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Canada’s Surging Banks Outperform Forecasts

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Written By: Mary Windsor – Forex Focus

Amid fears surrounding the country’s overheated housing market, the Canadian banking sector exceeded expectations following second-quarter reports. The concerns about high housing prices and overstretched borrowers seemingly had no effect on Canada’s five biggest banks: the Bank of Montreal (BMO), the Bank of Nova Scotia (Scotiabank), the Canadian Imperial Bank of Commerce (CIBC), the Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD)-Canada Trust. Each of them recorded increased profits in the latest round of reporting. The positive results led to upgrades in six of the country’s major banks by Barclays’ analysts just ahead of the earnings season for the second quarter. Laurentian Bank, TD Bank and BMO were all upgraded to “equal weight” from “underweight”, while National Bank of Canada and Scotiabank were upgraded to “overweight” from “equal weight”.

Scotiabank, in particular, exceeded forecasts as it saw a 30-percent boost in its net income to $2.06 billion. The boost in income saw the bank’s per-share price jump from $1.23 in 2016 to $1.62 in 2017. Scotiabank CEO Brian Porter says several reasons explain the bank’s outstanding performance—including international banking, Canadian banking, and global banking and markets—but much of the bank’s growth has stemmed from its investment in Latin American emerging markets. In a recent Financial Post article, Porter went on to discuss the contributions made from Pacific Alliance countries Colombia, Peru, Chile and Mexico—composing a market-friendly Latin American trade bloc—which show encouraging potential in both the short- and long-term. Mexico seems to be one of the highest contributors to Scotiabank’s improved earnings as its economy is interconnected with the US economy and its performance is bound to US economic health. The invigorated US economy bodes well for Mexico, where Scotiabank has invested a great deal; it is yielding fruitful returns, despite fears over the potential for a renegotiated North American Free Trade Agreement (NAFTA).

The positive economic performance has some analysts speculating that Bank of Canada Governor Stephen Poloz may raise the benchmark interest rate from 0.5 percent sooner than expected. There is cause for this assumption as the Canadian economy has historically maneuvered a flurry of external stimuli while managing its overheated housing market and overstretched borrowing rather well. Nonetheless, Poloz has tempered these expectations by underscoring the negative aspects still plaguing the Canadian economy. While the second-quarter earnings were surprisingly positive, this has not been outside of the ordinary. The past few years have also yielded positive data that has not had substantive lasting power. In that regard, Poloz has called for caution on behalf of forecasters and investors who may be overzealous to capitalize on this new performance. Of these weaker data points to which Poloz makes note, the most concerning are the drop in non-energy exports, anemic wage growth and a disappointing jobs market. For the time being, it appears that the Bank of Canada will hold off on any premature decisions about changes to the benchmark interest rate until more stable and robust numbers prevail.

The governor’s concerns are not unwarranted. Various short-term and one-off factors combined to facilitate the positive second-quarter reporting that sparked these calls for a change in interest rate—most notably a drop in imports that boosted gross domestic product (GDP) numbers for 2016. Additionally, business investment saw an 8.2-percent drop, marking the ninth consecutive quarter in which a contraction was recorded in that sector. External factors have also influenced the performance of the Canadian economy. Following the publication of the recent data, the Canadian dollar rose, but then almost immediately declined. Anxiety surrounding the country’s trade dynamics has also played a part in the overall performance as fears of reduced trade with the United States cause more misgivings.

This fits the narrative outlined by Don Pittis who, in a recent CBC News article, suggested that credit-rating agencies Moody’s, Fitch and S&P have historically skewed the Canadian banking market with their sometimes incorrect reporting. While the agencies have been effective at monitoring the market, they are neither imperfect nor immune from mistakes. Most notable were the positive ratings given to mortgage-backed securities prior to the 2008 banking collapse. Similarly concerning was their inability to foresee the 2014 collapse of oil prices that destabilized world markets.

Despite the cautiousness of the Bank of Canada and its governor, Stephen Poloz, there exists a slew of reasons to believe that the Canadian banking sector is fundamentally built for strong returns. For instance, a recent Bloomberg report explains that tighter regulation and less risky investment on behalf of Canadian banks yields returns that are less volatile and more consistent. Yet this still leaves the Canadian banking market exposed to a potential downturn in the overheated housing market. While this is a concern, it is not a threat to current bank returns. While Canada boasts historically low default rates, there is still a strong culture of insuring against the risk of default from borrowers. The party insuring this risk is the Canada Mortgage and Housing Corporation (CMHC), and banks are traditionally one of the financers for their customers’ insurance premiums. Ultimately, Canadian banks are in a starkly more beneficial position than their American counterparts, with more propensity for stable growth and lower stock volatility that, despite Governor Poloz’s remarks, are definitely a reason to be confident about Canadian banks in the near-term.

 

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