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Canadian bank headquarters stand on Bay Street in Toronto on Monday August 29, 2011.Brent Lewin/Bloomberg

For some Canadian banks, the strong job gains reported by the U.S. Labour Department on Friday are pure joy.

More jobs suggest a stronger U.S. economy and more borrowers, but they also point the way toward higher interest rates – and that's a potential boon to Toronto-Dominion Bank, Royal Bank of Canada and Bank of Montreal because of their large and growing U.S. operations.

The Labour Department said that U.S. employers added 242,000 workers in February, which is higher than expected. The department also bumped up the gains for the previous two months by 30,000.

The improvements come at a time when many observers have been doubting the strength of the U.S. economy. They appear to justify the Federal Reserve's rate hike in December and increase the likelihood of further rate hikes later this year.

"As far as the Fed is concerned, it is already seeing a clear acceleration in core price inflation, so it can't delay raising interest rates for much longer. A June rate hike is coming," Paul Ashworth, chief U.S. economist at Capital Economics, said in a note.

That's a big relief to banks. Earlier this year, they were weighing the possibility of rate cuts, perhaps pushing them into negative territory.

Banks make a lot of money by lending at higher rates than they pay on deposits, but net interest margins have been shrinking for some time. Ultralow U.S. interest rates – along with correspondingly low longer-term rates, defined by bond yields – have added to the challenge.

Higher rates should lead to better margins on loans, and therefore higher interest income and bank profitability, as long as long-term rates also rise to create a steep yield curve.

Bank for International Settlements (BIS), the Switzerland-based financial organization that counts 60 central banks among its members, came to this conclusion in a working paper published in October.

Although higher rates can force banks into setting aside more money to cover bad loans, because of higher debt-servicing costs, the upside overwhelms the downside.

"Under quite general conditions, there are good reasons to believe that both the level of interest rates and the slope of the yield curve are associated with higher net interest income," BIS said in its paper. "This relationship is likely to be especially strong at very low levels of nominal interest rates and to fade as interest rates move higher."

This offers one explanation for why U.S. banks enjoyed a four-day rally of nearly 9 per cent last week amid upbeat U.S. economic data, punctuated by Friday's payrolls report.

Among Canada's big banks, TD, RBC and BMO also look well-positioned.

After RBC completed its $5-billion (U.S.) acquisition of Los Angeles-based City National Bank in November, it pointed to the prospect of higher U.S. interest rates as one attractive feature in the deal. RBC believes City National will benefit from higher rates because the bank's high level of deposits can be put to work in terms of additional loans.

"The synergies, the organic synergies, are very significant, and on top of that we have very high leverage to increasing rates in the U.S.," Dave McKay, RBC's chief executive officer, said in January at the RBC Capital Markets Canadian Bank CEO Conference.

For TD, the benefits flow from its existing U.S. retail banking operations on the Eastern Seaboard. These operations are also rich in deposits, but relatively light on loans: Net interest income rose just 3.7 per cent in 2015, in U.S.-dollar terms.

For BMO, which operates BMO Harris Bank in the U.S. Midwest, net interest income from its U.S. operations actually fell slightly in 2015, year over year.

"Certainly [higher U.S. interest rates] will be helpful given the way our balance sheet is positioned," Bharat Masrani, TD's CEO said at the RBC Capital Markets Conference.

"But as usual, when we talk about rate increases, it's good to have them for the right reasons. It's good to have them in an orderly fashion. If rates kind of spike up because of bad reasons, that is not friendly either," he said.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 28/03/24 3:23pm EDT.

SymbolName% changeLast
BMO-N
Bank of Montreal
+1.35%97.68
BMO-T
Bank of Montreal
+1.13%132.25
BNS-T
Bank of Nova Scotia
+0.94%70.07
CM-T
Canadian Imperial Bank of Commerce
+1.13%68.67
RY-N
Royal Bank of Canada
+0.48%100.88
RY-T
Royal Bank of Canada
+0.29%136.62
SEB-A
Seaboard Corp
+1.09%3223.92
TD-T
Toronto-Dominion Bank
-0.63%81.75
Y-T
Yellow Pages Ltd
-0.3%9.86

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