Managing Partner offers his outlook for the big six, weighs in on whether TD’s troubles will impact other banks
This big six Canadian banks recent spate of earnings reports show that while there are some large differences between the banks, the sector is holding in relatively well, overall. TD Bank stock now faces significant pressure resulting from anti money laundering charges levelled against its US subsidiary. BMO has also had to deal with some issues around US credit which saw it miss expectations. The other four banks, however, have posted relatively strong earnings and seen their stocks rise accordingly. RBC, CIBC, and National Bank have all hit 52-week highs in the wake of their Q2 earnings, offering some positivity underneath the negative headlines impacting one bank.
Robert Wessel, managing partner and co-founder of Hamilton ETFs and a longstanding expert in Canadian financials, weighed in on bank earnings. He explained that he believes TD’s AML issues are specific to TD, and should not have any impact on the other five banks, highlighted some of the areas where they now face risk, and drove home the underlying correlation between bank performance and the Canadian economy.
“Bank revenues are highly correlated with the economy, so if the growth is weak, then generating strong revenue growth and earnings growth is more difficult to achieve. ,” Wessel says. “Things are holding up in a tough environment. Bank stocks are holding in and they’re not terribly expensive either. Valuations are pricing in a fair bit of bad news and there would be some upside from credit if the economy improved even a little bit.”
Across most of the earnings reports we saw relatively strong performance from capital markets divisions in Q2. Wessel notes that capital markets had been sub-par for the banks in 2023, but we’re now seeing revenues being reported that bring them more in line with longer-term averages.
Loan loss provisions have been a hallmark of these bank earnings since interest rates started rising in late 2021. Wessel notes that every bank is still building their reserves on the performing loan side for eight consecutive quarters, which continues to have a dampening effect on earnings. However, with the exception of BMO, most banks had stable to improving credit. Wessel greets that as a positive development, suggesting that the banks and regulators are approaching reserve levels that they are more comfortable with.
Despite that positive development and the fact that RBC, BMO, and National Bank all raised dividends, Wessel characterizes many of these earnings reports as “messy” given the number of one-time charges that these banks are still taking. Even after a ‘clean up quarter’ in Q4 of 2023, the operating environment and pressure to reduce expenses is still demanding a lot of one-time line items.
Easily the messiest of the earnings reports came from TD, which is currently facing a range of investigations into its anti-money laundering practices in the US. In its earnings TD reported its third consecutive restructuring charge and suggested there would be another charge next quarter.
Wessel emphasized that the issues facing TD are specific to that bank and there is little risk of contagion affecting other major bank stocks. Nevertheless, TD’s stock may remain somewhat depressed for the foreseeable future. That is in part due to the likelihood that fines will come in excess of $1 billion. While TD is well capitalized and should be able to handle a fine in the $1-$2 billion range, investors will discount the stock based on the risk that fines rise above those thresholds.
The other major risk for TD in particular stem from a potential set of restrictions on TD’s operations. There could be regulatory oversight, asset caps, or limits on acquisitions from the US regulators. Given that roughly one third of TD is in the US, a decline in earnings due to restricted operations or higher compliance expenses, or even just a reluctance to expand, could prove a long-term headwind for the stock.
“I don’t think TD goes back to a premium valuation anytime soon,” Wessel says.
Despite the negativity currently surrounding TD, Wessel emphasized that the other banks did relatively well in a quarter where expectations were muted and optimism was hard to find. He sees some opportunity, however, in today’s muted sentiment.
“We still think that the analysts are being conservative with respect to their fiscal 2025 provision forecasts,” Wessel says. “And therefore, we think earnings estimates have a very good chance of being revised upwards later this year, which I think would provide some support for the stocks in the next 12 months.”
