Rising trade tensions and weakening growth in major economies loom large as Canadian banks prepare to report earnings for the fiscal third quarter.
Several analysts are predicting that earnings for each share among Canada’s six largest banks will increase by 6 per cent to 7 per cent year over year – a steady but unspectacular rate – for the three months that ended July 31.
But investors will be watching for signs of weakness in two key measures of the banks’ resilience in quarters to come: Provisions for credit losses, or the money banks set aside to cover bad loans, and net interest margin, which measures the spread between what banks pay on deposits and earn from loans. Both could be hampered by global trends such as tariffs and trade wars, U.S. interest-rate cuts and the inverted yield curve.
“We do not expect [third-quarter] results to resolve the conflict between the pessimism and optimism surrounding the macroeconomic environment,” said Robert Sedran, an analyst at CIBC World Markets Inc. “If anything, we expect this conflict to be on full display as we see growth that is neither as strong nor as easily achieved as that of the last couple of years.”
Royal Bank of Canada’s results could be a bellwether, as Canada’s largest bank by assets reports first, on Aug. 21. Canadian Imperial Bank of Commerce follows on Aug. 22, and the remaining four major lenders – Bank of Nova Scotia, Bank of Montreal, National Bank of Canada and Toronto-Dominion Bank – will release their results from Aug. 27 to 29.
Analysts expect as many as three of the Big Six banks to raise their quarterly dividends: RBC, Scotiabank and CIBC.
Here are two themes to watch.
Expected loan losses
Analysts are predicting a gradual uptick in provisions for credit losses in the third quarter. If they are correct, it will be a function of anticipated losses reverting to something near their historical average, after a prolonged period of unusually low losses.
The core consumer loan books that encompass debt from residential mortgages and credit cards still look healthy. Propped up by strong employment rates, delinquencies on personal loans “remain well below their historical averages,” said Rob Colangelo, a senior vice-president at ratings agency DBRS Ltd., in a research note.
But many analysts will be watching to see how much each bank sets aside to begin building reserves against the possibility that performing loans might soon turn sour. Predictions of expected losses are required under fairly new accounting rules known as IFRS 9, and heavily influenced by changing economic forecasts.
“We believe many investors would prefer to see banks slowly build [anticipated credit losses] for conservatism so late in the economic cycle," said Darko Mihelic, an analyst at RBC Dominion Securities Inc. “We believe the action [or inaction] of many banks in [the third quarter] will be watched carefully by investors."
Net interest margins
Banks got some reprieve last year from an extended period of rock-bottom interest rates that squeezed profit margins coming out of the global financial crisis, as central banks in the United States and Canada began gradually raising rates.
Now, the Bank of Canada appears to have put rate increases on hold and the U.S. Federal Reserve has cut rates to try to nip signs of a slowing economy in the bud. Meanwhile, bond yields are falling as investors seek safe haven amid trade disputes, putting pressure on banks’ lending margins – particularly for RBC, TD, BMO and CIBC, which all have substantial U.S. operations.
That, in turn, will make banks’ constant efforts to cut costs and become more efficient even more important to their overall profitability.
“We have flattened our net interest margin assumptions [and some pressure in the U.S. seems likely],” Mr. Sedran said, although that’s “hardly catastrophic."
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