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This episode, Stu Kedwell, Co-Head, North American Equities, joins Dave to discuss Q1 earnings results of Canada’s top banks. Stu also takes a look at what’s in store for the financial sector, as broader economic recovery presses on. [6 minutes, 56 seconds] (Recorded February 24, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson, and I am joined for (S)Tuesdays on (S)Wednesdays this week with Stu Kedwell, Co-Head of North American Equities at RBC Global Asset Management. Stu, once again, my fault for the late taping this week, but thanks for joining us.

Hello, Dave. Thanks for having me, as always.

And the tardiness of this week's recording allows for more of the banks to report their earnings. Canadian banks are in earning seasons right now. And we always like to check in with you. You're a noted expert on Canadian banks and dividend stocks in the Canadian marketplace. It's always interesting to get your thoughts on what you've seen thus far and what you think it says about the broader economy in Canada and around the world.

Yes, I would say that these are generally strong results, as we were expecting, and we're seeing the mechanics inside of a bank on full display. First and foremost, the provisions for credit have come down after establishing very large allowances last year. The second is, trading businesses are very strong; not surprising when you see the level of activity and some volatility, that business is strong and probably elevated; it probably needs to come down a little bit. Wealth management results have been strong again with the markets, but we can also start to see glimpses of which businesses are still to recover. And inside of that, net interest margin has still been pressured modestly in the first quarter, but as the economy recovers, the first thing that will happen is, deposits will start to get used inside the economy, which will lower some of the bank's funding costs. So higher cost deposits will roll off. That will help net interest margins. Loan growth will gradually improve. Credit card balances will start to rise. Commercial lending will start to grow, which will be the next source of growth. That might be a little bit more on the back half of this year than it has been. Of course, the last thing is, credit card fees and things like this. When spending starts to ramp back up, some of those lines will start to improve as well. Noticeably on that front, of course, is travel and things like that. But results have been strong. As I say, they're nicely ahead of expectations, although, when it's just trading and credit, the market tends to say, well, that might not persist. But even underneath of that, these were pretty good results and allow us to look forward to how earnings can continue progressing in the next six to twelve months.

Yes, and we've seen a run up in Treasury yields thus far this year — the 10-year, 30-year, longer end, etc. — 30 and 40 basis points in Canada and the US. We saw bank stocks run in front of the earnings that are being reported. Do you think that run is what we sometimes see, which is a run up in front of earnings, anticipating that there's going to be a bead and things are generally good; change in loan loss provisions? Or do you think this is a broader call on the steepening of the yield curve and as you say, improving net interest margins down the road?

I think it's a bit of a play on the steepening of the yield curve, because central banks have come out and they have been quite consistent — and they were consistent again yesterday — by saying that they are not going to act in advance of the economy strengthening. They want to really see it. And the bond markets way of interpreting that is to say, well, short-term interest rates are likely to remain low, perhaps inflation will bubble a little bit, so, we want to get paid for that possibility. And to get paid for it, we want to see some slope in the yield curve. When you see 1.40% on a US 10-year bond today, don't forget we were 1.50% before the pandemic. So, this is still, in some respects, just the removal of some of the move since last March. It's not at a level where we worry about it derailing things. People say, well, why aren't you worried about that? Of course, you can worry about it. But the real level of interest rates is still minus 0.5%. So, if you're dealing with 2% inflation or thereabouts and 1.5% even on a 10-year bond, you're still talking about negative real interest rates. So that's still quite accommodative. But as that change happens, it does cause a little bit of volatility in certain pockets of the market. We've seen that as well. As I say, it's not really in areas where we have a dramatic amount of exposure. But if you're a very high multiple stock and your earnings are well into the future and you start to change the discount rate, which is linked to interest rates, you can get volatility in those areas. But meanwhile, elsewhere in the portfolio, you've seen nice gains and things that are a little bit more sensitive to higher interest rates like financial stocks. So net, it's all balanced out reasonably well for the market so far.

Yes, and we talked about on a previous podcast the potential for that rotation within markets and, as you've just explained, that is some of the rationale for why we're seeing some of that. Looks like it's starting to happen in markets around the world. Ultimately, we get a return to boring, which I think is good for guys like you and me.

Dave you hit the nail on the head; in this morning's daily market update, which is something I read every day and I highly recommend, I had myself pegged as a Gradual Graham, in that note this morning. That’s dollar-cost averaging in a good portfolio of high-quality stocks and letting time work on your behalf.

Stu's referencing an internal note that circles around and it was displaying different types of investors. And Stu and I would certainly fall on the boring, cautious side. And just because we're bankers, we're pretty dull to begin with. So that's why we're so grateful that anyone would listen to this podcast. Listening to two boring folks with great information, though. So, Stu, thanks again for joining us today. We'll see you next week.

Thanks, Dave. Take care.


Recorded: February 24, 2021

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