Hello and welcome to the Download. I’m your host, Dave Richardson, and I’m joined for Stu’s Days once again with Stu Kedwell, the Co-Head of North American Equities at RBC Global Asset Management. Stu, welcome back to your normal slot.
Great. Thanks for having me Dave.
The one thing that you pay a lot of attention to in the role that you’ve played for a long time is Canadian banks and their earnings. And they tell a broad story about what’s going on in the Canadian economy, along with what’s going on in the industry itself. The banks start reporting earnings next week. What are you looking for, and what message do you think the bank earnings are going to send this quarter?
I think it will be more of the same of what we’ve seen from the broader economy, and what’s taking place with what some other companies have reported. The results themselves should be modestly better than they were the last quarter. And the reason for that primarily is that the banks took enormous provisions for credit last quarter to try to get in front of the loans that will in all likelihood go bad in the next six to nine months. Most banks won’t have to take the same size of provision again, although we would expect many to remain pretty conservative in terms of how much money they set aside for future bad loans. The other thing that we will be paying careful attention to is what they call their “net interest margin.” That’s the difference between what they lend the money out at, and what they have to pay on deposits. And when interest rates are really low, that can be pressured a little bit. In all likelihood, we will see that for some time. The second thing that is pressured: while consumer loan growth has been pretty strong, business loan growth in all likelihood will subside. So last quarter you had a bunch of businesses, when the economy slowed, who took their lines of credit out and put the money on deposit with the banks. Many of them didn’t actually use it, but just as a safety precaution, they did that. In all likelihood, we will see some of that paid back. The system is still flush with deposits and looking for loans to make. But with the economy doing better -- but not anywhere near its potential -- many of those deposits have to be reinvested into government securities and other things. That pressures the net interest margin a little bit further. So when we think about a bank’s revenue, one half is the net interest margin -- this is still a little sluggish. The other half is the fee revenue that should bounce back. Because we’ve seen spending bounce back, we’ve seen markets bounce back, and we’ve seen a handful of things that drive that line bounce back. So the revenue environment will be, I would say, OK. A little bit better than last quarter, but still a little pressured. Expenses will probably be in good shape. Provisions for credit will likely remain. As I said before, not as high as last quarter, but still relatively elevated. Not that it doesn’t matter to long term. It does matter to the stock market, but long-term investors really are focused on when the earnings of the banks could get back to their old levels. We’re thinking somewhere in the 2022 to 2023 range, depending on the bank. And when we look at a normal valuation on that possibility, the banks still offer pretty good total return potential. While we may not see a dividend growth in the near while, we do have the possibility for the valuation to normalize once the earnings start to do a little bit better as this provision for credit period of time subsides. Of course, everyone thinks interest rates will remain low for some time, for the foreseeable future. Embedded in a bank’s revenue line is this interesting option if rates ever rise, and that option never expires. So that is something, as a bank investor, which provides a little bit of protection in the broad scheme of your portfolio. Because we have a whole bunch of other stuff that might be quite interest sensitive. So those are some of the dynamics that we’ll be working through in this quarter’s reporting season, which kicks off with CIBC a week Friday.
And Stu, we’re sitting here on this Tuesday and the S&P 500 is now within 1% of its all-time high reached on February 19. So the markets are very clearly looking at a lot of the positive developments around what is going to happen in the next year or so, and the comeback. Talking about Canadian bank earnings, it could be 2022, maybe even 2023, before they get back to where they were before. Is that why we’re seeing the Canadian market lag? We’ve talked about the limitations and the bank stocks lag relative to approaching their previous highs.
Yes, that’s bang on. I would say, right now with the S&P 500, the current earnings estimates are that we will exit 2021 at the same earnings level as 2019, and the banks will take a little bit longer than that. The primary issue or the primary impact right now at this juncture — and of course, interest rates can rise — is the spread between what they’re getting on the loans versus the deposits. It’s not as high as it used to be historically. So it takes a little bit more growth to get earnings back to that level. Banks like the Royal should hopefully see their earnings levels a little bit faster because they have less of their revenue associated in spread than some other banks where it’s more dominant.
Yes, for many businesses and individuals, those low interest rates are fantastic. But for banks, not necessarily so. So, again, it’s always interesting to get your thoughts on the banks, because I know you follow them so closely. And welcome back to Stu’s Days. Thanks as always for your time.
OK, and thanks for everyone for listening. I appreciate your time.