The Big Six: Part One

By David Dittman • March 5, 2012 • Canadian Edge Weekly

Four of Canada’s Big Six banks reported fiscal 2012 first-quarter earnings last week.

Two of them, Royal Bank of Canada (TSX: RY, NYSE: RY) and Toronto-Dominion Bank (TSX: TD, NYSE: TD), raised their dividends as they revealed results for the three months ended Jan. 31, 2012. Strong performance from traditional banking operations at home provided the foundation for both payout moves.

National Bank of Canada (TSX: NA, OTC: NTIOF) beat expectations but held the line on its dividend after boosting its quarterly payout three times a total of 21 percent since August 2010. Canada’s sixth-largest bank, which operates primarily in Quebec, now pays CAD0.75 per share per quarter.

Bank of Montreal (TSX: BMO, NYSE: BMO) also beat expectations, as its July 2011 acquisition of Chicago-based Marshall & Ilsley drove a 34 percent increase in reported net income. The quality of BMO’s beat is questionable, built as it was on a conspicuously large reduction in provisions for credit losses (PCL), both sequentially and year over year.

Bank of Nova Scotia (TSX: BNS, NYSE: BNS) and Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) will report Wednesday and Friday, respectively; we’ll have an update in the March Canadian Edge, which will be published Mar. 9.

Royal Bank of Canada (RBC), No. 1 among the Big Six in terms of assets, announced a 5.5 percent dividend increase to CAD0.57 per share per quarter along with its fiscal first-quarter numbers. That’s the second increase in less than a year for RBC.

RBC reported net income of CAD1.855 billion, while net income from continuing operations was CAD1.876 billion, up CAD267 million, or 17 percent sequentially. Net income from continuing operations was down CAD120 million, or 6 percent, on a year-over-year basis, though just 4 percent adjusted for items.

Canadian Banking net income grew 5 percent sequentially, or CAD46 million, to a record CAD994 million. Solid growth in home equity loans, personal and business deposits and business loans drove the quarterly gain. Year-over-year growth for the backbone of the bank was 7 percent, as strong volume trends across the business and better credit quality were offset by less favorable interest-rate spread and higher costs.

On a sequential basis PCL were down CAD9 million, or 3 percent, to CAD267 million on improvements in RBC’s Caribbean wholesale and retail portfolios. Compared to last year set-asides were basically flat; lower credit card provisions and Canadian Banking business-lending writeoffs were offset by higher PCL in Capital Markets.

Wealth Management net income was basically flat at CAD188 million on a sequential basis but down 25 percent, or 12 percent, on a year-over-year basis, because of lower transaction volume and higher costs.

Insurance net income was down CAD10 million, or 5 percent, to CAD190 million on higher claims costs and a “lower earnings impact” from a new UK annuity reinsurance contract. Net income was up 40 percent, or CAD54 million, compared to the three months ended Jan. 31, 2011, due primarily to net investment gains versus net losses a year ago, the new annuity contract and lower claims costs.

International Banking net income was CAD24 million, up CAD14 million from the prior quarter, primarily due to lower PCLs for its Caribbean banking unit partially offset by lower average client assets at RBC Dexia due to capital depreciation. On a year-over-year basis net income was off CAD44 million because of shrinking net interest margins and rising staffing costs.

Always volatile but critical Capital Markets net income was CAD448 million, up CAD294 million sequentially, on “significantly higher” fixed-income trading results in the US and Europe and solid growth for its loan origination and syndication businesses. Though the quarter-over-quarter comparison is helped by a CAD77 million loss related to a since wound-up “special purpose entity,” operating conditions improved as the quarter progressed.

Net income from this unit was down 30 percent compared to the three months ended Jan. 31, 2011, from what were record earnings that quarter that also included a one-time gain of CAD102 million.

As of Jan. 31, 2012, RBC’s Tier 1 capital ratio was 12.2 percent, down 100 basis points from a year ago because of the change in the regulatory capital treatment of insurance investments and the impact of Basel 2.5.

RBC basically exited the US retail banking market last year, orienting its growth strategy around global capital markets and weal management operations. But the 5.5 percent dividend increase is a reflection of strong bread-and-butter banking in Canada.

Toronto-Dominion (TD) management announced a dividend increase of CAD0.04 per share, or 5.9 percent, to CAD0.72 per quarter. It’s the third time since March 2011 TD has boosted its dividend, increases that total 18 percent.

Reported net income for the quarter was CAD1.478 billion, down CAD84 million, or 5 percent, from the three months ended Jan. 31, 2011. Adjusted net was CAD1.762 billion, up CAD145 million, or 9 percent, on higher earnings in all retail segments and a higher contribution from TD’s Corporate segment; these positives were partially offset by lower earnings in Wholesale Banking.

Reported PCL for the quarter were down 4 percent, or CAD17 million, to CAD404 million. Adjusted PCL for the quarter were CAD445 million, an increase of CAD24 million, or 6 percent, compared with the first quarter of fiscal 2011. Adjusted PCL include acquired portfolios from MBNA Canada and Chrysler Financial; increases were partially offset by lower organic PCL in Canadian Personal and Commercial Banking and US Personal and Commercial Banking.

Reported PCL increased CAD64 million, or 19 percent, on a sequential basis, while adjusted PCL were up CAD105 million, or 31 percent due to the acquisition of MBNA Canada acquisition and higher provisions on acquired credit-impaired loans in US Personal and Commercial Banking.

Canadian Personal and Commercial Banking posted unit-record net income of CAD826 million. Adjusted net CAD850 million, up 11 period from a year ago.

Net income for Wealth and Insurance was up 14 percent year over year to CAD294 million. Asset growth for the Wealth component boosted fee-based revenue, while organic growth and better claims management droved Insurance results. Lower trading revenue and “a severe weather-related event” offset those positives. TD Ameritrade posted CAD55 million, up 15 percent from a year ago.

TD’s US Personal and Commercial Banking unit was a highlight of the quarter, posting reported net income of USD165 million and adjusted net of USD345 million, 6 percent better than last year on both counts because of strong organic growth. Growth in loan volumes as well as deposits helped mitigate the impact of an increasingly complex regulatory framework south of the border.

Low interest rates in the US, likely to continue for at least the next two years in light of recent US Federal Reserve statements about monetary policy, also present challenges to TD and other Canadian banks with operations in America. But TD, like its counterparts, reports that credit quality for its US unit continues to improve, and it plans to open 35 new branches in calendar 2012.

TD’s Wholesale Banking unit generated earnings of CAD194 million, down 17 percent compared to the three months ended Jan. 31, 2011, because of weaker results from the investment portfolio. Management expressed confidence about the operation, which includes new equity and debt underwriting as well as mergers & acquisitions advisory services and is therefore highly sensitive to market activity, and its ability to weather any Europe-driven volatility.

As of Jan. 31, 2012, TD’s Tier 1 capital ratio was 11.6 percent.

TD’s growth plan is focused on the US, its strategy almost the direct opposite of RBC’s. But, like its bigger rival, TD’s ability to sustain and grow a dividend is rooted in Canadian banking.

National Bank of Canada, the smallest of the Big Six, reported record net income for its fiscal 2012 first quarter of CAD332 million, up 3 percent from CAD322 million a year ago. Like RBC and TD National Bank benefited from strong loan and deposit volume in its home market.

Net income for the Personal and Commercial segment, which is concentrated in Quebec, rose 9 percent to total CAD170 million for the quarter, driven by higher loan volumes. Like its bigger peers, National is experiencing tight net interest margins.

Wealth Management earnings were CAD33 million, down 31 percent from CAD48 million a year ago, impacted primarily by rising costs associated with acquisitions. National’s Financial Markets segment contributed net income of CAD129 million, up CAD15 million, or 13.2 percent, the first quarter of fiscal 2011. Higher fixed-income trading activity drove higher revenues during the period, while financial-market fee and banking-service income were flat.

At CAD45 million in the first quarter of 2012 the bank’s provisions for credit losses were CAD10 million lower on a sequential basis due to improvements in its credit card portfolio and business loans.

As of Jan. 31, 2012, National Bank had a Tier 1 capital ratio of 12.7 percent.

National was the first of the Big Six to boost its payout in the early aftermath of the Great Financial Crisis. In fact it’s grown its dividend by 21 percent since August 2010 and now pays an annualized rate of CAD3 per share.

Bank of Montreal (BMO) reported net income of CAD1.109 billion, though much of its headline-impressive 44 percent sequential and 34 percent year-over-year growth was based on the contribution from the July 2011 bolt-on of Chicago-based Marshall & Ilsley to its Midwest-focused US operations as well as the aforementioned and glaring decline in PCL.

BMO reduced provisions by 56 percent from CAD323 million in the year-ago quarter to CAD141 million, which contributed directly to the bottom line. Profit from US-based BMO Harris Bank, meanwhile, surged to CAD137 million from CAD54 million with Marshall & Ilsley’s contribution.

Whereas RBC, TD and National Bank reported solid domestic results, BMO’s Canadian Personal & Commercial profit fell 6.7 percent to CAD446 million, as volume growth was offset by declining margins. The decline was 1.2 percent on an adjusted basis that omits the impact of a securities transaction during the year-ago quarter. US P&C net income grew USD81 million to USD135 million year over year, while adjusted net was USD152 million, up USD93 million with a USD89 million contribution from Marshall & Ilsley. Adjusted net was off 19 percent sequentially due to lower net interest income, lower revenue and higher PCL.

Private Client Group net income was down CAD39 million, or 28 percent, to CAD105 million from a year ago, as the insurance aspect of the unit was adversely affected by interest rate movements. Results for the unit excluding insurance grew 27 percent, as higher revenues from acquisitions and higher fees were only partially offset by lower brokerage revenue.

Capital Markets net income shrank by CAD62 million, or 24 percent, to CAD198 million on a year-over-year basis, though earnings for the unit surged 39 percent sequentially. The first quarter of fiscal 2011 was a strong one for new equity issues and deal-making.

BMO’s overall net interest margin on average assets was 2.8 percent, down from 2.91 percent in the first quarter of fiscal 2011.

BMO’s outlook calls for gross domestic product (GDP) growth to slow to 2 percent from 2.3 percent in Canada but for the United States to lead a recovery for North America. Its presence in the relatively healthy US Midwest positions it well to benefit from this recovery, though the relatively weak performance of its Canadian operations stands in stark contrast to the other three Big Six banks to report so far.

RBC, at 14 percent, TD, at 18 percent, and National Bank, at 21 percent, lead the Big Six in post-GFC dividend growth. Bank of Nova Scotia has boosted its payout once since the normalization began, from CAD0.49 per share per quarter to CAD0.52 a year ago, when it announced fiscal 2011 first-quarter results. Canadian Imperial boosted its dividend for the first time post-GFC last summer, by 3.4 percent. We’ll know later this week whether BNS and CIBC will follow RBC, TD and National Bank.

Bank of Montreal, meanwhile, is the only one of Canada’s Big Six not to boost its distribution at least once in the last year and a half.

The Roundup

Results for 22 of 36 Canadian Edge Portfolio Holdings are in; you can review analysis of results for individual companies by clicking on links in the list below. Estimates and confirmed dates are included for those companies yet to report.

We’ll have a full review of the action thus far in the March CE, which will be published Friday afternoon, Mar. 9.

Conservative Holdings

Aggressive Holdings

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