Key Takeaways from the 2020 Canadian Banks CEO Conference

January 23, 2020 | Jonathan Yung


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An update on the state of Canadian banks.

It has been a quick three months since I wrote my last blog about the Canadian banking sector. In that article, I addressed some of the reasons why the banking sector underperformed in 2018 and the first 3 quarters of 2019. Although the underlying factors that have caused the banks to underperform have not drastically changed, it is a good time to review the sector and to analyze the mindsets of the banks’ CEOs.

The average performance of Canadian banks in 2019 trailed the S&P/TSX composite by approximately 600 basis points [6%]. The only bank that outperformed the broader index was National Bank, with a 34% total return including dividends. CIBC, TD and Scotiabank rounded out the bottom of the pack, with a total return including dividends of around 10%.

2019    Bank Index    10.1% (share price performance not including dividends)

            BMO               12.8%

            BNS                7.8%

            CIBC               6.3%

            NA                  28.6%

            RY                  10%

            TD                   7.3%

In 2019, we experienced a particularly tough environment in the banks’ capital market divisions. This was caused by weaknesses in the equity market during the last quarter of 2018. Banks also faced significant compression in Net Interest Margins (NIM), which is defined as the difference between the earnings a bank makes by lending out funds and the interest they pay on deposits. This NIM compression was exacerbated by the 3 rate cuts in the US that caused interest rate yields to fall. It would be unsurprising to see NIMs in the US decline further, while NIMs in Canada are generally anticipated to either remain flat, or rise slightly, assuming only one rate cut is in the cards. In 2019, the earnings growth was below the average rate of 2.7%. This rate came in as a slight disappointment, as the average rates during the previous 5 years were in the 4-10% + range. We have seen 2020E P/E multiples fall from a high of over 13X (2018) to 10.1X. This multiple is slightly below the average of 11X during the past 10 years.

Recently, our RBC CM Banking Analyst hosted the 2020 CEO conference, and gave us a few takeaways:

- Most of the banks reiterated their 2020 outlooks from Q4 2019, which suggests relatively soft EPS growth in 2020. Our analyst is forecasting an EPS growth of 4.7% in 2020, compared to 2.7% in 2019.

- The outlook on NIMs in Canada is generally flat, with a chance of slight improvement in Canada. There is some compression anticipated for BMO and TD, while CM is expected to be relatively stable.

- All banks will continue to emphasize efficiency, and will keep a tight leash on expenses. BMO had an unexpected write-off in its December report and saw its share price drop by over 3%. The report also reiterated that there is no further restructuring planned.

- Regarding credit, many of the banks noted that they are seeing slightly looser terms. There may be some economic weakness in Alberta and closely monitoring levered lending in the US. Otherwise, banks continue to expect their Provision on Credit Losses to rise modestly. Quebec has a relatively low level of consumer debt and good housing affordability, allowing National Bank to excel in this area.

- Capital levels are quite strong amongst Canadian banks, and some banks may even target stock buybacks.

To summarize, we are of the mindset that Canadian banks’ earnings growth will more likely be driven by the management of expenses, as opposed to outright revenue growth. Our analyst felt that the investment community, in general, has raised some red flags in 2019, and therefore has been cautious in this sector. Institutional portfolio managers have not been overly optimistic on the sector either, thus creating an opportunity for some short-term surprise on the upside, should the earnings growth take place at a higher rate than anticipated. However, given that we are in the late part of the cycle, as investors, we should remain vigilant regarding any potential weaknesses in global growth. Since the banks are not all performing equally, reviewing with your advisor as to which banks you own and at what concentrations would be a prudent exercise.