Bipan Rai: If we are in this environment where we’re batting down the hatches, obviously there are critical imbalances that will need to be addressed.

Skye Collyer: Welcome to today’s special episode where we’ll be doing a deep dive on the Q1 2025C Canadian bank earnings. This is the 18^th episode of its kind running in the series where we come back each quarter on this channel to help you break down and decode the latest Canadian quarterly bank earnings. My name is Skye Collyer, I’m ETF Specialist at BMO Global Asset Management. Today, we’re joined by our long time guest and trusted voice, Sohrab Movahedi, Managing Director of Financials Research at BMO Capital Markets and Bipan Rai, Managing Director and Head of ETF Strategy at BMO Global Asset Management. Sohrab and Bipan, thanks for joining us today. Sohrab, all six major Canadian banks posted first quarter profits that beat analyst estimates. When is the last time this has happened? And what would you say were the key themes this time for Q1 2025?

Sohrab Movahedi: Hey, Skye, thanks for having me back. Yes, you’re right. All big six Canadian banks exceeded consensus expectations in Q1 25. I had to go back and look; the last time all six had beat was Q1 2022, so 10 quarters ago. there was actually a common theme between then and now. One of their sources of the beat this quarter was very strong trading revenues. And more broadly, let’s call them the markets related businesses. So these would be capital markets businesses within the diversified businesses of the Canadian banks, as well as the wealth management businesses. Similar to 10 or 11 quarters ago, the Canadian banks finished the quarter anyway on a pretty strong balance sheets, whether you want to measure it on liquidity or funding levels, certainly allowance levels for credit quality, and of course, the fan favorite, which is their capital ratios, or the regulatory capital ratios. So when it was all said and done, this would have been one of the stronger quarters that the big six banks collectively would have reported both from an earnings, as you said, exceeding expectations, and but also from an ROE, which is a primary measure of profitability we like to use for the for the bank. So return on equity was also one of the stronger ones we’ve seen in more recent years.

Skye Collyer: Wow, 10 quarters ago. Okay, so we’ve come a long way, and we’re back. And when we last spoke at the end of 2024 your overall take on the Canadian banks heading into the new year was cautiously optimistic. So up to that point, you know, the previous year-over-year, we’d seen the sentiment toward the space rebound earnings that improved valuation multiples had expanded, and so Q4 brought us in the cross hairs of that really tricky part, right, watching and waiting to see if the banks could deliver those earnings to grow into those valuation multiples. So what did the Q1 results tell us, from that standpoint?

Sohrab Movahedi: I would say the banks held up their end of the bargain. In other words, the fundamentals were good, broadly speaking. Like I said, obviously the net was a beat relative to expectation, so maybe they did better than more subdued expectations. But the fundamentals of their businesses were good, even Canadian banking, which is really the bread and butter of their profitability. And Canada, as as we’ve all felt here, has been in a bit of a lukewarm, sort of economic expansionary mode. You know, even there, we saw some earnings expansion. The banks held up their end of the bargain. You know, one of the measures we like to look at is revenue growth on a per-share basis, and it would have been probably a record revenue growth quarter, certainly one of the strongest revenue growth per-share quarters we’ve had in a while. Obviously helped by trading in some of the markets related businesses. As good as what within their controls was to start 2025. 2025 was also a dawn of uncertainty for the operating environment that they are in. It started off with basically the resignation of the prime minister in Canada. We’ve had, obviously, the inauguration of the US president, and there’s been lots of tariff talks and trade wars, and we’ve had a source of economic outlook that is, I suppose, not just for Canada, but also for the US, and globally, there’s now concerns around slowing economic growth, and that, I don’t know if it’s a synchronized global slowdown.

Bipan will talk maybe to some of that stuff better than me, but I certainly can tell you, BMO Economics is now downgraded, if you will, their outlook for their Real GDP growth in Canada and so banks being placed on the economy and certainly their local economies, the more subdued or more cautious outlook on the on the operating environment and the economic backdrop, I think, certainly has us a little bit more focused on the cautious than the optimistic. End of that cautiously optimistic stance that we would have had coming into first quarter. Earnings estimates, I would say, for the banks in this complex operating environment, are a bit of a drifting target. And just so to acknowledge the level of uncertainty that has been introduced in fairly short order, I might add, one of the things that we did in BMO Equity Research was to try and account for that uncertainty through lower valuation multiples on the bank index. Think of it as a higher discount rate for the earnings estimates that we do have. So the assumptions, the working assumption, doesn’t quite have tariff and trade war details in it, because, quite candidly, nobody really has those details. But suffice it to say that it is something that we need to take into account and acknowledge, and we’ve done that through lower valuation multiples.

Skye Collyer: Thanks, Sohrab. So within that backdrop of on the more cautious and optimistic side, you know, dealing with all those levels of uncertainty of what’s going on around, you know, within Canada and the world. If we look at the Canadian banks right now, how well capitalized are they, and over the next couple of years, what do you suspect they’ll do with that capital?

Sohrab Movahedi: Obviously, an important question. I would say the Canadian banks are very well capitalized, and as I noted, they come in with strong balance sheets into this period of uncertainty, whether it’s capital levels, reserve levels, liquidity levels. Common theme, probably 10 or 11 quarters ago as well, was that they were sitting for what would have been good capital levels back then. Back then, they had opted for some inorganic growth opportunities. For example, Bank of Montreal had announced the acquisition of Bank of the West, TD had announced the intended acquisition of First Horizon in the US. Those did not transpire. As we kind of think about the current environment — BMO’s Bank of the West did transpire, but TD’s First Horizon didn’t transpire, just for crystal clarity — As we sit here today, I mean, I think capital levels are strong. From a regulatory perspective, the regulator seems to have taken a less restrictive, perhaps more accommodative stance towards some of the pending regulatory measures that they were going to introduce. Some of the banks, TD, for example, has done a disposition of a major investment it had in Schwab, so the banks are flush with capital and buybacks, we believe will be at least the preferred method of deploying their excess capital in the current environment. And I emphasize excess because first and foremost, they’re always trying to deploy their resources to grow the business and grow it organically. If and when there are organic growth opportunities, the default option is to do that, and to the extent that there is capital left behind, above and beyond what they need to organically support the growth of their business, they would be active on their buybacks. And I would say that four of the six large Canadian banks currently have active share buyback programs. National Bank and Scotia do not but that’s because National Bank just closed on an acquisition in early February, and Scotiabank hopes to have a buyback program started towards the end of this year. So unlike Q1 2022 capital this time around is looking to be returned to shareholders, I would say, as opposed to deployed for growth.

Skye Collyer: Thank you so much. Bipan, I’m going to bring it over to you, and we want to talk big picture from a macro perspective in regards to tariffs. Of course, this is on everyone’s mind. Trump TV is telling us about it everywhere. How might this affect the Canadian banks?

Bipan Rai: Yeah, it’s an especially important question to ask at this point in time, given the fact that you know, we are seeing trade fissures and an historically stable trade environment with respect to the US and Canada. So obviously this is going to have important and serious ramifications for Canadian industries. And you know, when it comes to tariffs, and the way that you know, from a top down perspective, I would frame that as a as something to consider for Canadian banks, you know, three places that I’m going to be looking at.

First and foremost, firstly is, of course, whether or not we continue to see the same degree of demand for loan growth going forward. I think, you know, if we are, you know, in this environment where we’re batting down the hatches, obviously there are critical imbalances that will need to be addressed. And you know, given the fact that I believe the last I checked, 10% of the labor force here in Canada is involved in direct trade with the United States. Of course, in indirect that does expand out even further, some estimates have close to 40%. And if we do see the unemployment rate tick higher there, I mean that does suggest that at the margin, you know, we could see households focusing more towards potentially curbing discretionary spending, paying down their extant loan balances, and really retrenching a bit further from that environment in that lens, and to me, that portends to a particular period where we could see loan growth by the significant degree. The second place that I would look for it potentially or frame things from a Canadian bank perspective is potentially, you know, allocation for credit losses, and what that means in terms of whether or not we continue to see performing PCLs increase on a go forward basis, at least in the early part of a protracted trade conflict. And the third place potentially could be in terms of compressed NIM margin. So, you know, those are the places potentially from a top down perspective in terms of what the macro backdrop portends to Canadian banks and how that could play out as a theme.

Now, offsetting that, I mean, sort of spoke a bit earlier about what really supported bank earnings for the last quarter, and that, of course, was capital markets activity related to trading that, of course, is a function of the degree of volatility in the market. Now, the problem with that is that, you know, if we were to see this degree of volatility continue, that’s not necessarily a sustainable sort of way for banks to generate earnings over the medium to long term. And so, you know, there could be some degree of concern from that vantage point, even though it does provide a meaningful offset to the earlier themes that I highlighted. But, you know, having said that, and I think Sohrab did a great job of alluding to this earlier, if you’re looking at Canadian banks and where we are right now, you know, allocation towards credit losses, there’s certainly a little bit higher here than relative to where we were pre-pandemic, and you layer that into where we are with respect to capital. I mean, to me, that makes us, you know, a pretty strong case to be made there that you know valuation that should mitigate some downside risk to current bank valuations on a go-forward basis, even if we were to be in an environment of a protracted trade conflict.

Skye Collyer: Sohrab, you recently wrote a research paper on this topic, exactly which is, which is perfect for today’s conversation. The research paper is entitled Tariffs, Economic Uncertainty, and Canadian Bank Valuations. So I want to drill into this even deeper. What further insights can you share for our listeners on the outlook for Canadian bank valuations, given the trade conflict with the United States?

Sohrab Movahedi: We’ve probably said this a number of times on prior podcasts, banks are leveraged place on the economy, and as the economy slows, then the growth prospects, certainly earnings growth prospects for those banks kind of slow. One of the one of the exercises we’ve done is looked at prior economic cycles and try to look to see what happens to the valuation multiple of the Canadian bank index, in particular during different periods of basically Real GDP growth in Canada, and where we are today. Again, I’ll refer back to the BMO Economics work. The forecast is for about a 50 basis point Real GDP growth in 2025. In prior periods, and we looked back about 30 years, in prior periods where real GDP growth in Canada has been in and around that level. Let’s call it in the 0-1% range. The forward P/E multiple of the Canadian bank index is around where the bank index is currently trading. So I suppose there’s a good news bad news story in here. Certainly investors look to have priced in the level of slowdown that our economics group, for example, is forecasting. And by the way, this would involve a bit of a contraction on that forward P/E from perhaps even three months ago, when we were a bit more optimistic about earnings growth prospects. You know, because we were a bit more optimistic on the economic growth prospects. So, so the risk, so that’s the good news.

Sohrab Movahedi: The bad news is, of course, there is still a little bit more risk to the downside, depending on the details and and I think you know it is, it is very important to keep in mind that, like the details are important. The devil is always in the details we need to know, not only the size and the length of the tariffs, the sectors impacted, the retaliatory measures, the level of government support, what Bank of Canada is doing in reaction, what sort of actions the companies themselves are taking. And then, you know, what sort of accommodations, let’s say the banks, as the lenders, will provide. And Bipan touched on this a little bit, and what I would just say that for us, for me as a bank analyst, looking at the Canadian banks, we are, in the first instance, focused actually on the consumer. Okay, so the consumer, and the Canadian consumer in particular, is likely, whether it’s through reduced spending, we are a bit more, perhaps fixated or focused on unemployment rate as a key measure for credit quality over the next 12-18, months. And you know, the logic being that companies will do what they can to preserve their longevity in a tough environment. And part of that usually involves managing their expenses and and unfortunately, a byproduct of that may actually be layoffs, depending on what industry and how people intensive it may be. So we’re actually mostly focused on the unsecured lending that the banks are doing to the consumer. Think of that as your credit cards and what have you. And then secondarily, thinking about some of those industry groups that are more acutely probably targeted by these tariffs and the level of lending that the banks would have would have to them.

But I think suffice it to say that long growth, as Bipan highlighted, will be something to pay attention to. There is, again, if Bank of Canada ends up cutting rates, and I think there is forecast of that in our economics department. The good news in that is it does take some pressure off that consumer from servicing the debt perspective. So the debt serviceability benefits to some extent from that. But you know, these are trying to find silver linings and otherwise a difficult set of circumstances.

Skye Collyer: Thank you. Sohrab. So many layers to peel back with the banks being so well capitalized, but you know, having to take into account the bigger picture, the bigger backdrop of staying focused on the consumer like you mentioned, and of course, today, being focused entirely on the Canadian banks, I would be remiss not to share that a lot of our clients ask about the US banks and getting exposure there. So when it comes to Canada at BMO, you can get exposure through ZEB. You can also get that similar exposure, but layer on income, with our BMO Covered Call Canadian Banks ETF, the ticker there is ZWB. So to kind of speak to those questions I do get from the field regarding US Bank exposure. What’s your take, I’m going to take it back to you Bipan, on getting exposure south of the border and how you can access that through BMO ETFs?

Bipan Rai: If we’re talking about US banks, we’re obviously talking about a very different market relative to Canada. But you know, expressing that via some of the ETFs that we have here at BMO on our product shelf, I mean the the first place to look in terms of a comparison point to the ZEB in Canada would naturally be the BMO Equal Weights US Banks Index ETF, which, of course, is ZUB on a hedged basis and ZBK on an unhedged basis. So that would be, you know, the sort of corollary towards the ZEB. You know, with respect to the ZWB, we have a corollary in the United States as well. That is our BMO Covered Call US Banks ETF, the ticker there is ZWK. Certainly it does have some attractive income component to it, which could be something to look at, especially with the current degree of market chop that we’re currently undergoing. But again, this feels like a fairly good seed into something new and exciting that we have been have recently launched here at BMO with State Street, and that, of course, is our SPDR Select Sector ETFs. Again, State Street is the US largest provider of US sector ETFs, and we’re happy now to make that available for our Canadian investors as well tradable on the TSX through BMO. And of course, you know these sector ETFs cover all 11 of the GICS sectors of the S&P 500. And if you’re looking for the financials sector ETF, of course, that of course, would be ZXLF and ZXLF on a currency hedged basis. So again, we offer all 11 of those GICS sectors on a hedged and unhedged basis. And if you’re not, if you’re looking to veer away from an equal weight basis, again, the ZXLF could be the instrument that you’re looking at in terms of the US financial sector, which encompasses the banks there.

Skye Collyer: Here at BMO ETFs, we have the largest offering of sector ETFs on the street in the Canadian marketplace for ETFs. So it seems to have been a natural extension and offer those 11 GICS listed here on the TSX. Thank you so much. Let’s get back to the Canadian bank exposure. I want to put these last three months change in perspective for investors who have exposure to the Canadian big six banks through our ETF, ticker ZEB. It was priced at $40.70 on October 31 quarter end last year, and grew to just shy of $43 at $42.98 as at Jan 31, 2025 so more recently, that move has retraced back to around $40.71 cent mark as at March 4 close. So we work through a lot of news here today on our discussion and Sohrab as we close out today’s episode, if you could just leave us with a few key reasons to be concerned and perhaps also retain some of that optimism as an investor of the Canadian big six banks as we move into the second quarter of 2025,

Sohrab Movahedi: Okay. I mean, I think, you know, we had, for example, in Canada, we had Liberal Party pick a leader yesterday, last night. So that’s one degree of uncertainty removed. We’ll probably have elections soon thereafter. So, so the good news is we’re making some inroads towards the recovery period. And I would say that it seems I’m not a politician, but it feels like there is going to be this improving, there’s going to be this focus on improving the fundamental drivers of the Canadian economy, whether it’s Canadian productivity, whether it’s increasing the interprovincial trade, all of these tend to attract capital resources to the country. And the prospects could be interesting for the right time frame. And I think you know, banks will have a role to play. And if you believe that there is a constructive construct for the for the Canadian economy, then you have to believe that it will also be helpful to the Canadian banks as grease in their gears, if you will, of the of the economy, Canadian banks have always been excellent total return investment options between their dividends and their earnings growth and and they tend to be very good medium term holdings. And so we would, you know, we would expect, notwithstanding some near term kind of volatility and uncertainty, that they will hold true to their typical investment case of being good total return vehicles over the medium term or certainly beyond the near term uncertainty.

Skye Collyer: Okay, that’s all for today. Thank you so much. Bipan and Sohrab for your time and sharing your insights. And of course, to our listeners for tuning in. If you have any questions, please visit our ETF Center at www.bmoetfs.com, for research, news and insights. We’ll see you here next quarter when we talk Q2 Canadian bank earnings. Have a great day, and thanks again for tuning in.

Podcast Transcript: Q1 2025 Canadian Bank Earnings