Paul Bagnell

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It’s been a tough year for investors in Canadian banks — the group’s shares are down about seven per cent so far this year — but it’s hard to find fault with the way the banks have executed on their business plans through the recently concluded fiscal year.

The last time the banks reported quarterly results, they delivered uniformly strong quarters – earnings growth came in at 11 per cent for the group as a whole – and showed once again that their businesses are well suited to keep profit growing in a low-growth, debt-heavy Canadian economy. Analysts are expecting the banks to report another strong quarter in their year-end results  – but are much more cautious on what fiscal 2019 will bring.  At least one analyst has cut his earnings estimates and price targets because he expects slower growth ahead.   

Here’s a look at what to watch for in the upcoming big bank results:

-- Earnings growth: Estimates compiled by Bloomberg show analysts expecting aggregate growth in earnings per share of 11 per cent. That’s a strong number in a Canadian economy currently growing by about two per cent, and characterized by low interest rates and high levels of household debt. 

With the bar set as high as 11 per cent, shares of banks that beat expectations will likely be rewarded. If this turns into one of those quarters where all or most banks beat, the group as a whole should move higher. That would be a relief to investors, who have watched the bank stocks take a drubbing this fall.

Rob Colangelo is a senior vice president at DBRS who covers Canadian banking and financial institutions. He expects a “strong quarter” from the lenders, and says impressive growth in commercial lending should make up for slower growth in loans and mortgages to individuals. “Commercial lending has been strong all year,” he told me when we spoke. “We expect mortgage growth to come in at between one and two per cent, but it could surprise to the upside. The fourth quarter is a seasonally strong one.”

Colangelo says profit growth in Canadian retail banking could be softer than in the past – mainly on moderating mortgage demand as new stress test rules continue to work their way through the market. And the big stock market declines of October will likely have dampened growth in the fee-based wealth management arms.

But, all in, Colangelo expects positive results from the Canadian banks, driven by commercial growth that outpaces sluggishness on the personal side, and good growth from U.S. banking operations.

Scott Chan at Canaccord Genuity also uses the word “strong” to describe the earnings quarter he’s anticipating. He expects 10 per cent earnings growth. But he’s concerned about what’s ahead for the banks in fiscal 2019.  More on that later.

-- Dividends: Two of the Big Six banks are expected to raise their dividends: Bank of Montreal and National Bank. Among the smaller banks, Laurentian Bank is expected to move its dividend up.

Regular dividend hikes from the banks are a huge part of their appeal, of course, and the stream of dividend income from the shares has softened the blow from sinking share prices. 

That seven per cent decline in the S&P TSX Banks Index we referenced earlier becomes a much more palatable decline of four per cent when dividend income is factored in.

-- Profit growth in the United States. DBRS’s Colangelo says this could be another quarter of double-digit growth in U.S.-derived profit for the banks with big operations there - Toronto-Dominion Bank, Bank of Montreal and Royal Bank of Canada.  And indeed, the macro environment south of the border seems just about right. GDP growth is running at 3.5 per cent, unemployment has fallen to 3.7 per cent, wage growth has recently moved up to better than three per cent and the U.S. Federal Reserve is raising rates faster than the Bank of Canada.

These are precisely the reasons why, for a long while now, we’ve heard portfolio managers tell us on BNN Bloomberg they prefer to own the Canadian banks with significant banking operations in the U.S.

But it’s time to question that thinking, says one veteran analyst. 

When the large regional banks in the U.S. reported earnings for the quarter ended on Sept. 30, notable trends included weak loan growth, says Gabriel Dechaine, who covers the banks for National Bank Financial. Loans grew by only three per cent versus the third quarter of 2017 as many companies are worried about global trade uncertainties, he noted in a report. 

Aside from trade tensions, many U.S. companies are holding large sums of cash, allowing them to finance growth strategies without calling their bankers.

And margin expansion was weak, Dechaine argues, citing figures which show net interest margins posting their weakest growth – 14 basis points – in six quarters.

“The ‘long-U.S.’ exposure theme is becoming logically more difficult to support,” Dechaine said in his note.

It’s an issue that will be crucial to investors in Canadian bank stocks. The fourth-quarter results and outlooks we get from TD, Royal and BMO should shed some light on whether Dechaine’s contrarian call is correct.

-- Growth in net interest margins will moderate. That’s because higher central-bank interest rates will deliver less benefit to net interest margins. Expect to hear the phrase “deposit beta” fairly often. 

While it’s still good news that the U.S. Federal Reserve and the Bank of Canada are increasing rates, banks are now opting to give more of those increases to their deposit holders than they have earlier in the rate-hike story. 

The Canadian banks had earlier used Bank of Canada rate hikes to add more basis points to interest rates charged on loans than to interest rates paid on deposits. That’s “low deposit beta” — a relatively weak link between BoC hikes and deposit interest rates. 

But now, competition for deposits — in both Canada and the U.S. — is compelling banks to pass on more of the hikes to deposit holders. That’s “higher deposit beta”.

The Bank of Canada raised its benchmark rate on July 11, just before the fiscal fourth quarter began on Aug. 1. And it hiked again on Oct. 24, just before the quarter ended.

Colangelo at DBRS observes that Canadian banks have begun offering more attractive interest rates on products like term deposits and demand deposits.

“They’ve been slow in passing on higher rates to depositors,” Colangelo said, “but they are now offering more attractive rates on things like three-year and 90-day term deposits and demand deposits.”

And Robert Sedran, an analyst at CIBC Capital Markets, made the same point when he flagged deposit beta as a key issue in a conversation with Amber Kanwar and Jon Erlichman on The Open recently.  

So net interest margins are likely to expand, but only modestly.

- Forecasts will be key. It always is when the banks close the books on a fiscal year. It may be more important this year. 

We’ve noted that Scott Chan at Canaccord Genuity is concerned about slowing trends in fiscal 2019, which began on November 1. He believes earnings growth is about to slow down at the banks “over the next few years” and has thus reduced the price-earnings multiple he uses to derive target prices to 11 times expected earnings from 12 times (11 times is in line with long-term historical averages). As a result, he has cut his price target on the banks by an average of seven per cent.

“The outlook will be more important than the actual quarter,” Chan says.

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Here is when each of the big banks will report its fourth-quarter earnings. Each reports in the morning, before markets open:

Bank of Nova Scotia: Nov. 27

Royal Bank of Canada: Nov. 28

Toronto-Dominion Bank: Nov. 29

Canadian Imperial Bank of Commerce: Nov. 29

Bank of Montreal: Dec. 4

National Bank of Canada: Dec. 5