Canadian Banks' Third Quarter Good Overall
Nothing in the results materially changes our valuations.
The big six Canadian banks-- Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM), National Bank of Canada (NA), Royal Bank of Canada (RY), and Toronto-Dominion Bank (TD)--reported third-quarter results that were, on the whole, good once again. Adjusted earnings per share growth was 11% on average, credit quality remained excellent, and overall management outlooks have not wavered. Our fair value estimates for the banks did not change materially this time around, with most seeing slight increases due to the time value of money.
This quarter it was Bank of Nova Scotia recording one-time charges, largely related to its string of acquisitions; this hurt results as well as the bank’s share price after earnings. Since the second half of 2017, we have expected Scotiabank to underperform, which has happened. We don’t see the bank gaining much positive momentum over the short to medium term, as its current spate of acquisitions won’t turn accretive until 2020. Contrast that with Toronto-Dominion’s latest acquisition of alternative asset manager Greystone, which will turn accretive in year one based on adjusted results.
Bank of Montreal made a comeback during the quarter as its one-time charges rolled off, the Canadian banking unit consistently increases revenue while containing expenses, and the U.S. banking unit continues to see outsize commercial loan growth. We also like the progress CIBC has made each quarter this year. We highlighted the bank as undervalued last quarter, and its shares have outperformed peers since. The bank saw the second-highest growth in assets under management and solid capital markets revenue growth, and returns on equity remain top tier, exceeding 17%. We also like that the bank’s loan growth, specifically its mortgage loan growth, is moderating. The strength of CIBC’s mortgage loan portfolio will be its big test as the credit cycle eventually turns, given that the bank has the most exposure to the Canadian real estate market.
Overall, with the appreciation in CIBC’s shares, the undervaluation we previously saw is now only 8%. Also, given Scotiabank’s underperformance, we now view the shares as fairly valued. We still view the other four banks as relatively fairly valued; none of the Canadian banks trade more than 10% from our current fair value estimates.
The housing market in Canada has slowed but still appears relatively healthy after new regulations aimed at curbing it came into place. Housing sales continued to make a comeback, growing in May, June, and July. Housing prices have also largely stabilized after some decreases at the start of the year. We still see no signs of credit deterioration on the Canadian banks’ balance sheets. After the United States’ progress with Mexico on North American Free Trade Agreement negotiations, Canada is back at the bargaining table, and it appears both sides are more willing to compromise on certain issues. In the end, given that punitive tariffs tend to hurt both sides, we expect cooler heads to prevail.
Canada is now caught in a tough position, where inflation is creeping above the 2% mandate, but increasing the target rate will only put more pressure on the already heavily indebted Canadian household. On the positive side, the consumer debt service ratio has stabilized as of the first quarter (the most recent data available). On the negative side, the interest portions of the debt payments are becoming more burdensome. For now, Canada has struck a decent balance, but this drama is far from over. We view increasing rates at too fast a pace as a serious risk. We are also monitoring the private mortgage market, which has gained some share but still accounts for less than 10% of the greater Toronto area, for example. Based on the current data, we still lean toward a manageable landing scenario for Canada.
Eric Compton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.