Record earnings at Canadian banks no match for US tax cuts

Bloomberg

Canadian banks are scoring back-to-back record earnings, beating big US lenders on profitability, productivity and dividend yields. They still can’t outperform US banks on the stock market.
Toronto-Dominion Bank, Royal Bank of Canada and the nation’s other six large lenders collectively boosted profit 10 percent to a record $8.9 billion in the fiscal third quarter. Still, that’s no match for a US economy seen having more runway than Canada’s, thanks in part to Donald Trump’s tax cuts.
Canada’s S&P/TSX Commercial Banks Index has gained 13 percent in the past 12 months, lagging the 21 percent increase of the US KBW Bank Index.
“Canadian banks are run well and everything, but where they’re sitting in our view is not as attractive as where our US banks are in terms of opportunity,” said Tony Scherrer, director of research and portfolio manager with Seattle-based Smead Capital Management.
US banks are well positioned for a lending revival fuelled by a strong US economy and a Millennial generation approaching their homebuying years — an emerging opportunity as lending in Canada slows, Scherrer said. “They’re ripe and ready and able to lend, but we’re in the very early innings of seeing those animal spirits kick in.”

Nafta Uncertainty
US banks — and even some Canadian ones with US operations — are also getting a boost from US tax cuts signed into law in December. The lower tax rates are expected to fuel annual profit gains at Wall Street’s biggest banks by more than $10 billion. Lower tax rates helped the six giant US banks — JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley — churn out more than $29 billion in net income in each of this year’s first two quarters.
Canadian bank executives cite economic reasons for the disconnect. The US economy is expected to expand 2.9 percent this year and 2.5 percent next year, outpacing forecasts of 2 percent for Canada this year and 1.9 percent in 2019, according to economists.
Uncertainty surrounding the renegotiation of the North American Free Trade Agreement may be weighing on Canadian stocks, along with lingering fears about the country’s housing market and overindebted consumers, Canadian Imperial Bank of Commerce Chief Financial Officer Kevin Glass said.
“I think all of those things would weigh on Canadian stocks relative to US stocks,” Glass said. US investors, who learned hard lessons a decade ago during the US subprime debacle and financial crisis, may be spooked by the rapid growth of mortgages and loans at Canadian banks that fuelled overheated housing markets and contributed to near record levels of household debt, according to Edward Jones & Co. analyst Jim Shanahan.
“Although the banks continue to put up these amazing numbers, the stocks never really get away from us because of just broader concerns in the market,” Shanahan said. “There’s an undercurrent of fear in the US as it relates to dramatic growth in residential real estate lending, because we lived through it and it was horrible.”
Still, it’s hard to ignore the superiority of the Canadian banks on measures such as return on equity and profit margins. In these areas, Canadian lenders including Bank of Nova Scotia, Bank of Montreal and CIBC are clear winners.
Canadian bank shares are more expensive than those of US lenders, having fetched a premium over US lenders for a dozen years. The Canadian banks index is trading at about 2.4 times tangible book value per share versus 2.0 times for the KBW Index of US lenders.