29 November 2018

CIBC & TD Bank Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 29 November 2018

Toronto-Dominion Bank and Canadian Imperial Bank of Commerce can thank a hot U.S. economy for higher profits. But the banks' sizable American operations aren’t expected to deliver as much growth in 2019 because of rising competition.

TD and CIBC, which both released year-end earnings on Thursday, have a lot of exposure to the United States following large acquisitions. Lately, profit growth from those divisions has been encouraging – particularly for TD. The bank, which endured years of anemic returns in its U.S personal and commercial bank after the global financial crisis, saw its annual profit from U.S. retail banking jump 26 per cent to $4.2-billion.

Oddly enough, the worry now is that the U.S. economy has been doing too well. The recovery is nearly a decade old and inflation and wages are ticking higher, prompting the Federal Reserve to hike interest rates eight times in the past two years.

Because business is booming, the U.S. banking market has become extremely competitive. “Competition has increased,” DBRS Ltd. analyst Robert Colangelo said. "Even though the U.S. is a very large market, it is limited in how much market share the banks can take – especially on the commercial side.”

Executives from both banks echoed this sentiment in conference calls Thursday. “It certainly has been competitive" when luring commercial deposits, said Greg Braca, group head of U.S. banking at TD.

“We’ve reached a threshold,” said Larry Richman, head of the U.S. region for CIBC. “As rates are rising, clients that have excess cash are wanting to get paid for it.”

Retail and commercial banks make money by attracting low-cost deposits and lending this money out at higher rates. Lately, U.S. banks have been able to charge more per loan, because interest rates have been rising.

But the market for attracting deposits is also getting more aggressive, which will force banks to pay up for deposits, slowing their loan margin growth.

A few more clouds are also forming over the U.S. economy. In a report released Thursday, credit rating agency Standard & Poor’s noted “the risk of recession for the U.S. has risen and growth will likely slow even if the U.S.-China tariff dispute doesn’t escalate into a trade war.”

S&P said the odds of a downturn over the next 12 months are 15 per cent to 20 per cent, compared with 10 per cent to 15 per cent in its previous forecast.

Despite shifts in the United States, total earnings at both banks are still expected to be higher next year. TD is particularly optimistic, with chief executive Bharat Masrani predicting total earnings growth of 7 per cent to 10 per cent in fiscal 2019.

CIBC is slightly less bullish, expecting 5-per-cent to 10-per-cent expansion. However, the bank remains optimistic about the quality of its loan book. “While there continue to be potential headwinds, as it feels like we are entering the later part of the economic cycle, we remain confident in our strong underwriting practices and the quality of our credit portfolios,” chief risk officer Laura Dottori-Attanasio said in a conference call.

Investors had divergent reactions to the profits announced Thursday. TD’s shares were relatively flat by the end of the trading day, closing at $73.48, while CIBC’s shares fell 3 per cent to $112.46.

For the full fiscal year, which ended Oct. 31, TD reported net income of $11.3-billion, nearly 8 per cent higher than fiscal 2017, while CIBC’s annual profit climbed to $5.2-billion, up 12 per cent from the prior year.

Earlier this week, TD and CIBC announced the details of their participation in Air Canada’s acquisition of the Aeroplan loyalty rewards program. TD is betting heavily on Aeroplan, committing to $1-billion worth of upfront payments and future expenses as the lead financial partner. Its contract with Air Canada will start in 2020 and last until 2030.

CIBC will be a secondary partner in the new arrangement, and has agreed to pay $292-million in total to participate.

28 November 2018

RBC Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 28 November 2018

Royal Bank of Canada reported solid profits on Wednesday for the ninth straight year, and, like clockwork, the bank’s executives were rewarded with skeptical questions from analysts about the odds of future success.

Such scrutiny is almost automatic for Canada’s largest public company by stock-market value. Canadian banks have faced one obstacle after another over the past decade. There was the financial crisis, the slow economic recovery, the fears of a housing bubble, the collapse of energy prices from 2014 to 2016. Now, the price of Alberta heavy oil is tumbling again.

But through it all, the country’s biggest banks have remained sturdy – and RBC has been one of the most dependable. Its total profit in fiscal 2018, which ended Oct. 31, hit $12.4-billion. That’s 38 per cent higher than the earnings announced five years before.

For all that growth, RBC can’t shake the questions about its resilience. Before Wednesday, its shares had fallen 4.9 per cent in the past 12 months, despite delivering better earnings in each consecutive quarter over the past year.

The latest results did persuade buyers to push the stock the stock 2.7 per cent higher on Wednesday, to $98.10. But the broader market also rose sharply. Winning over investors is expected to remain tough.

“The market is pricing in substantial headwinds for 2019,” Eight Capital analyst Steve Theriault wrote in a research report on Wednesday. RBC’s stock trades at less than 12 times last year’s earnings.

What is the root of the market’s skepticism? On top of regular hiccups such as commodity price swings, which threaten to bring higher loan losses in Alberta, the 2008 crash still lingers in some investors' minds. There have been continuous political, economic and market disruptions in the decade since – everything from the unexpected election of U.S. President Donald Trump to the quantitative easing that lasted longer than many thought it would and suppressed interest rates.

Still, by now, RBC’s continued strength is tough to overlook. On Wednesday, the bank reported that its Tier 1 capital ratio is 11.5 per cent, a full percentage point higher than RBC’s target level, and much higher than it was before the financial crisis. That means the bank has loads of money tucked away to serve as a buffer when a downturn comes.

RBC’s return on equity, one of the industry’s most closely watched metrics, also sits at 17.6 per cent. To put that in perspective, JP Morgan Chase & Co. is constantly praised as one of the world’s best-run banks, but its ROE is 14 per cent.

This return largely stems from a stellar personal and commercial banking (P&C) business that contributes nearly 50 per cent of RBC’s bottom line. The division remains highly profitable, despite a recent housing slowdown. In fiscal 2018, the bank’s residential mortgage portfolio grew 5 per cent, but total P&C revenues rose 8.6 per cent in the fourth quarter, compared with the previous year.

“Companies are investing. Employment is strong. There are a number of tailwinds from an economic perspective," chief financial officer Rod Bolger said in an interview.

The strong economy means interest rates are rising at last, and that has been a major boon to lenders, allowing them to charge more for mortgages and many other loans. The rates banks pay on deposits are also rising, but not as quickly.

Of course, nothing lasts forever, and lately there are growing expectations of a U.S. recession, or at least a sharp slowdown. Asked about the largest systemic threats that RBC faces, Mr. Bolger, the CFO, cited trade tensions and the risk of higher unemployment. At the moment, this threat is most imminent in Alberta, because the province is wrestling with low prices for oil and gas.

As for RBC’s own oil and gas exposure, chief risk officer Graeme Hepworth brushed off the questions on Wednesday, noting that the sector amounts to only 1 per cent of RBC’s total loan book and calling the risk “pretty small, pretty manageable.”

RBC must also demonstrate that its U.S. City National division will deliver better profits. The bank has invested in it this year, and that has taken the steam out of profit expansion. The American market dynamics are also changing, with many affluent and high-net-worth clients moving their money out of deposits and into better-yielding assets, which makes it harder for banks such as City National to find cheaper ways of funding their loans.

RBC’s executives, though, are not sweating it. “We’re feeling good about the outlook for the economy and for the bank," chief executive officer Dave McKay said on a conference call on Wednesday.

Investors that trust them could see big gains. “If RBC can in fact deliver, we believe there is meaningful upside for [its] shares as the bank continues to do a lot of the right things," Mr. Theriault, the analyst, said in his report.

27 November 2018

Scotiabank Q4 2018 Earnings

The Globe and Mail, Tim Kiladze, 27 November 2018

Bank of Nova Scotia signalled that it will take a breather from major acquisitions, after racking up deals totalling nearly $7-billion over the past year.

Chief executive Brian Porter said the focal point in 2019 will be on merging these purchases into the bank’s existing operation instead of seeking out new acquisitions. At the same time, Scotiabank continues to prune divisions that it considers “non-core,” or those that are not crucial to its future, disclosing Tuesday that it’s selling its banking operations in nine Caribbean countries as well as its life insurance businesses in Jamaica and Trinidad.

“This year is going to be focused on integration,” Mr. Porter said on a conference call. “We’re not in the business of acquiring anything this year.”

Mr. Porter has been refining the bank’s business mix since he took over five years ago and has exited, or announced a plan to exit, 22 businesses or geographic markets in that time. Mr. Porter told investors to expect more divestitures in the next year, though he did not provide specific targets. Analysts expect Scotiabank to sell its 49-per-cent stake in Thailand’s Thanachart Bank, something that has long been rumoured.

The bank’s move to slow down on acquisitions follows some investor concern about the pace of deals and the bank’s ability to generate good returns on them. Over the past 12 months, Scotiabank has announced three sizable acquisitions, the largest of which was the majority stake in Banco Bilbao Vizcaya Argentaria S.A.'s retail banking business in Chile, for a cost of $2.9-billion. Other notable deals included snapping up money managers MD Financial Management and Jarislowsky Fraser Ltd., two separate acquisitions that cost the bank a total of more than $3.5-billion.

Individually, each deal was in line with business goals that Scotiabank had previously spelled out. Collectively, however, they made investors pause. Concerns about Scotiabank’s ability to extract good acquisition returns, coupled with some fears about economic weakness in emerging markets and some tremors from North American free-trade negotiations, have weighed on Scotiabank’s share price, which has overshadowed the bank’s solid earnings growth of 10 per cent in the past 12 months, after adjusting for one-time costs incurred in 2018.

Since Nov. 1, 2017, which was the start of the previous fiscal year, Scotiabank’s shares have dropped about 15 per cent. The average performance of the five other large Canadian banks over the same period is a drop of about 2 per cent.​

“After having deployed $7-billion on acquisitions over the past year, Scotiabank has (rightfully) shifted its strategic focus to integration and execution," National Bank Financial analyst Gabriel Dechaine wrote in a research note. “While we normally view this type of commentary as predictable, in Scotiabank’s case, execution on M&A [mergers and acquisitions] integration is of utmost importance.”

While some investors have been down on the bank, the lender’s profit continues to climb, particularly in Canadian banking, which contributes 50 per cent of total earnings. Despite a recent slowdown in housing sales, Scotiabank’s average mortgage portfolio grew 3 per cent year-over-year, and the lender expects residential mortgages to continue growing at around 4 per cent next year.

Projected interest rate hikes by the Bank of Canada are also likely to boost profits, because banks will be able to issue loans at higher yields. Meanwhile, the deposits that fund these loans take longer to re-price to higher rates, boosting their lending margins. Scotiabank expects total profit from Canadian banking to climb 7 per cent or higher in 2019.

Earnings also jumped in the international banking unit, which is now dominated by Latin America – and particularly by what Scotiabank calls the “Pacific Alliance” countries of Chile, Colombia, Peru and Mexico. The division’s total profit climbed 17 per cent in 2018, after adjusting for one-time items. While this surge was boosted by the recent BBVA Chile acquisition, even after stripping this addition out, profit still jumped 15 per cent.

The news Tuesday that Scotiabank is exiting nine small Caribbean countries and selling the operations to Republic Bank comes as much of the region struggles to deliver consistent economic growth – a problem that has also affected Royal Bank of Canada and Canadian Imperial Bank of Commerce. RBC recently sold its Jamaican operations, and earlier this year CIBC tried to sell off some of its FirstCaribbean bank by taking it public in the United States, but ultimately had to pull the deal.

“Due to increasing regulatory complexity and the need for continued investment in technology to support our regulatory requirements, we made the decision to focus the bank’s efforts on those markets with significant scale in which we can make the greatest difference for our customers,” Scotiabank said in a statement.
The Globe and Mail, David Berman, 27 November 2018

You might be tempted to invest in Bank of Nova Scotia because of its big dividend yield, low valuation or large emerging-markets footprint. But here’s a better reason: The stock is a dud.

The share price has slumped 13.5 per cent so far in 2018, making it the worst-performing stock among Canada’s five biggest banks. It has underperformed its peers by 7.2 percentage points (not including dividends). And the stock has trailed the year’s best performer, Toronto-Dominion Bank, by 11.3 percentage points.

Scotiabank’s fiscal fourth-quarter earnings report, released on Tuesday morning, didn’t help the situation. The bank missed analysts' earnings expectations by 2 cents – it reported a profit of $1.77 a share, after adjustments, versus an expectation of $1.79 a share. Although the share price rose 0.1 per cent to $70.15, Scotiabank trailed its four biggest peers.

So why warm to a cold bank?

The answer lies in a simple stock-picking strategy: Since lagging banks have an impressive track record of catching up with their big-bank peers relatively quickly, investors can score market-beating gains by scooping them up.

We’ve been tracking this strategy using data going back to 2000. Buying the prior year’s worst-performing bank stock and holding it for one year has produced an average annual return of 17 per cent (not including dividends).

That’s better than the 11-per-cent average return you would get from holding all of the biggest five bank stocks over the same period. And it’s much better than the 5-per-cent average return for the S&P/TSX Composite Index.

The strategy has delivered peer-beating returns 69 per cent of the time, and it has beaten the broad index 75 per cent of the time, which is a compelling record.

Although buying Scotiabank in 2015 was the most recent misfire (the stock trailed its peers by 5 percentage points that year), the strategy has worked well in the past few years. Buying Scotiabank again in 2016 and Canadian Imperial Bank of Commerce in 2017 produced peer-beating returns.

This year looks good too, relatively speaking. Yes, Bank of Montreal, last year’s laggard and this year’s pick, is down 2.6 per cent year-to-date. But the stock is outperforming its peers by 3.7 percentage points and is beating the S&P/TSX Composite Index by more than 5 percentage points.

Indeed, BMO is the second-best bank stock this year, and it is just 0.4 percentage points behind first-place TD.

Which brings us back to Scotiabank. The stock looks set to end the year as the laggard in 2018 and the top pick for 2019, making the list for the third time in five years.

All Canadian bank stocks have been struggling this year for a number of reasons. Rising interest rates are making bonds look more attractive next to dividend-paying stocks, the mortgage market is slowing, and low oil prices are threatening the Canadian economy and raising questions about whether bank loans to the energy sector will be repaid in full.

As well, Scotiabank has issues of its own. The bank has considerable exposure to Mexico, Colombia, Chile and Peru, but emerging markets have fallen out of favour with investors this year amid concerns over trade tariffs, falling commodity prices and rising U.S. interest rates.

More importantly, the bank has been on a $7-billion acquisition binge over the past 12 months – including its US$2.2-billion deal for BBVA Chile last November, when Scotiabank’s share price was near a record high. The weaker share price since then may be reflecting concerns over whether its acquisitions will pay off.

Betting on successful integration is a tough one for most investors to get right. Add to that the complexities of commodity prices, monetary policy and – most problematic of all – a coherent trade strategy from the U.S. White House, and you can be forgiven for nursing some uncertainty over bank stocks.

But Scotiabank shares now yield more than 4.8 per cent, the highest dividend payout of the biggest five banks. And they trade at just 9.5-times estimated earnings, according to Bloomberg, which is a cheaper valuation than all but CIBC.

Put another way, there is a wide gap between Scotiabank and its peers. Over the next year, the bank will probably close it.

25 November 2018

Analysts Offer Mixed Outlook on Big Six Q42018 Results

The Globe and Mail, David Berman, 25 November 2018

Canada’s biggest banks will report their fiscal fourth quarter results starting this week, and analysts are expecting a strong finish to the year. But given the stock market is dominated by concerns over slowing economic activity, will investors care?

Bank of Nova Scotia will kick off the reporting on Tuesday, followed by Royal Bank of Canada on Wednesday and Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday.

Next week, Bank of Montreal and National Bank of Canada will report their results on Dec. 4 and 5, respectively, for the three-month period ended Oct. 31.

Analysts anticipate the Big Six banks will show profit growth of about 12 per cent, year-over-year, driven by their strong international operations, accelerating commercial loan growth and rising interest income. They also expect BMO and National Bank will raise their dividends.

“It has been a good year. Moreover, notwithstanding the share price performance in the last few months, commentary at recent conferences and investor days suggests that fiscal 2019 will be another good one,” Robert Sedran, an analyst at CIBC World Markets, said in a note.

But the quarterly results will arrive during an unsettled period for the stock market. Investors are focusing on the threat of trade tariffs, inflationary pressures and rising interest rates, which is causing wild swings by major indexes. In Canada, higher borrowing costs are weighing on the housing market, which is also adjusting to tighter lending regulations, and low oil prices are hitting the energy sector.

The S&P/TSX Composite Index is down 7.4 per cent this year. Although bank stocks are outperforming the broad index, ever-so-slightly, no one is cheering: The S&P/TSX Commercial Banks Index is down 6.9 per cent this year after taking a 9.5-per-cent nosedive since September.

Will fourth quarter results lift the mood? Analysts expect TD, BMO, RBC and CIBC will benefit from their U.S. divisions, where profits are being driven by recent tax cuts and strong economic activity, and they expect Scotiabank’s profits will get a lift from the bank’s recent acquisition in Chile.

Together, profits from the banks’ U.S. and international operations should rise 31 per cent over last year, according to Sohrab Movahedi, an analyst at BMO Nesbitt Burns.

But expectations for Canadian personal and commercial banking – the meat and potatoes of bank operations – are far more muted. Darko Mihelic, an analyst at RBC Dominion Securities, pegs fourth quarter P&C growth at 3 per cent, year-over-year.

“We maintain our view that Canadian consumer loan growth is likely to slow in an environment of slower GDP [gross domestic product] growth and rising interest rates given the relatively high level of consumer indebtedness," Mr. Mihelic said in a note. "We are of the view that this will ultimately lead to slower net interest income and total revenue growth over the next few years.”

Residential mortgage growth in Canada slowed to just 3 per cent at the end of September. That marks the slowest pace in decades, according to Gabriel Dechaine, an analyst at National Bank Financial. Strong commercial loan growth has been picking up the slack, but analysts are starting to wonder how long this particular engine can keep going.

“With the mortgage market slowing, it begs the question: How sustainable is the trend of double-digit commercial loan growth?” Mr. Dechaine said in a note.

Canada’s energy sector is also likely to emerge as a key theme. The price of Western Canadian Select crude, the heavy bitumen produced in the oil sands, has fallen 74 per cent since July, driving down energy stocks and raising concerns about the impact to the Canadian economy.

The last time oil fell sharply, between 2014 and 2016, bank stocks declined nearly 22 per cent over the same period amid concerns that struggling energy companies would have trouble meeting their debt obligations.

Perhaps bank stocks will perform better this time around. Valuations have fallen to 9.7-times estimated 2019 earnings – well below the 10-year average price-to-earnings ratio of 11.1, according to RBC Dominion Securities – which implies that bad news is already baked in.

As well, the Big Six emerged from the previous energy-fuelled downturn with their operations relatively unscathed, bolstering confidence that these financial behemoths can handle commodity turbulence.

“The banks still managed earnings growth of 6 per cent and 4 per cent in fiscal 2015 and fiscal 2016, respectively, and loan books would have benefited from clean up and monitoring brought on by the last downturn,” Mr. Sedran said.

But the lower oil goes, the bigger the worries.