Betting against the banks doesn’t pay
Recession talk, oil price declines fail to put a damper on sector’s earnings
Canadian banks have once again defied predictions of impending doom by posting another round of strong earnings results this week.
Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday became the two latest banks to beat expectations. CIBC said earnings in the third quarter rose 6.2 per cent compared to last year and announced it would raise its quarterly dividend by 2.75 per cent. TD, meanwhile, said profit jumped 7.5 per cent.
The earnings beats follow strong results from Bank of Montreal, Royal Bank of Canada and National Bank of Canada earlier in the week, leading to a price surge by bank stocks. CIBC’s stock spiked 5.86 per cent Thursday, while TD was up 1.54 per cent.
The TSX Capped Financials Index is up 6.7 per cent since the start of the week.
“Broadly speaking, we are seeing better-than-expected results,” said John Aiken, financial services analyst at Barclays Capital. “Comments from management continue to be positive about the coming quarters.”
The bar was certainly low for banks heading into earnings season. Canada’s economy is believed to have fallen into recession in the first half of the year, following a negative GDP print in the first quarter and monthly contractions in both April and May. Oil prices also declined for the three-month reporting period ending July 31.
The market has been heavily discounting bank stocks during the past year on the assumption there would be fallout from the oil crash. Robert Sedran, analyst at CIBC World Markets, noted in a report earlier this month that Canadian bank stocks trade at a notable discount to their U.S. peers despite having a more diversified business model and stronger earnings growth.
David Baskin, president of Baskin Wealth Management, said Canada’s banks continue to be “screaming bargains” in light of this week’s earnings and dividend hikes.
“The banks don’t raise their dividends unless they’re pretty sure about the future,” he said. “The last time a major Canadian bank cut its dividend was in the 1930s, so they don’t want to become the first bank in 80 years to have to cut their dividend.”
In addition to CIBC’s dividend increase on Thursday, RBC raised its dividend earlier in the week.
Even though banks managed to beat profit expectations, there is clear evidence that the weak economy, particularly the struggling energy sector, is impacting their bottom lines.
CIBC said that gross impaired loans in its oil-and-gas portfolio rose 36 per cent to $34 million in the third quarter. There were no impaired loans during the same period last year.
“As we expected, low oil prices are challenging for some of our clients,” RBC chief executive David McKay told analysts during a conference call Wednesday. The bank’s impaired loans also rose, to $183 million in the third quarter from $46 million in the second quarter.
The full fallout that the current economic environment is having on banks, particularly their ever-important loan books, has likely not turned up yet. So far, the loan books have not been impacted materially, but analysts note that the damage to the economy from slumping oil prices typically has a lagging effect on consumer loans.
Still, Aiken at Barclays notes the banks have done a prudent job in reining in costs, meaning they are well prepared if Canada’s weak economy starts biting further into profits.
“The banks have done an impressive ( job) growing their expenses much more slowly than their revenue, which is what you want in this environment,” Aiken said.