Paul Bagnell

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On the morning of Sept. 21, Canadians will have lots of questions about what the newly configured House of Commons will mean for them – and investors in Canadian bank stocks will be no exception.

The banks have received ample attention from the Liberals and Conservatives – all of it critical.

The New Democratic Party platform takes aim at large corporations generally, with a promise of higher corporate tax rates.

The Conservatives have pledged a Competition Bureau investigation into bank fees, and to make it easier for Canadians to do business with fin-tech companies that may offer better rates on mortgages, credit cards or lines of credit.

But a Liberal win – even a minority – clearly poses the most questions for the banks and their investors.

The Liberals have pledged to raise the corporate tax paid by banks and insurance companies with annual earnings of at least $1 billion. The rate would go to 18 per cent from the current 15 per cent. That policy proposal was announced right in the middle of the most recent earnings season, as banks reported billions of dollars in profit for their most recent fiscal quarters.

The party has also promised something called the Canada Recovery Dividend, a less-defined levy on the same financial institutions that would apply over a four-year period.

Taken together, the two measures will generate $2.5 billion in annual revenue for the federal government over four years beginning in 2022-23, according to the Liberals. The party justifies the proposals by saying the banks and insurance companies enjoyed swift rebounds in profit during the pandemic – largely due to huge commitments of public dollars to support consumers and businesses.  Bank executives, indeed, have credited those programs with a lower-than-expected rate of loan defaults in their lending books.

That $1-billion profit threshold would mean new levies would apply to each of the Big Six banks and three of the big life insurance companies: Manulife Financial Corp., Sun Life Financial Inc. and Great-West Lifeco Inc.

Gabriel Dechaine, an analyst at National Bank Financial, has assessed the hit to profits that the new measures would deliver if the Liberals are re-elected.

He says a key question is whether the higher corporate tax rate would apply to bank and lifeco profits generated in Canada only, or generated in all the jurisdictions where the institutions do business.

If applied to “Canadian-sourced” earnings only, the average bank would experience a two per cent drop in profit, while the profit hit to the lifecos would be insignificant. The higher tax rate would generate an extra $1.3 billion to the federal government.

If, however, the higher tax rate applied to profits earned anywhere, the higher tax rate would generate $2.5 billion.  That appears to leave no room for the Recovery Dividend, given that Ottawa aims to raise that sum from the two measures combined.

The Recovery Dividend would also affect the banks more than the lifecos, Dechaine believes. It is the banks that have experienced big upswings in their regulatory capital – from which that Recovery Dividend would presumably be paid.  Ironically, a major reason for the excess capital on the banks’ books these days is the early-pandemic edict from Ottawa’s regulator – the Office of the Superintendent of Financial Institutions – that banks not raise their dividends or buy back shares until further notice. That ban is still in effect.

In a note to clients on Aug. 29, Dechaine predicted the bank stocks could be “range bound” until what he called an “election overhang” has passed.

“The local issue we expect to weigh on bank stocks is the upcoming federal election,” he wrote, “where the Liberal Party platform contains several elements that are potentially negative to the banking industry.”

Investors have indeed been cool on the bank stocks lately.  Since Dechaine’s note, the S&P/TSX Banks Index has fallen 1.5 per cent, as investors wait for the morning of Sept. 21 (or whenever the votes are tallied).