Ruth Saldanha: With the big Canadian banks all announcing mixed quarterly earnings this past week, how should you play the space now? Morningstar analyst Eric Compton covers this space, and he’s here today to give us his take.
Eric, thank you so much for being here today.
Eric Compton: Yes. Thanks for having me.
Saldanha: So how do you read quarterly earnings for Canada’s big banks?
Compton: Yes. So, the earnings, they’re not great, they’re not great in some ways. So, yeah, they’re kind of mixed up, so, like, as you introduced the question. So, some things are going well for them. Balance sheet growth is very good. Loan growth is very good. We have many banks that are seeing quarter-on-quarter growth of 3% to 4%. Many banks will turn in double-digit growth for the year. So, that’s a really strong result and that’s driving along with the increase in interest rates which is a good result for net interest income. So, the banks saw good net interest income growth this year, actually largely coming in ahead of our expectations.
However, the weakness occurs on the fee side. Therefore, investment banking has seen a very weak environment. Trading results are often not good for most banks. Due to lower market levels of wealth-related yields, which are often driven by asset levels, those yields are slightly weaker. So you see good strength on the net interest income side, but a lot of weakness on the fee side. So, that’s the mix you see. So, they’re not great, but they’re not that great either. So, I would say, that’s kind of the earnings this quarter.
Saldanha: One of the things that worries Canadian investors is the fact that some banks have missed their quarterly estimates entirely. Are you at all worried about this?
Compton: Yes. So, I usually don’t get too caught up in quarterly fluctuations. At Morningstar, we try to (queue) that long-term view. Therefore, quarterly earnings, they will fluctuate slightly. Diving a little deeper, like looking under the hood, the long-term trend that we see is that we think balance sheet growth is good right now, but we expect it to slow a little bit as rates pick up, as the economy slows both in Canada and in the US So, we kind of expected that slowdown. So, it doesn’t change our view on that. If anything, things turn out better than we thought.
In terms of fees, yes, they are a little weaker than we expected. But again, in our modeling, we have some of those cycles there. So, yeah, some quarterly misses, not something you want to see. But we think in the grand scheme of things, a lot of the loss of payments is going to be cyclical, and then we already have a little more economic weakness in our model. So, nothing too crazy yet.
Saldanha: One of the things that has changed quite a bit since we last spoke is Canadian real estate prices, which have corrected slightly over the past few months. Are you worried at all about this fix and what impact it will have on banks?
Compton: Yes. So, the way we’ve always viewed it and the way we still view it, we view it as a risk to future growth. So, real estate prices are coming down, it seems they are starting to come down in the US too. We always say that there will be buyer’s remorse on some of these things. But the way we see it is more because consumers in Canada are growing. They have to be more eager to buy a lot of these properties, especially in this high priced property market. So the spending power will decrease in the future, so that’s the growth risk. But we don’t see it as some kind of 2008, 2007-style US recession that exists. So there’s actually been a lot of exposure this quarter where banks are talking about what percentage of loans they’re going to pay back and when, what that means like the average mortgage payer in Canada. And yes, people will be paying more for their mortgages in the future, but it won’t make me really worry about the safety of Canada’s financial system.
Saldanha: So, with all this said, what is your most popular Canadian bank choice and why?
Compton: So, we still like – I think we brought this up maybe last quarter – we still like National Bank of Canada. Again, they are one of the smallest banks in Canada that we cover. So, they get some attention, which I think could lead to some discounts. And we still love ratings. They’re still the cheapest name under our Canadian coverage, and we think they’ve got some things going for them going forward. So, in this last quarter, their Kredigi, a type of credit investment unit, the results have reached a little more than average just because of the market environment and some economic pressures that are starting to appear. So we think it’s more cyclical. Eventually, it will turn around and come back at them. Assets under management have actually held up quite well for them even in a tough market environment. So, we like the growth profile there for them. And they also have lower exposure to the highest priced real estate market. So, overall, with their high return on equity and, we think, a top-line profile for earnings combined with good valuations, we still like how National Bank of Canada is positioned among Canada’s big six banks. So, yes, I’m sticking with National Bank of Canada as my top choice for now.
Saldanha: Great. Thanks so much for joining us with your perspective, Eric.
Compton: Yes. Thanks for having me.
Saldanha: For Morningstar, I’m Ruth Saldanha.