Headwinds from higher loan-loss provisions don’t tell the full story, says investment advisor
The latest quarterly reports from Canada’s Big Six banks have painted a grey picture of misses as provisions for rising risks from soured loans weighed on earnings. But investors should also be careful not to fixate on the negative, according to one advisor.
“People are quite cognizant that there's uncertainty about the timing and possible severity of the next credit cycle,” acknowledged Graham Priest, an investment advisor at Blueshore Financial.
Among the storm clouds hanging over banks, Priest cites rising expenses amid higher staffing costs, worries around softer loan growth, capital constraints, credit concerns, and recession fears. The prospects of a payment shock, with more homeowners potentially defaulting on their mortgages, are also a potential risk.
“With higher interest rates impacting more clients, there are concerns about loan losses,” he says. “We’re seeing banks increase their loan-loss provisions.”
Higher loan-loss provisions create headwinds
The past year has seen the Office of the Superintendent of Financial Institutions (OSFI) increase its domestic stability buffer requirement for banks twice: once last December and again in June. Those hikes in OSFI’s DSB requirement, alongside other challenges, have weighed on earnings across all of Canada’s Big Six banks.
TD missed analyst expectations as it was confronted with rising expenses and loan-loss provisions; the bank set aside $766 million for troubled loans in the quarter ended July 31, in contrast to $351 million a year ago. Non-interest expenses went up 24% over the previous year, primarily due to higher salaries and bonuses.
“Even though TD is setting aside money for provisions for credit losses, they’re looking to do buybacks. … Although it’s a challenging environment, they do have some excess capital,” Priest says. He argues the bank’s aggressive stance on buybacks – along with its Canadian and US commercial banking franchises, strong revenue growth for the quarter, and diversified business mix – makes it a strong option for bank investors to include in their portfolios.
RBC, meanwhile, saw profits increase by $295 million to $3.9 billion, but that good news came with a sting in the tail as the bank put aside $616 million toward provisions for credit losses, compared to $340 million last year. It also bared plans to lay off around 1,800 jobs.
Despite dour headlines, banks remain attractive
BMO fell short of estimates as its provision for credit losses swelled to $492 million, more than three and a half times the $136 million it set aside last year. Scotiabank, for its part, saw its credit-loss provisions spike from $412 million to $819 million, while net interest income for the quarter amounted to $4.58 billion in Q3, compared to $4.68 billion for the year-ago period.
Meanwhile, National Bank’s quarterly earnings fell short of analysts’ expectations as it logged a $111-million provision for credit losses, compared to $57 million a year ago. Rounding out this latest earnings season, CIBC set aside $736 million for a potential souring of consumer loans, nearly triple the $243 million it had stored last year; its personal and business banking division saw net income drop by nearly $100 million compared to the year-ago period.
For many Canadians investing in banks, the news of layoffs, rising costs, and warnings of a softer economy peppering this latest round of earnings might sound discouraging. While they may not be attractive for an overweight position at the moment, Priest maintains that current bank valuations are nonetheless reasonable.
“They’re still attractive businesses. Right now, investors are being paid to wait with strong dividend yields,” he says. “Although growth in the underlying shares might be impeded, there’s still strong income being generated from those shares between now and when investors may potentially be selling those stocks.”
