Surging loan losses and dwindling capital reserves will be in investors’ crosshairs when Canada’s big banks report earnings next week, capping off the most tumultuous quarter in years.
Upheaval and uncertainty caused by the pandemic make it especially hard to forecast banks’ financial results, and analysts’ estimates for the second fiscal quarter vary widely. But they agree on one thing: There will be a massive build-up of provisions for credit losses – the funds banks set aside to cover loans expected to go bad – that will eat into profits as well as the capital cushions banks have built up over the past decade.
For the three months ended April 30, provisions at Canada’s largest banks could be five times higher than in the previous quarter, reaching $11.9-billion, or 1.98 per cent of all loans, up from 0.37 per cent, according to RBC Dominion Securities Inc. analyst Darko Mihelic. In that scenario, earnings per share would fall 82 per cent on average from a year ago, and some banks would be hit even harder.
“In our opinion [the second quarter] will be a pivotal quarter," Mr. Mihelic said.
Bank of Nova Scotia and National Bank of Canada will be the first to release results, on May 26, and all eight of the country’s largest banks will report by May 29. The Big Six are expected to maintain their dividends, even after major lenders around the world have suspended payouts, but dividend increases and share buybacks are on hold.
One key question is how cautiously banks will forecast the financial carnage from the pandemic. Most of the provisions booked this quarter are likely to be estimates of future losses, with only a modest uptick in loans that are already delinquent. That’s because a wave of government relief programs have offset or delayed some of the impact on businesses and consumers, and banks have deferred payments on hundreds of thousands of loans.
Those payments will eventually be due, however, and there are already glimpses of what may be in store. In April, the largest U.S. banks reported first-quarter earnings, up to March 31, earmarking US$24-billion in provisions for credit losses, an increase of roughly 350 per cent year over year. And Toronto-Dominion Bank announced early that it will take $1.1-billion in loan loss provisions for its U.S. retail banking arm, up 487 per cent from a year earlier.
Some banks may be eager to take their lumps now. “We believe there are tactical reasons for banks to make provisions as conservative as they can," said Gabriel Dechaine, an analyst at National Bank Financial Inc., in a research note.
Mr. Dechaine expects provisions for credit losses will rise to an average of 1.09 per cent of total loans in the second quarter and that earnings per share will fall 42 per cent year over year. And John Aiken of Barclays Capital Canada Inc. expects provisions of 1.2 per cent of all loans and 1.5 per cent for the Big Six lenders. Yet each analyst has a wide margin for error.
“It is practically impossible to handicap the extent of credit losses,” said Ebrahim Poonawala, an analyst at Bank of America Corp.
A spike in loan loss provisions will eat into the reserves banks rely on to keep lending through a downturn. Canadian banks’ common equity Tier 1 ratios – a key measure of a bank’s resilience – are expected to fall but remain above 11 per cent on average this quarter. That’s well above the 9-per-cent regulatory minimum.
Yet analysts will adjust those ratios lower to account for the leeway regulators have given banks during the crisis, including favourable treatment for loans with deferred payments. True ratios could be lower, averaging 10.9 per cent and as low as 10.6 per cent at Bank of Montreal, Mr. Mihelic said, and will likely decline further for the next four quarters.
By most projections, Canada’s major banks have enough capital to absorb losses through the crisis, but capital levels this quarter may provide clues about which banks are most at risk of needing to issue equity to bolster reserves.
Banks are also expected to show slower growth in lending and tighter margins, after the Bank of Canada slashed its benchmark interest rate by 150 basis points. But profits from capital markets could be a rare bright spot, driven by strong trading revenue amid volatile stock markets and soaring fees from underwriting new bond deals.
“We anticipate [the second quarter] will only show the initial impact, and more pervasive effects are still yet to come," Mr. Aiken said.
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