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Morningstar | Canadian Bank Third-Quarter Roundup

The big six Canadian banks reported third-quarter earnings 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 waivered. Unsurprisingly, our fair value estimates for the banks this time around did not change materially, with most banks 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 the bank’s string of acquisitions, hurting both results and the bank’s share price post 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. BMO made a comeback during the quarter, as its one-time charges rolled off, the Canadian banking unit consistently grows revenue while containing expenses, and the U.S. banking unit continues to see outsized commercial loan growth. Finally, we also like the progress CIBC has made each quarter this year. We highlighted the bank as undervalued last quarter, and shares have outperformed peers since. The bank saw the second-highest growth in assets under management, 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 the bank’s mortgage loan portfolio will be its big test as the credit cycle eventually turns, given the bank has the most exposure to the Canadian real estate market.

For more information on individual names, please see the individual earnings notes published for each bank.

Overall, with the appreciation in CIBC’s shares, the undervaluation we previously saw has now decreased below 10%. Also, given Scotiabank’s underperformance, we now view shares as fairly valued. We still view shares in the other four banks as relatively fairly valued, and none of the Canadian banks trade at greater than a 10% difference from our current fair value estimates.

Housing markets in Canada have slowed, but still appear relatively healthy, after new regulations aimed at curbing them 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 U.S.’s progress with Mexico on NAFTA negotiations, Canada is once again back at the bargaining table, and it appears both sides are more willing to compromise on certain issues. In the end, given punitive tariffs tend to hurt both sides, we would 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 Q1 (the most recent data available). On the negative side, the interest portion 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 of a pace as a serious risk. We are also monitoring the private mortgage market, which has gained some share, but still accounts for under 10% of the greater Toronto area, for example. Based on the current data, we still lean toward a manageable landing scenario for Canada.