Photo: The Canadian Press
Canadian banks will give a glimpse of where they see the economy going when they start reporting quarterly earnings this week.
Analysts will be watching for trends in key indicators such as loan growth, capital raising and how much banks are setting aside in case loans go sour.
The results for the period ending July 31 come at a time when decades-high inflation has pushed central banks to raise interest rates, including the Bank of Canada’s one percentage point hike in July, the highest increase in more than 20 years.
Higher rates have pushed up mortgage lending costs and led to a pullback in the housing market, which is normally a big driver of bank loan growth.
The Canadian Real Estate Association said national home sales fell 5.3 percent in July from June and 29.3 percent from July 2021, which translated into less lending activity for banks.
“I expect slower loan growth given the rise in mortgage rates,” said James Shanahan, senior equity research analyst at Edward Jones.
Overall, however, Shanahan said he expects a pretty good quarter for banks, as higher interest rates also translate into higher loan margins, though he noted that with many locked-rate loans take some time to show in earnings, with commercial loans usually respond faster.
On the capital markets side, banks are expected to report a sharp drop in investment banking revenue as companies and investors become more cautious, but Shanahan said trading revenue could help cushion the impact despite market pressures.
“This has basically been driven by higher market volatility and so could be a source of strength.”
That’s the trend that played out when US banks reported, with the five largest US banks reporting a 50% drop in investment banking revenue, while revenue commercials were up 22%, he said.
Banks’ decisions on loan loss provisions will be another key area to watch as it shows what they see going forward for economic conditions and the performance of these loans.
Shanahan said that with the economy still at near full employment, he doesn’t expect any dramatic changes, but analysts expect banks to increase their reserves again after starting to reduce them over the past year.
National Bank analyst Gabriel Dechaine said in a note that he expects a “tempered” turnaround in the credit cycle, with all banks adding to loan provisions, with larger ones from Scotiabank and RBC , as they have released around 80% of the provisions they had accumulated. in the first months of the pandemic.
Provisions for credit losses are accounted for as expenses, so they have a material effect on bank earnings.
The latest crop of results comes as banking stocks have come under some pressure as part of broader economic uncertainty.
Scotiabank analyst Meny Grauman said in a note that the performance of bank stocks has reflected wide swings in the broader economic outlook.
The bank’s price-to-earnings ratio fell as economic concerns rose in the spring over the fallout from Russia’s invasion of Ukraine and China’s COVID-19 lockdowns, but it is now returning to a more balanced consensus of investors, he said.
“Investors seem to be pulling back from the cap and realizing that while rising rates will hurt economic growth by design, the result is not necessarily a deep and prolonged recession,” Grauman said.
“At current valuation levels, the market appears to be in a mild recession with limited impact on credit performance, which is indeed our baseline scenario.”
Dechaine noted that Big Six bank shares are down about six percent year-to-date, underperforming the market by about 1.4 percent, which could be too much.
“At this point, we wonder if too much negativity has been reflected.”
He said that for banks to expect a better performance, although it depends on the outlook for rate hike activity.
“Market expectations need to shift to a more dovish stance from the Bank of Canada, which would deflate concerns related to the housing market (a primary sector glut). We’re not there yet, but we could be close.”
Scotiabank begins reporting on Tuesday, followed by RBC and National Bank on Wednesday, CIBC and TD Bank on Thursday and Bank of Montreal on August 30.