The future no longer looks grim for the Big Six Canadian banks, analysts said, after all-but one of them reported a better-than-expected fiscal third quarter that could even pave the way for a dividend hike in early 2021.
The banks are still attempting to recover from the worst of the COVID-19-induced economic shutdown but five of the six were able to widely beat analyst expectations because of record showings in their capital markets divisions.
Overall, the numbers are still bad, but they’re already a massive improvement from the second quarter, when the group reported that profits had fallen by 50 per cent. The largest profit losses this time around hit 30 per cent, but stalwarts like Royal Bank of Canada and the National Bank of Canada only reported one and two per cent declines respectively. Loan loss provisions, meanwhile have been sliced by hundreds of millions of dollars, with RBC setting aside 75 per cent fewer funds than it did in the second quarter.
Edward Jones Investments analyst Jim Shanahan said the outlook for the sector is a good one, especially for those investors who buy into the banks because they are looking to collect dividends. Yields for the Big Six are already attractive, he said. But because the group is raising capital ratio and is flush with liquidity, Shanahan is projecting an across-the-board dividend hike for early next year that would make these stocks even more appealing for income-oriented investors.
“I think if you’ve got yield of four to six per cent for the group and the outlook is once again calling for rising income, these are attractive stories,” Shanahan said. “If they continue to build capital the way they have for two more quarters and continue to deliver earnings in excess of the dividends they’re paying, I think regulators may allow these banks to increase their dividends.”
The Office of the Superintendent of Financial Institutions has prohibited the banks from raising dividends and buying back shares due to concerns over liquidity and capital ratios. If the banks continue to improve at this rate, however, Shanahan can see regulators loosening those restrictions over the next two quarters.
Aside from benefiting from a potential dividend hike, Shanahan said investors should be interested in a name like Toronto-Dominion Bank. The bank reported that its capital levels had spiked to 12.5 per cent and is now the highest among the group, Shanahan thinks that it could be lining itself up to make an acquisition in the U.S. The company has long been interested in increasing its branches in Florida and credit card portfolios.
“These capital levels suggest TD could be in position to do what they did last crisis which is take advantage of the opportunities in the market given their substantial regulatory capital,” Shanahan said.
Horizons ETFs portfolio manager Nicolas Piquard owns the Big Six banks through the Horizons Enhanced Income Financials ETF because of the yield they offer. At a time when Canadian government bonds are offering little in the way of a payout, Piquard said the banks work as a substitute.
While he’s bullish on these names, some of them still are risky. And in the interests of income investors, the riskier names are the ones carrying higher yields. Piquard pointed to the banks that have significant exposure outside of Canada, specifically in the U.S. The Republicans and Democrats being unable to work out a stimulus package won’t benefit the cause of TD or Bank of Montreal, he said.
“The way things are looking now, it could be banks who have less of an international exposure could do better given that Canada has weathered the storm a bit better and you noticed it with (Bank of Nova Scotia) earnings that were a bit weaker,” Piquard said.
Indeed, Scotiabank was the only member of the Big Six that failed to beat analyst expectations. it was also the only party that raised its loan loss provisions from $1.8 billion to $2.1 billion. Morningstar analyst Eric Compton said Scotiabank’s exposure outside of Canada, particularly in Latin America could stunt its recovery in comparison to the rest of the sector.
“I’d rather be in the camp where you need to count on Canada to get through COVID-19 as opposed to Canada plus Mexico, plus other parts of Latin America,” Compton said. “When you have to count on five different countries to get through, it could be a little more difficult and the risks would be higher.”
As for the other banks, Compton also doesn’t expect the record capital markets revenue to be sustainable and so the fourth quarter for these banks will rely on other portions of their businesses recovering and offsetting the difference.
The best opportunity to invest in these would’ve been when they bottomed out in late March, he said. There’s less upside with names like RBC and National Bank, which are less than 10 per cent away from reaching their pre-pandemic highs. That doesn’t mean they’re bad investments, it means that outperformance will be harder to come by. It also has a positive connotation.
“Part of the reason they’re higher priced is it seems some of the risks are evaporating,” Compton said.
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