Investors got the quarter they were counting on when Canada’s Big Six banks reported earnings this week – and then some.

When shares of the banks began rallying on Oct. 29, investors were buying because they believed the banks’ outlook on credit quality was about to take a sharply positive turn.  And they were right. Each of the big banks decided to set aside – or “provision” - much less money than they did just a quarter ago for an anticipated wave of loans slipping into default because of the economic shock from COVID-19. In fact, each of the banks cut provisions for credit losses (PCL) by more than analysts had forecast. Because every dollar of a PCL is a dollar lost to the net income line, earnings per share topped expectations in every case.

When Bank of Montreal and Bank of Nova Scotia each clobbered expectations on Dec. 1, shares of all the banks moved higher and investors quickly revised upward their near-term earnings expectations. Some analysts believe we may be a quarter or two away from banks actually taking money out of loan-loss reserves and back into the income statement – something that would act as a significant short-term boost to earnings.

But there was another trend in the results that may significantly affect the banks’ strategies in 2021: At each of the Big Six, levels of regulatory capital rose meaningfully. That suggests we may soon see some of the banks making acquisitions.

The banks’ key capital ratio is their Common Equity Tier 1 (CET1) ratio, and under the Office of the Superintendent of Financial Institutions’ current instructions, it must stay at more than 9.0 per cent. Slower loan growth during the pandemic has meant “risk weighed assets” – the denominator in the formula used to calculate the ratio – has grown more slowly than profit has added to capital levels – the numerator – this year.  By the end of the fiscal fourth quarter (Oct. 31), the banks were sitting on capital that was between 2.75 percentage points and 4.1 percentage points more than the regulatory minimum. Toronto-Dominion Bank leads the pack with a CET1 Ratio of 13.1 per cent.

Canada’s banking regulator – OSFI – has put a temporary ban on raising dividends or buying back shares as a way of ensuring the banks are sufficiently capitalized to endure a huge wave of pandemic-driven bad loans. That makes acquisitions more likely, because banks will want to put their excess capital to use.

I spoke to Jim Shanahan, an analyst who covers the banks at Edward Jones, and asked him if he believes the banks with significant U.S. businesses were most likely to be buyers. Those are TD, Bank of Montreal, Royal Bank and, to a lesser degree, Canadian Imperial Bank of Commerce. It’s in the U.S., after all, where most of the potential banking acquisitions are.

He agreed with that view, but noted Canadian lenders will be up against difficult competition from U.S. banks for quality assets. That’s a big difference from the years after the financial crisis, when Canada’s banks were much better capitalized than their weakened U.S. counterparts. This time around, the U.S. players are flush as well.

“There will be interest in acquisitions, but there will be competition,” Shanahan said. “TD Bank and Royal Bank have the most excess capital, so they potentially stick out as candidates.”

TD has expressed earlier interest in expanding its big U.S. retail banking business into the southeast United States, he noted. TD has also bought U.S. loan portfolios in the past, and could go that way again, he noted.

Royal Bank’s Los Angeles-based City National business is a banker to high net-worth individuals, and the bank has said it wants to expand City National’s footprint to other U.S. markets.

Of the other two, Bank of Montreal is a big lender to businesses in the U.S. Midwest. CEO Darryl White, however, downplayed the acquisition narrative when asked about it on a conference call, saying he preferred to invest in growth within BMO.

CIBC has the smallest U.S. platform – via its purchase of Chicago-based PrivateBancorp – but has been clear since that acquisition was made in 2017 that it considered PrivateBancorp a foundation on which to build a larger U.S. business. Now might be the time.

If Bank of Nova Scotia were to make a deal, it would likely be in Latin America. But Scotia has done more selling than buying in that region in recent years, sharpening its focus on the appealing economies of Colombia, Peru, Chile and Mexico. It has also integrated two big Canadian acquisitions in recent years – Jarislowsky Fraser and MD Financial – and watched its share price languish as investors fretted about those lengthy integrations.

And apart from that, Scotia CEO Brian Porter said in an interview Thursday the bank will likely buy back its own shares when OSFI gives the green light.

“We think our shares are still inexpensive and very attractive," Porter said.

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