Investors got the quarter they were counting on when Canada’s Big Six banks reported earnings this week – and more.
When bank stocks started to rally on October 29, investors were buying because they believed the banks’ outlook for credit quality was about to take a distinctly positive turn. And they were right. Each of the major banks has decided to set aside – or “provision” – much less money than there is barely a quarter for an anticipated wave of defaulted loans due to the economic shock of COVID-19 . In fact, each of the banks reduced credit loss provisions (PCL) more than analysts expected. Because every dollar in a PCL is a dollar lost to the bottom line, earnings per share have exceeded expectations in all cases.
When the Bank of Montreal and the Bank of Nova Scotia each beat expectations on December 1, shares of all banks rose and investors quickly revised their expectations for near-term earnings upward. Some analysts think we could be a quarter or two of the banks that actually take money out of loan loss reserves and put it back into the income statement, which would be a big short-term boost to profits. .
But there was another trend in results that could significantly affect banks’ strategies in 2021: In each of the Big Six, regulatory capital levels have increased significantly. This suggests that we may soon see some of the banks making acquisitions.
The main capital ratio of banks is their Common Equity Tier 1 (CET1) ratio, and according to current instructions from the Office of the Superintendent of Financial Institutions, it should remain above 9.0%. Slower loan growth during the pandemic meant that “risk-weighted assets” – the denominator in the formula used to calculate the ratio – grew more slowly than profits added to capital levels – the numerator – this year. By the end of the fourth fiscal quarter (October 31), banks were sitting on capital that was between 2.75 percentage points and 4.1 percentage points above the regulatory minimum. The Toronto-Dominion Bank leads the pack with a CET1 ratio of 13.1%.
Canada’s banking regulator – OSFI – has temporarily banned raising dividends or repurchasing stocks to ensure banks are sufficiently capitalized to withstand a huge wave of bad debts caused by a pandemic. This makes acquisitions more likely, as banks will want to use their excess capital.
I spoke to Jim Shanahan, an analyst who covers banks at Edward Jones, and asked him if he thought banks with large US businesses were most likely to be buyers. These are TD, Bank of Montreal, Royal Bank and, to a lesser extent, Canadian Imperial Bank of Commerce. The United States, after all, is where most of the potential bank acquisitions are located.
He agreed with this view, but noted that Canadian lenders will face tough competition from US banks for quality assets. This is a big difference from the years after the financial crisis, when Canadian banks were much better capitalized than their weakened American counterparts. This time the American players are also flush.
“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 present themselves as candidates. “
TD earlier expressed interest in expanding its large US retail banking business into the Southeastern United States, he noted. TD has also bought US loan portfolios in the past and may continue to do so, he noted.
Los Angeles-based Royal Bank’s City National is a high net worth banker, and the bank has said it wants to expand City National’s presence into other U.S. markets.
Of the other two, the Bank of Montreal is a major lender to businesses in the US Midwest. CEO Darryl White, however, downplayed the importance of the acquisition story when asked about it on a conference call, saying he preferred to invest in growth within from BMO.
CIBC owns the smallest US platform – through its purchase of Chicago-based PrivateBancorp – but it has been clear since this acquisition was completed in 2017 that it saw PrivateBancorp as a foundation on which to build a larger US company. . Maybe now is the time.
If the Bank of Nova Scotia made a deal, it would probably be in Latin America. But Nova Scotia has made more sales than purchases in this region in recent years, placing more emphasis on the attractive economies of Colombia, Peru, Chile and Mexico. He has also integrated two large Canadian acquisitions in recent years – Jarislowsky Fraser and MD Financial – and has seen his share price languish as investors worried about these lengthy integrations.
And aside from that, Scotia CEO Brian Porter said in an interview Thursday that the bank would likely buy back its own shares when OSFI gives the green light.
“We think our stocks are still cheap and very attractive,” Porter said.