QUESTION OF THE WEEK

First off I’ll state that yes, the banks did report their fiscal Q2 earnings (Feb-Apr) at the end of May and for the most part the quarter was uneventful as the results were reasonably in line with expectations. We saw similar patterns amongst the big six banks as retail banking results improved year-over-year, but fell short quarter-over-quarter. Most net interest margins fell, loan loss provisions were relatively in check, and capital levels were solid. We thought that the banks had an opportunity in their wealth management and capital markets businesses to capitalize on strong equity returns during the quarter and it was evident through the results that some banks had done just that, while others struggled. With that overview done, I think it’s also worthwhile reminding investors that bank CEOs have been trying to lower earnings growth expectations for some time now and analyst estimates are now reflecting this tone as all of the big six are forecast to have earnings growth in the single digit range in fiscal 2013 (fiscal year end is October 31). So, should investors expect a surge in earnings growth to push the banking sector higher? No, but at the same time the banks have not entered a period of earnings contraction, so we don’t believe investors should panic and sell due to the declines we’ve seen in the bank share prices since the end of last May. The most common concern that we hear about the banks is personal lending and the housing market. Don’t Canadians have too much debt? When interest rates move higher in Canada won’t housing prices fall and people will find it more difficult to pay their mortgage? Shouldn’t we sell now to pre-empt this activity from hurting future earnings? We won’t deny that Canadians have increased their borrowing and it’s very likely that housing prices could decline when interest rates appreciate. However, let’s also not forget that banks can make money with higher interest rates as well and that recent statistics are suggesting that Canadians are no longer expanding their personal balance sheets. Yes, it will be difficult for banks to grow revenues considerably during the remainder of 2013, but they still have the potential to grow earnings and make a lot of money. In addition, banks have been very active in returning value to shareholders through share buybacks and dividend increases. Therefore, we remain comfortable with investors owning Canadian banks, even though share price returns may not be as strong as we’ve seen in recent years.

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^{Source: Richardson GMP Limited}