Hello and welcome to the Download. I'm your host, Dave Richardson, and it is a very, very special Stu’s days broadcast today, because it's my daughter Sarah's birthday, December 12. I believe she gets particularly excited when her birthday falls on a Stu’s days. I think you get deals at some of the chicken places. Like the Stoonie Stu’s days. It's pretty exciting, if you're into chicken. My daughter likes her chicken. She doesn't eat much else. She eats like a 10-year-old, even though she's 17 now. I'm hoping she comes around.

So do I. I have a very narrow palate. I love chicken nuggets. I'm right beside her.

You have a narrow palate. I would have thought you'd be pretty sophisticated.

No, I got the palate of a six-year-old boy.

Really? You don't like spice?

Not big on spice. Down the middle of the fairway. Peanut butter and jam, type of thing. I'm very happy.

Really. So what did your mom used to cook you when you were a kid? Did she have a fairly limited menu? Or your dad, or whoever was cooking?

Well, it was mom. But then the other thing, I had to make dinner once a week from a very young age, and I used to make chicken with seasoned salt. That was a good one. With rice or potatoes, that type of thing.

Wow. Maybe we get everyone who listens to the podcast together and we'll do a «Stu cooks» dinner for the listeners.

My recipe book is just a handful of pages.

It'd be pretty narrow. Well, speaking of bland, we've got a nice bland discussion lined up for the listeners today. Maybe this is fitting that you've got the narrow diet, because one of your favorite things are banks. And banks are bland. Well, they are more exciting than they used to be, but they're still run of the mill. Interest rates go up and down, economy gets better or worse, you make more money or make less money, and stocks float around at a pretty reasonable valuation, pay some dividends. It's kind of a dull world.

Yeah, and grow their dividends.

Grow the dividends. Got to remember that one. Pay and grow. So, Stu, maybe we'll start with the Canadian banks, because they just went through a round of earnings and it's their year-end earnings. So we can look back at the year that was. And I know every bank is different, so we'll try and just generalize the Canadian banks as much as anything. And then did they say anything, or did they make any announcement that give us any clues about what 2024 is going to look like in the Canadian economy or in the banking industry across Canada?

A couple of things on that front. Some banks had good quarters; some are a little bit more challenging. I think overall, the message was— and we'll talk in a second about the regulator— capital ratios were pretty reasonable, earnings not too bad. As I said, better at some. Probably the one big thing this year was the way that the accounting works for banks on their provisions for credit. And this is different than past cycles. The banks have to estimate how much credit losses they will have in the next twelve months, and they have to put that aside before the losses take place. They give you these scenarios, they give you a base case, a pessimistic case, and they apply weights to them. Through this year, the banks have been putting what they call performing credit reserves through their income statements. The loans are still performing, but they've made their pessimistic case a little worse, or changed some of the probabilities, and they've put reserves against it. And that's different than the past because a lot of people say, well, I'm going to buy the banks when we have this big spike in credit, and that's not as likely to happen this time. It's not to say we are seeing some deterioration, not so much in mortgage delinquencies, but credit cards, personal lending, things like this starting to pick up a little bit. But as the year progresses, you might take a reserve on a nonperforming loan, but release a reserve on a performing loan because you were there in advance. So credit was a headwind this year and it will probably be a modest headwind next year, but the accounting is a little bit different. So that came through pretty clearly. I would say most of the banks are getting ready for a modest recession that might see unemployment tick a little higher, house prices tick a little lower. They're preparing for that in advance. A lot of focus on efficiency and retooling the business. When we look forward, not that we're super forward looking, but we're already looking at what 2025 earnings might look like; forget 2024. And when you look at the banks in 2025, they will in all likelihood be through some of the worst of the provisions for credit. And they're starting to look more interesting, for sure. And they've rallied in response to that. And we've talked in the past about how those rallies can be violent. But dividends are good. We're going to see modest dividend growth for a period of time. And then that should improve when things get better. I think they all laid out their mortgage books about higher payments that are coming the way for many, and how they expect that to roll out. And again, I wouldn't say there was anything incrementally concerning on that front. It's not to say it's not going to be a challenge, but nothing incrementally concerning. And then the regulator came out last Friday and the banks all have what they call Tier one capital ratios, and all the banks are north of 12%, and the regulator has set the minimum at 11.5%. There was some question about whether or not the regulator would bump that up to 12%. But they've come out and left it at 11.5% and said, we've looked at the banks, we've looked at under different scenarios— the regulators get to see more than investors do, of course— and they left that capital ratio at 11.5% and thought that the banks were well positioned and well capitalized.

Stu, let me lay out a couple of scenarios around interest rates and then maybe talk through whether this accelerates or pulls forward dramatically the view of banks and bank stocks, or pushes back. So the general consensus is that the central banks— Federal Reserve, Bank of Canada— start lowering rates in the middle of next year. We talked to Eric Lascelles about last week’s jobs report, with the first somewhat positive economic news that had come out in several weeks. But most of the reports are surprises to the downside. Inflation out again today in the US, kind of ticking down the way we'd like to see it happening. Oil prices have stayed pretty well anchored. But I was reading some articles yesterday, and one article I was reading went, well, we don't want to repeat the mistakes of the 1970s, so the Federal Reserve is going to be really careful before they lower rates. Let's say instead of lowering in the middle of the year, they lower out in the fall of next year. And how do you think the banks would react to that relative to expectations, or would it have no impact at all?

It would and it wouldn't. A couple of things on that front. First off, the bond markets are trying to get in front of that, too, to some degree. Short-term interest rates have yet to come down from the central banks. But farther out the yield curve, they've moved down a little bit. The idea that they might head lower does a couple of things. First, if you're worried about provisions for credit, when interest rates are lower, there's a greater likelihood that provisions for credit won't be as high. There's just not the same pinch point on credit. The second question is: when will they come down and what will unemployment look like? Because that's the source of provisions for credit. That's the second thing you look at. And then the third thing is net interest margin and loan growth, the underpinnings of their business over time. With interest rates today, if you're a bank with a big deposit base— deposits that people use for everyday life—, if interest rates start to come down, that might impact their net interest margin a little bit. If you're a bank that's been paying a lot for deposits, it might be a small benefit. And then, of course, the last part is that there's still lots of securities on these bank balance sheets that are at lower rates than what we see today. So as they mature, even if rates are a little bit lower, they get an uptick in what they invested at. So we have to mix that all together. I would say a flat interest rate environment from here even is a modest positive for all the banks because they've come down. Maybe the economy won't fall the same way that people were worried about. And there's pros and cons inside of the balance sheets that they can work through. You know, I think all the banks would take that environment.

What about the other side of the argument? That the Fed and Bank of Canada are going to have to move even faster? It may even be as early as March that they start lowering rates. Would that dramatically or more quickly change the outlook on banks?

It's not just banks; it's the market as a whole. If they have to lower faster, is that because the economy drops more than they thought? That's a very delicate thing for any central banker, because if you tell the market that you're data dependent, then you need to see some weak data to justify cutting. But by the time you see weak data, that probably means there's more weak data behind it. Again, that's a bit of a plus and minus. I still think, for banks, particularly in Canada, if rates were going to come down faster, that would relieve some of the pressure on the chunk of your income that's going to pay your interest.

And certainly relieve some of the pressure or potential pressure on the housing market.

Exactly. It would change the affordability calculations, those types of things.

Any particular difference in the way that you're looking at US banks versus Canadian banks right now? I sometimes forget, because we've known each other so long, that you've got the north American mandate. By the way, we should say it, Stu Kedwell is the co-head of north American equities at RBC Global Asset Management. I sometimes forget to give your official title. For all the new listeners who are joining us, this is a very smart and powerful man that I get to talk to every week. Looking on both sides of the border, is there any difference with where the US banks are relative to Canadian banks right now that's interesting?

Well, the first thing that's interesting is a Canadian bank has lots of different businesses. They're what you call a universal bank. And inside of a universal bank, there's some businesses that are firing in all cylinders, others that are a little bit sluggish. Inside the US, you can go find a great business that does just that one thing. You know, when you go to the US, you have a bit more choice. I would say, generally speaking, even on the universal banking front, the amount of pressure on the US consumer versus the Canadian consumer— we've talked about the delay in feeling higher mortgage rates, things like this— so US banks get a bit of a nod on the exposure to their main customer. So that's a bit of a positive. The second thing is, as interest rates come down, there have been other banks in the US that have been more pressured by losses in their security portfolio or not having the same NIM (net interest margin) expansion. As you know, there are banks that benefit from that. Capital markets activity, in all likelihood, will be the first business that really starts to increase at some point here. So you can find banks that are very focused on capital markets activity. So I would say in the portfolio, on a north American basis, we're probably finding a little bit more interesting things to do in the US than Canada at this juncture. But there's still benefits on both sides, interest on both sides.

And dividends everywhere. Which I know you like. So, Stu, just one more question. It's a lighter question. You work for a bank, but do you consider yourself a banker?

Yeah, I guess I do. I'm a royal banker.

There you go. You certainly know how they work. One of the things that I always take away and enjoy whenever we talk about banks, and I hope the listeners enjoy as well, you do have a keen knowledge of how the banks operate and what are all the different levers that move the value of those stocks and their earnings. So it is always fun. I know you're sometimes reluctant, but it's always fun talking to you about what's going on inside the banks because you really do know how the sausage is made, so to speak.

Well, thanks very much, Dave. I don't know, maybe you'll have sausage for the birthday dinner. A chicken sausage, maybe?

I think my daughter's thinking more rotisserie chicken, with the lovely sauce. But anyway, Stu, thanks as always. We'll catch up with you next week.

Thanks, Dave.