Canadian Banks’ Q4 Earnings: Insights for Investors

Canada’s largest banks are gearing up to report third-quarter earnings, and with the economy slowing the focus will be on revenue growth, loan performance and the impact of rate cuts on net interest margins.

These results will come against the backdrop of big gains in 2024 for many Canadian bank stocks. Shares of RBC (RY), CIBC (CM), Scotiabank (BNS) and National Bank of Canada (NS) [TL1] have all outperformed the 17% gains of the S&P/TSX Composite Index Banks and the Morningstar Canada Index. The outliers among Canadian bank stocks covered by Morningstar are Bank of Montreal (BMO), which up just 1% so far in 2024, and TD Bank (TD), down 8% this year.

The stellar performance for Canadian bank stocks come despite multiple headwinds facing the industry. Challenges include slowing economic growth, muted consumer spending, rising unemployment, an increase in bad loans, credit strain and mounting provisions.

These issues have sparked investor anxiety over the sector’s resilience and growth prospects. The good news is, the picture is not as gloomy as the market may be preparing for, says Morningstar banking analyst Michael Miller.

“Generally speaking, I expect this to be a decent quarter for the Canadian banks,” he assures.

For investors in Canadian bank stocks, third quarter earnings come at a time when many of the shares are trading at rich valuations. RBC, CIBC, Scotiabank and National Bank of Canada are considered overvalued by Morningstar with 2-star ratings and BMO is fairly valued. Among the Canadian bank stocks covered by Morningstar, only TD Bank is undervalued with a four-star rating.

Here’s a primer on key themes to watch during the upcoming bank earnings season. More details of Morningstar’s view on six major Canadian banks can be found lower down in the story.

How Strong is Canadian Credit Quality?

Rising credit costs have been an ongoing headwind for the group in recent quarters but some stabilization on this front may be on the way. “Deteriorating consumer credit quality in the U.S. has been responsible for a disproportionate amount of rising credit losses for the banks as Canadian credit quality has been surprisingly resilient in the face of high interest rates and rising unemployment,” Miller says.

Notably, consumer credit losses for U.S. firms have stabilized recently. Miller says a similar trend may be seen in the U.S. operations of the Canadian banks. “Additionally, lower interest rates should provide some credit relief across the board,” he says

Debt Levels Not an Existential Threat

Interest rates were elevated in the first half of the year, before the Bank of Canada started its monetary easing cycle, leading to a modest loan growth for Canadian lenders. Lower interest rates should provide support on this front, spurring a meaningful asset growth across the sector, Miller says.

“While there are uncertainties related to consumer debt levels and the mortgage market, we view them as a threat to future growth and not an existential risk to the Canadian banking system,” he argues.

An exception to that could be TD Bank due to the imposition of an asset cap on their stateside business. The bank was recently fined USD 3 billion with a rare enforcement of a US asset cap owing to money laundering charges.

“Toronto Dominion is facing serious regulatory inquiries into the bank’s anti-money-laundering/Bank Secrecy Act compliance which will likely lead to fines and potential restrictions on its US operations,” says Miller.

Furthermore, the lender is planning to “restructure their portfolio to focus on higher yielding assets [and] could face some headwinds,” he adds.

The strategy aims to improve a bank’s profitability in the long term, but involves costs, disruptions and the possibility of exposure to riskier assets in the near term.

The Impact of Rate Cuts

Net interest margins, a key metric to monitor the banks’ earnings report, will be another area to watch out for. NIM reflects how well a bank is managing its lending and borrowing activities in a falling rate environment.

“We’ve seen multiple interest rate cuts in Canada, which will help out on funding costs, but on a broad level, banks tend to prefer higher interest rates,” says Miller, while stressing that it’s “a truism not a hard rule”, and that time will tell how things pan out.

Investment Banking Earnings

On a brighter note, earnings from investment banking, trading and advisor services have been growing steadily in 2024. “Capital market income has been quite strong this year and lower interest rates [which makes borrowing cheaper] should provide some support for continued momentum [evidenced by] solid issuance levels and market activity globally this year,” notes Miller.

While performance in this area tends to fluctuate widely from quarter to quarter, making any extrapolations meaningless, “but overall market conditions are favorable for the banks at the moment,” adds Miller, justifying his cheery outlook for banks’ capital markets businesses.

Canada Banks: What to Expect

Here’s a snapshot of commentary from Morningstar equity analyst Michael Miller, highlighting notable trends and developments for leading Canadian banks.

TD Bank Group TD

“For TD the key element will be how they are working through their regulatory issues in the U.S. In October, details on the specific fines and penalties being levied against the firm for its AML issues were made public. We are not expecting any more bombshells, but this will be an ongoing issue for the firm. It faces an asset cap on its U.S. operations until regulators are satisfied, upsetting the firm’s growth plans in the country and there will be incremental operating costs as it improves its regulatory controls.”

[The asset cap doesn’t apply to TD Securities or its Canadian operations.]

Royal Bank of Canada RY

“For Royal Bank of Canada, the focus will be on how well they are integrating HSBC Canada and their ability to realize the expected cost and revenue synergies. That said, the bank has been one of stronger performers in the group from an execution standpoint and the initial signs have been positive so there isn’t a ton of active concern about acquisition.”

BMO Financial Group BMO

“Recently, Bank of Montreal has been an underperformer, both in terms of share price and business performance. The bank has seen an unfortunate mix of weak revenue growth, poor credit performance, and narrowing net interest margins. The focus here will be if they can reverse this trend, particularly in the US where the issues have been more acute.”

Canadian Imperial Bank of Commerce CM

“There’s nothing too exciting for Canadian Imperial Bank of Commerce but their adjusted expense growth in the last quarter was faster than expected and higher than their 2024 guidance. They did reiterate that guidance with the quarter, but we will be watching for what cost growth ends up being.”

Scotiabank BNS

“There could be updates on the firm’s regulatory approval to complete the second tranche of the Key Corp minority investment. At the time, the 14.9% acquisition of the firm appeared purely financial with limited strategic value, though admittedly BNS managed to secure a decent price for the shares. They have alluded to strategic value to the investment, but providing details on tangible benefits would help reduce my reservations greatly.”

National Bank of Canada NA

Analyst: Michael Miller, CFA

“While there may not be any new information forthcoming from National Bank of Canada, its planned acquisition of Canadian Western bank is probably the most important topic for the bank right now. We also have mixed feelings about this deal, but they have been progressing through the regulatory approval process on the deal.”

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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