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For the second consecutive quarter, all six Canadian banks delivered record earnings per share and beat consensus estimates by an average of 13%. Kim Parlee speaks with Mario Mendonca, Managing Director at TD Securities, about whether market conditions will remain favourable for Canadian banks.
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- Well, let's start with the bottom line here. It was a stellar quarter for all the Canadian banks. Record earnings growth. Again, low bar. And then also, I'd say juiced up performance from PCLs in this latest quarter. But maybe just kind of tell us what you saw in the second quarter right across the board.
- Well, this was another very strong quarter. The banks beat estimates by about 12%. That was on top of a 20% beat last quarter. Estimates have been revised meaningfully higher coming out of Q1. Estimates from the-- average estimate from bank analysts increased about 8% coming out of Q1, another 6% coming out of Q2.
That 14% increase in estimates, and that's the 2022 estimate, that is the greatest increase in estimates I've ever seen in a given year. Now, I think part of it relates to the application of the new accounting standards for credit losses, but there's no doubt that the momentum is very strong. And importantly, I still think estimates, consensus estimates, look a little light. I think the bank could probably beat estimates on a go-forward basis as well.
- Maybe take us through each of the banks. We can talk about what you saw there and then we'll bring it back up the big picture. But if you look at the performance in the last quarter, BMO was a standout. You make note of in your note. Why was that?
- Well, BMO has had two consecutive quarters where they're what we call pretax, preprovision earnings. These are earnings before you take into account taxes and before you take into account credit losses. BMO has delivered the two best quarters. I guess National to some extent as well, but more so BMO this quarter with 38% growth year over year in pretax, preprovision earnings.
And I think a lot of it relates to BMO being in the right place at the right time. They are strong commercial lender, very strong capital markets bank, which has been the key driver of revenue. They're not very large in credit cards, which has been weak. They don't have a lot of demand and notice deposits, which have caused a lot of margin pressure. And on top of that, BMO has done a very good job of keeping the lid on expenses.
BMO's efficiency ratio, which was always the highest in the group over the last 12 months, is now pretty much in line with the group average. So I think BMO has just executed well on expenses. And they've also been, as I said, in the right place at the right time.
- Let's stick with the one do you think that were standouts. National.
- Yeah. Similar to BMO, National has had several quarters now where capital-markets-related revenue has been very strong, and no bank generates more capital-markets-related revenue relative to the size of the bank than National. Just by comparison, about 26% of National's revenue comes from capital-markets-related revenue.
For, let's just pick two other banks that would be at the lower end, think Scotiabank and TD, where it would be around 15% and 10% of their revenue comes from capital markets. So National has clearly been in the right place at the right time. But on top of that, National has benefited from very strong growth coming out of their Cambodian business, about what they call their ABA business. It's been very, very strong. So again, National similar to BMO, right place, right time, also good execution.
- All right. Down the list, Royal, what stood out for you in this latest quarter?
- Well, Royal is just a very strong player, period. Royal is very strong in every business. Capital markets, they are very large in the US and in Canada, a very large domestic retail business, wealth business. But Royal hasn't performed as well in terms of the stock. It's still up about 20% year to date, but it hasn't performed as well as, say, BMO and National.
And I think in part what we're seeing here is that the bank's deposit franchise has resulted in a little bit more margin pressure, NIM pressure, for Royal than it has for some other peers. That suggests to me that when rates are rising, which I suspect we'll see the effect of rising rates later in '21 and early '22, Royal should be one of the prime beneficiaries of rising rates and what it could mean to their margin.
When you add to that that Royal is a very large credit card player in Canada, as people get out of their homes and start spending again and traveling, Royal could be one of the big beneficiaries in the card space as well. So I would say the results are good, but they're set up for better as the year progresses.
- CIBC?
- A good player. CIBC is dealing with some of their own sort of micro issues. They're trying to improve their performance in the domestic retail business. We might see elevated expenses. We haven't so far, but we might see elevated expenses in that bank in the second half of the year as they try to retool the domestic retail business.
But my sense from the results of the last couple of quarters is they've been able to invest in the business while cutting costs elsewhere, so keeping their operating leverage, which is the difference between revenue growth and expense growth, they've been keeping that positive.
On top of that, we're starting to see a re-emergence of mortgage growth for CIBC, an area where they sort of lagged their peer group. So CIBC is dealing with more micro issues rather than macro issues, but again, I sort of like the way things are trending in their domestic retail business.
- It all sounds generally quite positive, which we'll come back to. But Scotiabank, and I should mention, of course, we're not going to talk about TD for obvious reasons. But you made a note in Scotia just talking about the PCLs, how it looked a little different than the other banks.
- For sure. Now, Scotia has been impacted by the pandemic more than any other bank. Where you really see it is in what I'll broadly call fee income. So think about credit card fees, net insurance fees, deposit fees, anything to do with consumer activity. Travel, for example.
Scotia's revenue has been hit, by far, more than their peers because of the aggressive lockdowns in Latin America, no one traveling to the Caribbean, where they also have a big business. So Scotia, from a fee income perspective, looks like they have the most to gain as Latin American growth resumes and we all start traveling again.
But you mentioned credit specifically, and this is worth thinking about. We are moving further and further away from those deferral periods, the periods where the banks essentially gave a payment holiday to their customers. And we're moving further and further away from the period over which governments were providing significant support.
So any time you have-- anywhere you have significant unsecured consumer debt, meaning credit cards, you're going to see more credit losses emerge. For example, in this quarter, we saw CIBC's credit card losses move a little higher. In Scotia's case, they have $5 billion of credit card exposure in Peru, $4 billion of credit card exposure in Colombia. And we saw very significant losses emerge in those two buckets this quarter, which was different from what we've seen, generally, for the banks that operate predominantly in Canada and the US.
But I would be remiss if I didn't also note that Scotia is holding very substantial credit provisions. Just as a reminder, in 2020, the banks, Scotia in particular, built significant expected credit losses. Those expected credit losses will be brought to bear to absorb the actual losses that emerge in the credit card books.
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- Well, let's start with the bottom line here. It was a stellar quarter for all the Canadian banks. Record earnings growth. Again, low bar. And then also, I'd say juiced up performance from PCLs in this latest quarter. But maybe just kind of tell us what you saw in the second quarter right across the board.
- Well, this was another very strong quarter. The banks beat estimates by about 12%. That was on top of a 20% beat last quarter. Estimates have been revised meaningfully higher coming out of Q1. Estimates from the-- average estimate from bank analysts increased about 8% coming out of Q1, another 6% coming out of Q2.
That 14% increase in estimates, and that's the 2022 estimate, that is the greatest increase in estimates I've ever seen in a given year. Now, I think part of it relates to the application of the new accounting standards for credit losses, but there's no doubt that the momentum is very strong. And importantly, I still think estimates, consensus estimates, look a little light. I think the bank could probably beat estimates on a go-forward basis as well.
- Maybe take us through each of the banks. We can talk about what you saw there and then we'll bring it back up the big picture. But if you look at the performance in the last quarter, BMO was a standout. You make note of in your note. Why was that?
- Well, BMO has had two consecutive quarters where they're what we call pretax, preprovision earnings. These are earnings before you take into account taxes and before you take into account credit losses. BMO has delivered the two best quarters. I guess National to some extent as well, but more so BMO this quarter with 38% growth year over year in pretax, preprovision earnings.
And I think a lot of it relates to BMO being in the right place at the right time. They are strong commercial lender, very strong capital markets bank, which has been the key driver of revenue. They're not very large in credit cards, which has been weak. They don't have a lot of demand and notice deposits, which have caused a lot of margin pressure. And on top of that, BMO has done a very good job of keeping the lid on expenses.
BMO's efficiency ratio, which was always the highest in the group over the last 12 months, is now pretty much in line with the group average. So I think BMO has just executed well on expenses. And they've also been, as I said, in the right place at the right time.
- Let's stick with the one do you think that were standouts. National.
- Yeah. Similar to BMO, National has had several quarters now where capital-markets-related revenue has been very strong, and no bank generates more capital-markets-related revenue relative to the size of the bank than National. Just by comparison, about 26% of National's revenue comes from capital-markets-related revenue.
For, let's just pick two other banks that would be at the lower end, think Scotiabank and TD, where it would be around 15% and 10% of their revenue comes from capital markets. So National has clearly been in the right place at the right time. But on top of that, National has benefited from very strong growth coming out of their Cambodian business, about what they call their ABA business. It's been very, very strong. So again, National similar to BMO, right place, right time, also good execution.
- All right. Down the list, Royal, what stood out for you in this latest quarter?
- Well, Royal is just a very strong player, period. Royal is very strong in every business. Capital markets, they are very large in the US and in Canada, a very large domestic retail business, wealth business. But Royal hasn't performed as well in terms of the stock. It's still up about 20% year to date, but it hasn't performed as well as, say, BMO and National.
And I think in part what we're seeing here is that the bank's deposit franchise has resulted in a little bit more margin pressure, NIM pressure, for Royal than it has for some other peers. That suggests to me that when rates are rising, which I suspect we'll see the effect of rising rates later in '21 and early '22, Royal should be one of the prime beneficiaries of rising rates and what it could mean to their margin.
When you add to that that Royal is a very large credit card player in Canada, as people get out of their homes and start spending again and traveling, Royal could be one of the big beneficiaries in the card space as well. So I would say the results are good, but they're set up for better as the year progresses.
- CIBC?
- A good player. CIBC is dealing with some of their own sort of micro issues. They're trying to improve their performance in the domestic retail business. We might see elevated expenses. We haven't so far, but we might see elevated expenses in that bank in the second half of the year as they try to retool the domestic retail business.
But my sense from the results of the last couple of quarters is they've been able to invest in the business while cutting costs elsewhere, so keeping their operating leverage, which is the difference between revenue growth and expense growth, they've been keeping that positive.
On top of that, we're starting to see a re-emergence of mortgage growth for CIBC, an area where they sort of lagged their peer group. So CIBC is dealing with more micro issues rather than macro issues, but again, I sort of like the way things are trending in their domestic retail business.
- It all sounds generally quite positive, which we'll come back to. But Scotiabank, and I should mention, of course, we're not going to talk about TD for obvious reasons. But you made a note in Scotia just talking about the PCLs, how it looked a little different than the other banks.
- For sure. Now, Scotia has been impacted by the pandemic more than any other bank. Where you really see it is in what I'll broadly call fee income. So think about credit card fees, net insurance fees, deposit fees, anything to do with consumer activity. Travel, for example.
Scotia's revenue has been hit, by far, more than their peers because of the aggressive lockdowns in Latin America, no one traveling to the Caribbean, where they also have a big business. So Scotia, from a fee income perspective, looks like they have the most to gain as Latin American growth resumes and we all start traveling again.
But you mentioned credit specifically, and this is worth thinking about. We are moving further and further away from those deferral periods, the periods where the banks essentially gave a payment holiday to their customers. And we're moving further and further away from the period over which governments were providing significant support.
So any time you have-- anywhere you have significant unsecured consumer debt, meaning credit cards, you're going to see more credit losses emerge. For example, in this quarter, we saw CIBC's credit card losses move a little higher. In Scotia's case, they have $5 billion of credit card exposure in Peru, $4 billion of credit card exposure in Colombia. And we saw very significant losses emerge in those two buckets this quarter, which was different from what we've seen, generally, for the banks that operate predominantly in Canada and the US.
But I would be remiss if I didn't also note that Scotia is holding very substantial credit provisions. Just as a reminder, in 2020, the banks, Scotia in particular, built significant expected credit losses. Those expected credit losses will be brought to bear to absorb the actual losses that emerge in the credit card books.
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