Hello, and welcome to The Download. I'm your host, Dave Richardson, and it is Stu’s days, which are growing so darn popular, I'm wondering what province is going to be first to make Stu’s Day a staff holiday? You're not going to predict that?

I'm not going to predict that one, Dave. With where Canadian productivity is right now, you could almost argue that people are taking Tuesdays off every week. Isn't that where we're at, Dave? That is possible.

So, Stu, I'm throwing you a prediction right out of the gate. I was telling the story to some people. This is how incredible you are. I don't know if I mentioned it on the podcast, but I was doing a speech somewhere. We had lunch together in Montreal. We both like our steamed hot dogs. And you're talking about buns. And you're looking at the bun, and you're evaluating it because you've got an investment in the bun company. So you're thinking about that and looking at the volume, the quality of the bun. So very focused on the investment that you have for the people who invest with you. Then a couple of weeks ago, we're on the podcast and you start mentioning the Value meals that are coming at McDonald's and some of the other fast-food chains. So then I'm watching CNBC last Friday, and there's a guy on, an analyst from one of the US banks, making a big bet on a bun-making company because the demand is going to go up because of the demand for these Value meals. And so you put an upgrade on the bun company. Look at you. You pieced it all together way before everyone else.

Well, it does seem increasingly. I don't remember paying this much attention to buns growing up. Maybe there was so few to choose from, but now it's brioche, potato bun, soft white bun, whole wheat, you name it. The amount of focus on what's going outside the content is as big as what's going on inside.

That's right. People are eating more of them. They can eat the buns because you've got all these drugs that help you lose weight. So you don't need to worry about eating the bun anymore. You had people who were skipping the bun before.

I guess that's the Ozempic-Wegovy combo.

Yeah, That's right. Have a Big Mac combo and stab yourself. Or poke yourself. I guess stab is a little violent. We don't want to be violent on the podcast, Stu. We're both very much pacifists in all regards. But I won't tell you, the other one you had the last time was the prom story and the pinning the corsage. I had my own prom crisis last Friday, too. So it was good to know my investments are making money because I'm invested in a lot of buns. So that's good to know. It was a good feeling as people ransacked my house. But let's get to something that you are the expert, probably. I know you're going to be modest and say you're not; that you're just one of many. But the Canadian banks and their earnings. All the earnings are out. And we can now look back at what’s going on in the different banks. But to a large extent, it's a reflection of what's going on in the Canadian economy and what's going on with the consumer, which can lead to some conclusions around different elements of investing. You look at the bank earnings. Let's just start off with good, bad, or across the board. A couple stand out as particularly good or bad? Just in a general overview, were the earnings pretty much what you expected and were they okay?

The underlying mechanism, you can look at banks on all sorts of time horizons. When we look at them from a long-term horizon, what do we look at? We look at the capital ratios, because we want those to be strong. That was pretty much across the board. Then we often look at what we call pre-tax, pre-provision earnings, because those are earnings regardless of the current credit conditions. Those too were not bad. Expenses have been held in check pretty well across the board, and that's allowed what hasn't been a tremendous amount of revenue growth, but the revenue growth that has been out there has been magnified because there's been some operating leverage inside of the banking system. Then you look at the different business lines in capital markets that were pretty strong. Wealth management has been stronger because markets are better. But some traditional banking activities are still pretty slow. Loan growth is not blowing anyone's socks off. Net interest margins? Puts and takes, but not bad because it's competitive. You're paying for deposits, but the banks also have a lot of securities that roll over time, and they're rolling into higher interest rates as well. So all things considering, you would say, not bad. And the banks that flourished were the ones where credit was a bit more contained than others and capital markets were stronger. When we get into a cycle like we're in, you have interest rates start to rise, loan growth starts to slow, and then there's some provisions for credit, generally speaking. We're on to the third symptom of this slowdown. The way I think about it is if I have a cold. The first symptom I get is I feel my sore throat kick in. Then my head starts to hurt. And then eventually I get the cough. But the cough is the last symptom as the cold eventually disappears. Credit losses are the late cycle, the later symptom in the context of a bank share price and how it moves. So we've been thinking that credit will likely peak in the back half of this year or into the first half of next year, and that continues to be the case. But there were a couple of banks where credit was a little bit higher than expected, and that causes some short-term angst. But again, we are focused on that being one of the later cycle or one of the last symptoms of this move. And eventually what ends up happening is interest rates start to decline, loan growth starts to pick up, and that's regreasing the rails. And so when rates drop and there's more financing available, then companies that are feeling the pinch of the current environment, they start to feel it less and have less provisions for credit. And eventually — this will probably be maybe 18 months from now — there'll be recoveries on some of the losses that the banks have taken provisions on. So right now, I would say, it still going according to plan in terms of how we're thinking about the banks. And that's what we see here. Going into the fall, the one thing about loan growth, which might lead us into some discussion around the presidential cycle is, companies ask, should I borrow more money? On the one hand, they're thinking, rates might be lower, so should I wait? And will I get some clarity after the election, which will just give me a little bit more confidence to maybe do some activity? As we get into the fall, we'll have some lower interest rates from central banks. That'll stimulate some loan growth, and that will kickstart the other side of the cycle at some point.

Let me take your analogy a step further on the cold and start to get an understanding of when then this group of banks — we'll get them all together; we won't pick any one in particular — but try to identify what's the right time for you to start adding exposure. So you've got this cold. I'm on the podcast with you here. I hear you coughing. You've told me how you got sick and you’re through the recovery. You're coughing right now. You're still sick. And I'm thinking about going to the Blue Jays game with you on Thursday afternoon. It's a good afternoon game. We're here on Monday. So I'm worried about asking my boss that I'm going to take Thursday afternoon off. But I'm not going to do it until I'm pretty sure that there's a chance you're going to be coming to the game with me. In other words, when I'm going to buy the stock or when I'm going to add exposure to the stock is the point where I would ask my boss if I can have Thursday off. Is this when you're coughing? Is that when you go, okay, well, I know I'm going to be better in the not-too-distant future. Do I start buying ahead of that? Does the market start to identify that and is that when they start to bid up the price? Or does that come later? Do we need a definitive sign of I'm healthy again. And that's the point where I want to be starting to look at some of these stocks as being more attractive?

It gets into your time horizon a little bit, and it gets into all the business lines within the bank. We've got a couple of banks today trading at all-time highs in Canada. And those banks tend to have very universal business lines. So maybe trading in capital markets has been strong or capital markets in general. So you have some provisions for credit, but there's other business lines firing in all cylinders that are helping to pay those provisions. There are others that don't have quite that same universality or they're not firing in all the same cylinders. So what you're normally looking for is for provisions for credit to peak. The issue in the past has been that they normally peaked with big spike. And you put this big spike aside and you say, okay, that's it. And immediately, like the old saying, you can't lose money on the same loan twice. You've made this provision for credit, and you get back to normalize earnings power in a hurry, and eventually, you might get some recoveries off that provision. The accounting works a little bit differently this time. So the plateau might last a little bit longer. This is something we're doing a lot of work on. But it's in that plateauing process that you want to be buying the stocks, because what we do know is that the plateau will eventually ease. Interest rates will start to come down. Loan growth will resume. And as I say, eventually, we'll get to a period where there's some recoveries and things start to get better. So it's in this process. When you get to the third symptom, in your head, you're telling yourself, okay, we've been through the first two, we're on to the last one. For people with a trading mentality, there's probably a little bit of waiting going on with the election. But from an intermediate term standpoint, you're like, yeah, this is the range where the chances of making good money over the cycle is pretty good.

And that's where I've got to know the patient. I know Stu, he's a pretty robust guy. Even if he's not 100% healthy, he's going to make the ball game on Thursday. Somebody else might still have a head cold; not even at the cough. Knowing where each individual bank is in that process is a critical element as well.

Yeah. Although I do want to go back to the very first line about the capital ratios, because all these banks are making the ball game, right?

Yes, very much so. We'll be very clear on that. Let's not let an analogy get off the rails completely.

And what we do during those periods of elevated provisions is also spend a lot of time with management to make sure we understand the earnings power of the bank on the other side, and to make sure that those management teams are isolating the credit experience so that it doesn't infiltrate into all their other normal growth plans.

And then, Stu, the Bank of Canada is widely expected to be cutting rates this week. It's never 100%. It's not a done deal, but that's the expectation. And if it's not now, it's sometime over the next two or three months. Is the lower Bank rate going to be a net positive to the big banks, or is that a negative when they start reducing rates?

I think in this case, it would be a positive just because more recently, data on the economy has been a little sluggish. The US economy, you can see some data that's a little sluggish, but other data is still quite healthy. In Canada, it feels like we're falling more on the sluggish side. So lower rates would assist there. If you can have marginally lower interest rates, you begin to have a little bit more money for everything else. If you're a consumer, you've got so much leaving your pocket. If less leaves your pocket, you can use it for other debt. You can use it to reconsume. You can use it for a variety of things that are more of assistance to the economy. I still think there's a high likelihood that we'll see a lowering of interest rates in short order, but the one thing that is complicated is that we've had such a high level of immigration, so a lot of the statistics on a per capita basis don't look very robust. At the same time, immigration takes time to season in terms of generating the ultimate growth that comes with it. But when you listen to the commentary across the banks and some of the stress that the consumer is feeling, the Bank of Canada, I would have to think, is pretty close. But I'm not the governor of the Bank of Canada either.

Sure, because then you'd be Tiff Kedwell. And then it'd be Tiff days, which doesn't really work. We'd have to figure out a different day to do the podcast. But the challenge on this, if you start to look at the book of mortgages that are coming due across the country, just even over the remainder of this year, which wouldn't necessarily be at the bottom or where rates bottomed out in the middle of COVID. Mortgages are coming due around 3% this year, and they're maturing into 4.5 or 5%, depending on the term. If they go a shorter term, it's even higher than that. And that's a big bite out of someone's disposable income. That can be $300, $400, $500 a month that all of a sudden disappears, that was going to consumption and is now going to making interest payments against the same house that you were living in. Nothing changes. I just don't have as much money to spend. And this year is the low end of that. You start getting into '25 and '26. That's when you start to see very low-rate mortgages coming due into much higher rates, if rates stay where they are and don't start to come down at some point. And that really puts a constraint on the economy.

Yeah, that's 100% true. And there's positives out there. Incomes have grown. They haven't grown as much on a real basis, but they've grown, which allows for more interest coverage. But you can see discretionary income is lower, particularly amongst mortgages that have reset. You can see the banks tell you it's down 5 or 10%. To your point, the real big areas are 2025, 2026. Today, if you had a five-year mortgage in 2019, it might have been at 2%, or the five-year was 2% anyways in 2019. Today, we're at 3.5%. That's 1.5% more. But it's those 2020 and 2021 when the five-year rate was down under 1%, that's what's potentially going to bite a bit more. We're sitting here today. The five-year peaked out last October at 4.30%, and we're at 3.58% today. That's a noticeable improvement. Inflation is heading in the right direction. Whether or not it's this month or the next meeting, I think the facts are certainly in favor of a decline at some point in shorter-term interest rates.

As you say, that's ultimately good for the economy. As we look at where we are at this stage of things with the banks, that's likely something the banks would appreciate. Keep things going, get the economy moving a little bit more, and again, take down where provisions might have to go in the future.

Yeah, I think that's right, Dave.

Wow. So, Stu, have you had one of those Big Mac combos?

I have not saddled up to the McDonald's bar recently. Probably been a little bit more focused on pizza recently. It's up on my Instagram feed, and I feel like there's a lot of pizzerias in Toronto I got to try out. There's one in Hamilton that won the Best Slice in North America. So one of our team guys went out there to get a slice. But I've been focused on pizza, notwithstanding my knowledge of McDonald's combos.

Oh, really? You're going to have to give me the name of that place because I like getting the good pizza when I can find it. So I didn't realize that there's an award-winning pizza in Hamilton. That sounds pretty exciting. Well, I'm going to go do that. You're going to go back to evaluating quality bun companies, checking out the buns, and we'll check in with you next week when hopefully we got some lower rates and another employment report in the books out of Canada and the US, and we might have even a better view of where things are going. So thanks again, Stu. Always great to catch up with you.

Great. Thanks, Dave.