow for some operating leverage. The 2024 outlook for provision for credit losses was below our current projections. But as we said, we have long been expecting a deterioration in the credit environment in Canada.
3. National Bank of Canada (NA)
National Bank of Canada NA is the sixth-largest Canadian bank, and this group of six banks collectively holds almost 90% of the nation's banking deposits. National Bank of Canada is the most Canadian-focused of the Big Six, with roughly 85% of its revenue derived from Canada. National Bank of Canada also has the most concentrated branch network in Canada among the Big Six, primarily located in Quebec. The bank has made a point of gradually shifting more of its business outside Quebec over time and now has roughly 45% of revenue coming from outside Quebec.
The bank remains focused on improving the operational efficiency and selling prowess of its core personal and commercial banking segment. National Bank of Canada has also expanded its wealth-management earnings, increasing total fee revenue coming from this segment. This has been accomplished in large part through acquisitions, but organic growth has also been solid, and the bank boasts arguably the only true open-access platform among the large Canadian banks. The bank also offers zero commission pricing for its direct brokerage services. National Bank of Canada's financial markets segment has seen solid growth and retains good market share as a provincial government debt underwriter; we expect this segment to be a steady contributor. Beyond this, the bank also has its Credigy (specialty finance) and ABA (Cambodia based bank) segments, which provide extra growth streams for the bank.
Because it operates almost entirely within the favorable Canadian banking environment, National Bank of Canada has consistently earned the highest returns on tangible equity among its peers. We also like its lower exposure to the hottest housing markets compared with competitors. While it is smaller than its peers and the bank can run into stiff competition, the bank's unique stronghold in Quebec will be difficult to break. Overall, National Bank of Canada is a solid, Canadian-focused franchise with the best returns on equity of the Big Six, but it often doesn't get as much attention as the "big five," which can lead to opportunities for investors.
4. Royal Bank of Canada / RBC (RY)
Wide-moat-rated Royal Bank of Canada RY, or RBC, reported decent fourth-quarter results. Adjusted earnings per share came in at CAD 2.78, flat year over year. Provisioning increased 16% quarter over quarter, which is in line with our expectations of increasing credit costs for all Canadian banks in the coming quarters. The current results do not fundamentally change our view on RBC or our CAD 130/USD 95 fair value estimates.
Looking deeper into credit, this quarter's provisioning increase was driven by a 62% increase of provisioning on the performing portfolio, similar to what we observed with Scotiabank's results, although provisioning on impaired loans also occurred, increasing another 2 basis points from last quarter. The management team expects peak loss rates toward late 2024 and 2025. We note that only 14% of RBC’s Canadian mortgages will renew in 2024, with 25% coming in 2025, which would allow the bank to continue to build reserves as credit strain potentially increases. We still believe credit costs will be manageable, but we anticipate increasing our provisioning forecast for the next two years to better accommodate the updated guidance.
Fees were roughly as expected but expenses continued to be a disappointment, an increase of 13% from a year ago. Excluding acquisition costs related to Brewin Dolphin and preparation for the HSBC integration, expenses were 9% higher, which is still ahead of our expectations. Management reiterated its focus on cost-control measures and expected core expense growth in 2024 to be low to midsingle digits and targeted 1% to 2% positive operating leverage. We hope the progress to a 1% to 2% reduction in all-bank headcounts will bear fruit in the coming quarters. Moreover, we think this quarter's wealth segment's turnaround efforts related to City National Bank will allow the 2015 acquired bank to go back to profitability next year. Net interest margin improved slightly sequentially, to 1.51% from 1.50%. RBC maintains a positive sensitivity to higher rates. We hope the core low-cost deposit Canadian bank franchise and an more optimized balance sheet for its U.S. segment will allow the bank to see continued benefits from higher rates
5. Toronto Dominion Bank TD
Wide-moat-rated Toronto Dominion TD reported adjusted earnings per share of CAD 1.83, a 16% year-over-year decline and a sequential decrease of 8%. Beneath the messy results, outsize expense growth and the guidance for negative operating leverage in 2024 were the main negatives. Adjusted expenses came in 4% higher than a quarter ago, with additional restructuring charges of roughly CAD 363 million expected in the first quarter of 2024. It remains difficult to predict the future expense level over the short term, but as we factor in a mid-single digit percentage core expense increase in 2024 and low-single-digit percentage increases thereafter, we don't think we're far off with our current projections. We may slightly increase our current expense projections, which may be a slight negative to our current fair value estimate of CAD 94/USD 69.
Net interest income, or NII, increased 3% sequentially, as net interest margins from Canada and the U.S. both improved. Trading fees were also solid this quarter. The management team expects the bank to miss its medium-term target of adjusted EPS growth of 7%-10% in 2024, with negative operating leverage. We caution investors that the current restructuring efforts will have more bumps along the way and it will likely take more than a year to play out. The target reduction of 3% in headcount across business lines will likely incur more severance costs along the way.
Provisioning for loan losses ticked up during the quarter, driven by some provisioning on performing balances and some provisioning on impaired balances. Provisioning in the performing loans was mostly driven by capital markets and Canadian commercial lending portfolios. Impaired balances continued to trend higher. We continue to expect to see reserve builds across the industry for coming quarters, as credit strain increases. We still expect any future losses to be manageable.
The bank also provided an updated estimate of reasonably possible losses related to all legal and regulatory matters—the upper bound of total estimates increased to CAD 1.44 billion from CAD 1.26 billion a quarter ago, with the lower bound unchanged at CAD 0. While this type of fine would not be material, it is never ideal to fall under the regulator’s gaze in this way, and it can lead to other sources of value destruction.
