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Morningstar | Financial Markets Segment Remains Sore Point for National Bank of Canada; Cost Control Still Decent

Narrow-moat National Bank of Canada reported okay fiscal second-quarter results. The bank’s financial markets segment continued to struggle, even as most peers saw a comeback in the quarter. However, the bank’s other segments achieved decent growth pushing net income into growth territory, rising 2%. Share repurchases helped drive EPS growth to 5%, while credit remained stable, even as peers have begun to see some more normalization. The return on common equity was down 80 basis points compared with the second quarter of 2018, however, it was improved compared with last quarter, coming in at 17.8%, the highest level among the six largest Canadian banks. We are already projecting a deterioration in returns on equity of roughly 200 basis points over the next five years. Management also backed off its 1%-2% operating leverage goal, admitting that even hitting 1% would be considered a good result for the year at this point. After making some minor adjustments to our forecasts, we are maintaining our fair value estimate of CAD 70 per share.

Credit quality remained fairly steady, as the PCL ratio remained in the mid-20s (0.23% this quarter), gross impaired loans were roughly flat (0.42%), and management maintained its PCL ratio outlook for the year. The bank continued to grow HELOCs at a steady clip, up 6% year over year, while mortgages were up almost 4%. As we have seen in past quarters, the total balance of insured mortgages actually declined, while the balance of uninsured mortgages drove all of the growth, which is what we are seeing across the industry. National Bank of Canada does have one of the lower exposures to the GTA and GVA markets (with the average LTV being 52% and 50%, respectively), being much more concentrated in Quebec, which tends to be a more affordable market. With the Bank of Canada now predicting growth will return to the Canadian housing market, these will all be areas to watch as the housing cycle develops.

The financial markets segment was once again a drag on earnings, weaker than peers, driven entirely by weakness within the equity markets business. Corporate and investment banking revenues were actually up nicely, increasing 12%. The bank had strong performance in the quarter from its core personal and commercial banking segment, with net income up 9%, as expenses only increased 2% while revenue was up 5%. Loans were up 6%, while deposits were up 7%, demonstrating decent balance sheet growth as well. Wealth Management also continued to do well for NBC, with assets under management up 12% and net income rising 5%. As we had expected, fee income growth has begun to come around a bit, up 3%, but it is still trailing AUM growth. The specialty finance and international segment saw continued strong growth in ABA related revenue, up 6% compared with the first quarter, even as the branch build out slows, while Credigy was down year over year but still up 2% compared with last quarter.