TD, RBC second-quarter profit bump helped by rising rates, macro environment

Two of Canada's biggest banks reported second-quarter earnings Thursday that benefited from bigger profit margins on the back of rising interest rates, though the bump could be less pronounced in coming quarters as pressure mounts for banks to raise the interest rates they pay on deposits.

Toronto-Dominion Bank and Royal Bank of Canada handily beat analysts expectations with double-digit growth in the quarter ended Apr. 30, helped by a strong economy and growing net interest margins or the profit made on loans as interest rates rose on both sides of the border.

TD reported a bigger quarterly bump of the two, with net income attributable to common shareholders of $2.85 billion for the quarter, up 17 per cent from a year earlier, while RBC reported a nine per cent increase to $2.98 billion.

On an adjusted basis, TD and RBC earned $1.62 and $2.10 per diluted share for the period, respectively, beating analyst expectations of $1.50 and $2.05, according to Thomson Reuters Eikon.

TD's chief executive Bharat Masrani said it was "another terrific quarter" for the bank, with all its businesses on both sides of the border performing well.

"Canadian retail had a banner quarter... We benefited from our number one share in core deposits, with rising rates driving further margin expansion," Masrani told analysts on a call discussing its results Thursday.

Both TD and RBC saw increases in net interest margins, the difference between the money they earn on loans they make and interest they pay out to savers, in both their Canadian and U.S. businesses, said Shannon Stemm, an analyst with Edward Jones in St. Louis.

The Bank of Canada has raised its trend-setting interest rate once this year and is expected to do so at least once more before the end of 2018.

A rising rate environment is helpful for the banks at the beginning of a cycle, but lenders won't be able to get away with not passing on those benefits to depositors as rates continue to climb, she said. It's a dynamic that is already underway in the U.S., but not quite yet north of the border, she added.

"After a given amount of time, as rates are going up, they have to start increasing deposit rates too," Stemm said in an interview. "And so, that squeezes that margin that was falling to the bottom line."

Year-over-year increases in net interest margins (NIM) for both banks' Canadian divisions helped fuel their big profit beats. TD's Canadian retail division's NIM was 2.91 per cent, up from 2.81 from a year ago, while RBC's Canadian personal and commercial banking division had a NIM of 2.79 per cent, up from 2.67 per cent a year earlier.

"One of the benefits has been that deposit rates have not risen as quickly as loan rates," John Mackerey, vice-president, global financial institutions group at DBRS in New York.

"So that's certainly helped with the margin expansion."

Cooling housing market

In turn, both banks saw strong earnings at home as mortgage growth remained steady despite a cooling housing market in the wake of tighter regulations for uninsured mortgages introduced at the beginning of the year.

TD's Canadian retail division net income was $1.83 billion, up 17 per cent compared with last year. RBC's Canadian personal and small business banking division reported a seven per cent increase in net income to $1.46 billion.

TD had $269 billion in its Canadian real estate secured lending portfolio at the end of the latest quarter, up five per cent from $256 billion a year earlier. RBC, meanwhile, had $258 billion in uninsured and insured residential mortgages across Canada at the end of the quarter, up 5.1 per cent from a year earlier.

Rod Bolger, RBC's chief financial officer, said the bank expects mortgage growth to remain in the mid-single digit range for the full year.

"And even if mortgage growth slows more than expected, the overall NIM benefit from rate hikes more than offsets the revenue impact from slower growth," he told analysts on a conference call Thursday.

"For example, if mortgage balances grow at half our expected rate, the impact on 2019 revenue would be less than the benefit we received from one Bank of Canada rate hike."