Banks cut costs, but real hurricane hasn’t hit yet
Executives at Canada’s largest banks have been stuck on repeat, telling investors about their efforts to cut and control costs.
Starting a week Tuesday and through early December, this chorus “will reach a crescendo” when the banks report earnings for the last time this fiscal year, analysts at Scotia Capital said in a note.
A trio of financial institutions have already announced that they will record restructuring costs in the fourth period: $85 million in severance and professional fees, before taxes, at National Bank; an estimated $200 million at Canadian Imperial Bank of Commerce; and some $300 million at Toronto-Dominion Bank, according to Scotia. Already in 2015, CIBC recorded $85 million in restructuring charges, before taxes, and TD has booked $337 million.
Canadian banks are aggressively protecting their profits in the face of a sluggish domestic economy, slowing loan growth, changing consumer habits and a fresh crop of new deep-pocketed competitors. One of those competitors, Apple Inc., made its mobile payments system available to Canadians just last week.
Slimming down isn’t a purely Canadian phenomenon: “Costcutting is about the only cylinder still firing in the profit engine,” McKinsey & Co. consultants said in a September report and forecast.
But domestic banks might not be cutting expenses fast enough — or it’s taking longer for savings to bear fruit. The focus has been on downsizing their physical footprint by shuttering branches, reorganizing divisions and laying off employees. Some of these structural savings have been redeployed into technology spending.
But the average growth rate of expenses at the big Canadian banks exceeded revenues in fiscal 2013, 2014 and the first three periods of 2015, analysts said. Even as these companies keep hiking dividends and generating enormous sales, this prolonged operating leverage in negative territory is a troubling trend.
“With other earnings levers facing headwinds, we expect operating leverage will play a bigger role for the banking sector in 2016-17,” Scotia said in its report. Six of the eight banks it covers have recorded expense growth higher than revenue. “Despite the more frequent references to cost containment that the sector has been making of late, it is difficult to point to signs of tangible progress in the actual results thus far.”
CIBC analysts don’t expect the streak to end in 2016, either. In an earnings preview, they predict earnings growth across the sector will be at its lowest since the financial crisis. Operating leverage won’t rebound until 2017, as many of these cost savings will be recycled into other initiatives in the near-term.
Most large Canadian banking stocks have taken a hit. The S&P/ TSX Banks Index has fallen 5.6 per cent so far this year, rebounding from a loss of 14.4 per cent as of Aug. 24, and it’s on pace to be the first year in the red since 2011. Of the Big Six, only shares of CIBC have gained during the past six months.
Investors have been bracing for Canadian banks to feel the brunt of the precipitous decline in oil prices, prompting CIBC analysts to ask: “If it’s supposed to be a Category 5 hurricane, why is it sunny outside?”
Fourth-quarter results might be soft, but they won’t be catastrophic.
With other earnings levers facing headwinds, we expect operating leverage will play a bigger role for the banking sector in 2016-17.
SCOTIA CAPITAL