Podcast Transcript: Q4 2024 Canadian Bank Earnings
Dec. 19, 2024Bipan Rai
Further out into 2026 the picture could look constructive for loan growth.
Skye Collyer
Welcome to today’s special episode. We’ll be doing a deep dive on the Canadian quarterly bank earnings for Q4 2024. This is the 17th episode running of its kind in this series where we come back each quarter on this channel to help you break down and decode the latest quarterly Canadian bank earnings. My name is Sky Collyer. I’m Director, ETF Specialist at BMO Global Asset Management, and I’m actually a first-time host of this series, so it’s a pleasure to be here, and I do want to pay tribute to our former host, Dan Stanley; BMO GAMs, Co-head of Institutional Distribution, who helped start up this series over four years ago. So, Dan, thank you for having recently passed over the torch to me. It’s an honor to be here and carry on the good work you started.
So today we’re joined by some familiar faces. We’ve got our long-time guest and trusted voice, Sohrab Movahedi, Managing Director Financials Research at BMO Capital Markets, as well as Bipin Rai, our Managing Director and Head of ETF Strategy at BMO Global Asset Management. Sohrab and Bipan, thanks so much for joining us today.
Sohrab, the Canadian banks just released their fourth quarter earnings. As we know this also marks the fiscal year end for 2024 so before we peel back how we did over the last three months. I want to take our listeners back a year ago to Q4 of 2023. You did a great job at helping to paint the picture of how the Canadian banks were at a bit of an inflection point. You use this analogy of f1 Formula One, race car driving. You said it’s kind of like the Canadian banks are heading into the pit lane for a pit stop over the next couple quarters, looking to rejoin the race, and that things were starting to look less negative and more optimistic. So here we are, 12 months later. How far have we come?
Sohrab Movahedi
Well, Skye, welcome looking forward to having you as the host for at least 16 more episodes of this thing, hopefully. So, look, I think the analogy has probably aged well. Back in April of 2024 what we ended up doing is we probably tried to essentially call the point where we started to see quarterly earnings starting to improve, at least based on our modeling. At that point, call it the inflection point, we actually upgraded a bank that we hadn’t recommended for 10 years, and we turned a bit more positive. And I think we were inclined to turn a bit more positive, simply because we were able to see with a bit more confidence, still cautious, but with a little bit more confidence, a rebound in that earnings trajectory that was relative to valuation levels that I think gave us downside protection as well. So, we were inclined, and in fact, a bit more comfortable to go to our clients and say that those that are underweight banks may want to rethink that positioning a little bit more constructively, because not only the valuation multiples were depressed, but I think we were essentially depressed valuation multiples on depressed earnings, and there was reason to believe that earnings are improving. And I think since then, dare I even say, may have been a bit of a well-timed call. Since then, I think the sentiment towards the space has rebounded. Let’s call it the valuation multiples have expanded. So now comes the hard part. They have to be able to deliver the earnings to grow into those earnings multiples, but cautiously optimistic is what I would say as we finish 2024.
Skye Collyer
It’s always interesting to see how far we’ve come in in the last 12 months. I mean, just to put it into perspective for any investors out there who have exposure to the Canadian big six banks through our ETF ticker ZEB, that’s the BMO Equal Weight Banks Index, they’ve experienced some great returns over a 12-month period. To put it into perspective, ZEB was priced at just under $30 on October 31, of last year, 2023, to just over $40 on October 31, of this year. So, we’ve seen some nice growth over that time period. So back to the races, if you will. And so, let’s now hone in on quarter over quarter, we saw the Canadian banks showcase strength in Q3 of this year they reported approximately $15 billion in after tax earnings reflecting an average of approximately 7-8% increase year over year. So how did we do this quarter?
Sohrab Movahedi
I’d say it was a good, but not a great quarter finish to the year. And so I say that because of this big six banks, three exceeded consensus expectations, but three fell shy. So collectively, the big six delivered about $13.4 billion of earnings in the fourth quarter. The good news is that was still up from last year by about 4% but obviously that rate of growth was a little bit lower than the one you quoted from the third quarter, and so they brought the full year, though, given that kind of finish to the year, the full year across the Big Six ended up coming in closer to 56.5 billion dollars, which was a modest, a more modest increase over the prior years. Call it about $55.6 billion. So came in a little bit of a slower start to the year. We’ve we saw the second two quarters or the second half of the year kind of improve that earnings growth trajectory pickup, and I’d say more importantly, as we took the guidance that management teams’ kind of shared with us, with respect to their businesses, but also digested the economic backdrop, I think generally, everything turning less negative. I’m not going to say turning more positive, but turning less negative. We actually are now modeling close to 6% earnings growth in 2025 and higher than that going into 2026 so prognosis encouraging is what I would say coming out of 2024.
Skye Collyer
Thanks so much. Now, Bipan, from your big picture view, what are some of the key themes that stood out for you from this quarterly Canadian bank earnings release.
Bipan Rai
Thanks, Skye. Yeah, there’s a couple of things that I would point to. Certainly, I think Sohrab did an excellent job really summing it up by saying it was less negative than beforehand. One of the places that I tend to look at is sort of in terms of the holistic capital picture and what that could mean going forward. And I think an important takeaway now is that banks remain flush with capital, right? And that makes sense. You know, given how much time and effort has been spent over the past several years in terms of building up buffers as the Bank of Canada raised interest rates, and you know, either two loans came under a fair bit of pressure, but you know now we’re at a different point in the monetary policy cycle. The bank can is obviously easing rates quite aggressively. And you know, with banks having already marked up PCLs appropriately, what do you do with that excess capital? Right? That’s going to be a theme potentially to watch for, insofar as the is the bigger picture is concerned. And some of the assets that I tend to look at, you know it could mean potentially further down the line, additional growth in the loan book in the coming years. And certainly, I’m curious to hear Sohrab’s thoughts on that, which could, you know, obviously help net interest income, or potentially it could mean increased dividends and share buybacks. And you know, at least at this point, from my vantage point, it does feel like that banks are relatively well positioned to outperform going forward.
Skye Collyer
Thanks so much. You mentioned the Bank of Canada, so I wanted to get your insights on the recent statements regarding rates. We had a big move this week as well. So how do you expect that may benefit or challenge the Canadian banks going forward?
Bipan Rai
Certainly. So why don’t we talk a little bit about summarizing the most recent Bank of Canada decision and the corresponding press conference from Governor Macklem. So, you know, we all know, we all digested the fact that the Bank of Canada eased administered rates by 50 basis points at this past week. Now the policy is at the upper end of what the bank tends to refer to as its neutral policy range. The other interesting development this week was that the bank amended its guidance, for lack of a better term in the final paragraph of the statement, sort of alluding to the fact that you know that it may not, or at least taking out the conditionality when it comes to potentially cutting interest rates further. My own feel is that this is really just a message being sent that now that policy is closer to neutral, that you know they have to kind of manage the expectations of the speed of moves going forward. So we shouldn’t necessarily expect additional 50 basis point incremental cuts going forward. Of course, the past two meetings, we’ve seen that this is the bank’s way of telling us to manage your expectations going forward if there are going to be any interest rate cuts. The way not to interpret this is to assume that the bank is done with its easing cycle, at least from our vantage point of what the data tells us, given the fact that we are at three and a quarter percent when it comes to the overnight rate, that’s still too restrictive, given the fact that we have seen some degree of slack open up in the economy, which does bring into sharper relief some downside risks to the overall inflation picture. So again, you know, with 175 basis points worth of easing from the Bank of Canada over the past six months, I mean, that is fairly aggressive in terms of a rate cutting profile, so it makes sense the bank would want to proceed more cautiously from here. Now, you know, looking ahead, could the bank ease by more? Possibly. In my view, it’s probably more likely that we end up with a terminal rate that’s closer to 2% given the fact that, again, the economic backdrop is somewhat patchy, don’t think we’re going to end up in a recession at this point. I think we’re probably going to be at least a little bit more consistent with a softer landing. On a holistic basis, of course, on a per capita basis, that’s a little bit different. We are an environment where the Bank of Canada is easing rates, and we don’t end up in a recession. I think that’s a pretty constructive backdrop for banks going forward. I mean, you know, lower capital costs as prior, sort of additional tier one capital is refinance to lower rates. I think that’s going to be very beneficial for banks. Also, further out into 2026 I think, you know, the picture could be, could look constructive for loan growth from banks as well. And again, we do have instruments that are well placed to capitalize on that backdrop.
Skye Collyer
Thanks so much Bipan. Sohrab, let’s get back over to you. I wanted to talk about the recent shift in the US political landscape, Trump coming back to the White House. How does this impact the Canadian banks with US presence?
Sohrab Movahedi
The gist of it, of course, is that I think the expectations are that under Trump presidency, for example, there will be some regulatory relief across all of the different types of industries out there, including banks. I would say one of the benefits of that might be peer pressure, and we may see less inclination on the part of the Canadian regulator to continue to, for example, be a bit more restrictive with their capital requirements for the banks. The second thing, I think that, its still early days, but the conclusions are that, at a minimum, having the election behind us, that business in the US is more inclined now to be able to plan for a bit more certain future, and that may spur some activity, both in terms of transactions, company to company, but also in terms of investments in plants and property. And obviously, banks are there to lend. So banks in Canada that would have a presence in the US should be able to at least benefit from what I will refer to as a bit of a high tide that we expect should be coming in the US. And then, you know, Bipan touched on it. There are always considerations for beyond organic growth opportunities and for a bank, you have to obviously have a strong balance sheet. And a good measure of strong balance sheet would be the level of capital you have all of the banks, I think have in Canada, very strong balance sheets, well capitalized, and so we’ll see. Because beyond spurring some incremental, let’s say business activity, which might be good for the overall economy in the US, you know the benefits of lower regulation, we may actually see also some improved likelihood or increased tendency of consolidation further in the US banking industry, which is nowhere near as concentrated as Canada. And some of the banks, may even think about whether or not deploying some of the capital in the US, if the right opportunity presented itself, maybe something that they would consider. So, I would broadly Skye, kind of characterize this all as positive, certainly for banks in Canada that have an established US brand and presence.
Skye Collyer
Thank you, Sohrab. Bipan, another way to take advantage of the Canadian bank exposure is through our fixed income ETF, ticker ZBI, the BMO Canadian Banks Income Index ETF, which tracks the Solactive Canadian Bank Income Index. So, it provides exposure to a Canadian bank financing portfolio, including fixed income, preferred shares, LRCNs (otherwise known as Limited Recourse Capital Notes for our listeners out there). So, can you tell us a little bit more about ZBI and why you like it right now?
Bipan Rai
Certainly so I mean, if we back up and we look at things from a, say, 40−50,000 foot perspective in Canada, I continue to like fixed income in Canada relative to equities, I just think that’s the space to be in over the coming years, especially if we’re if we’re correct in our call that potentially the Bank of Canada will need to cut rates by more than what the market is pricing in right now. And you know, beyond just looking at, you know, instruments that track Government of Canada securities, it’s time to look at spread products, potentially. And I think ZBI particularly is well placed. The way I tend to think about it is, you know, if you’re looking at Canadian banks, you’re looking to play them via the BMO ETF product suite. I mean, ZEB, which is the BMO Equal Weight Banks Index, gives you exposure to common stock. And of course, that has done incredibly well this year. What ZBI does, though, is it gives you exposures to other types of bank capital. You know, these include, that includes funding instruments, including hybrids, like preferred shares, including the traditional retail prep market, which is expected to shrink further in the coming years, alongside other securities that are treated as capital from a regulatory perspective. And that includes the Limited Recourse Capital Notes, otherwise known of these as the LRCNs. And again, these are instruments that are only really available to institutional investors. So, this gives a decent way of participating in those in that type of capital, as opposed to the traditional way together, these instruments are known as Additional Tier 1 capital or AT1s. So, if you do hear that sort of reflected in in the Common Market parlance, that’s the way to interpret them. And again, remember, much like common stock, banks have been traditionally very diligent when it comes to ensuring capital appreciation, and that theme remains intact. So, there’s no reason really to expect that not to be the case for AT1s going forward. Again, as I mentioned, we love scooping up spread products in Canada over the next couple of quarters. And again, ZBI is a play on that theme. You get an attractive yield to maturity of around 4.3% which is above the yield to maturity for some of the instruments that track the broader fixed income space in Canada. And one of them is, of course, the ZAG, which offers a yield to maturity of 3.45%. You also get that yield at a much shorter duration, at around just over two years, where, compared to the ZAG, which has a duration of over seven years, that leaves you a lot less exposed to interest rate volatility, which, of course, can pop up from time to time. Also, one of the other reasons we like the ZBI is that, you know, you get a much lower beta to the broad market relative to the ZEB. Now that makes a lot of sense, considering the fact that, again, the ZBI is more of a fixed income instrument, so that gives you some of the diversification benefits as well, as opposed to the ZEB. So again, just really synthesizing what the ZBI is and why we like it a lot more. I mean, it offers an attractive yield at a much shorter duration, and you get that diversification benefit as well Skye.
Skye Collyer
Thanks so much. Great to get your insights on how we can get that Canadian bank exposure through a fixed income offering here at BMO. Sohrab, I’d like to finish the discussion with you on your expectations going forward for 2025 you mentioned earlier, estimating around 6% earnings for this upcoming year, and even higher into 2026 so do you have any new scenarios or valuations, any key catalyst you’re watching for?
Sohrab Movahedi
I would say what started off as, I’ll refer to as a vicious circle in 2023 where it was a capital markets or markets related revenue winter, and there was worries of recessions, and so reserve building and central banks were still trying to fight inflation, and there was pressures on expenses and negative operating leverage, and then we had a regulator that was increasing rather unexpectedly, capital requirements at the banks like we had a bit of a perfect storm. I would tell you that I think that’s turning into a bit of a virtuous circle for the for the Canadian banks, and that’s happening like we mentioned, we’ve got some certainly out of the US election results, there’s expectations of improved transaction activity amongst companies. There should be a bit of a rebound, if nothing else, because of the easier comps of the softer, yester years in markets related businesses. But the banks took actions on their expenses. There were the restructuring charges that they’ve taken which would allow them to manage expenses to, you know, more modest growth levels. And hopefully, and probably, I would say, even certainly, within the revenue growth. So, we’re back into positive operating leverage territory. And, and as Bipin mentioned, you know, the rate environment will also ease. I’ll say some of the pressure that would have been otherwise there from a credit quality perspective at the banks. And so I don’t know if it’s a specific theme, but it feels like every one of those line items on the income statement that that had been feeling negative pressure is either starting to see some tailwinds, or at least some of those headwinds dissipate. And then I think if you take that with the combination of less our expectations, basically that regulatory capital pressures have essentially eased for this cycle. Then some banks may do buybacks, they may do proactive capital deployment. But not only, we are now looking at the prospects of, let’s call it mid-single digit earnings growth, but we’re actually contemplating improvements in return on equity as well. So, the primary case has typically been, you know, these are compounding type investment opportunities. And I think once again, as we look into 25 and even into 26 which are kind of like our investment horizons, that notion of compounding, getting the total returns higher and hopefully above market are there again. So, no one catalyst, I would say, I mean, but fairly, I suppose, dependent on the vibrancy of transaction activity in the markets related businesses to come back.
Skye Collyer
Thank you so much. Very insightful and so much to potentially look forward to in the space. So, I want to thank you Sohrab and Bipan for your time today. As a reminder to the audience, you can get exposure to the Canadian banks via ZEB the BMO Equal Weight Banks ETF, ZWB the BMO Covered Call Canadian Banks ETF and ZWB.U, which is the USD purchase option. We also have ZEBA, which is our BMO Canadian Banks Accelerator ETF. And earlier, we discussed at length with Bipan our fixed income ETF, ZBI the BMO Canadian Bank Income Index ETF. If you have any questions, please visit our ETF Center at bmoetfs.com for research, news and insights. That’s all for today. Thanks again to Sohrab and Bipan for sharing your insights and to our listeners for tuning in. Our regular Views from the Desk podcast will be taking a brief break for the next two weeks, so we will see you back here in January. On behalf of our team, wishing you and yours a very happy holiday season.