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Bank buildings are photographed in Toronto's financial district on June 27, 2018.The Canadian Press

Bank of Nova Scotia and Bank of Montreal added a combined $3.2-billion more to reserves against future losses in the third quarter, bracing for the likelihood of a slower economic recovery as cases of the novel coronavirus spike in key markets abroad.

Both banks’ provisions for loan losses were higher than analysts anticipated, as they bulked up defences at the expense of current profits. Scotiabank’s earnings fell 34 per cent from a year ago after the bank set aside nearly $2.2-billion to cover loans that may go bad, while BMO’s $1.05-billion in new reserves helped drag total profit down 26 per cent.

Each lender also saw earnings from their bedrock retail banking divisions in Canada cut in half. But they were buoyed by robust returns from capital markets divisions riding a wave of trading activity and wealth management divisions that capitalized on resurgent stock markets.

Scotiabank and BMO were the first two major Canadian banks to report results for the fiscal quarter that ended July 31, sending mixed signals for the sector as BMO comfortably beat analysts’ profit estimates and Scotiabank fell short. Although executives at both banks said they see encouraging signs of recovery among consumers and businesses, the true health of their respective credit books is still obscured by payment deferrals granted on hundreds of thousands of loans, most of which are soon to expire.

Scotiabank profit drops 34% as loan-loss provisions near $2.2-billion

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Betting that the worst economic shocks from the pandemic are behind them, bankers said they are confident they have stockpiled ample capital and enough provisions to absorb losses. But they are also adjusting to rising probabilities of a prolonged, uneven return to prepandemic levels of growth.

“As we looked at how, when economies have opened up, we’ve seen some jurisdictions struggle with a spike up in [COVID-19] cases … we do think it’s a little more likely that it takes longer to fully recover than we thought three months ago,” Tom Flynn, BMO’s chief financial officer, said in an interview.

For the fiscal third quarter, Scotiabank earned profit of $1.3-billion, or $1.04 per share, compared with $1.98-billion, or $1.50, a year ago. On average, analysts expected earnings per share of $1.12, according to Refinitiv.

BMO reported profit of $1.23-billion, or $1.81 per share, compared with $1.58-billion, or $2.34 per share, in the same quarter last year. After adjusting for certain items, BMO said it earned $1.85 per share, well ahead of analysts’ consensus estimate of $1.66 per share.

Both banks kept their quarterly dividends unchanged, after the country’s banking regulator advised them not to raise payouts. And each raised their capital levels – Scotiabank’s common equity Tier 1 (CET1) ratio, an important measure of its ability to absorb losses and continue lending, rose to 11.3 per cent while the same ratio at BMO increased to 11.6 per cent – as corporate clients paid down large sums drawn on credit lines early in the pandemic.

The next great test for banks will be the looming expiry of payment deferrals on huge numbers of mortgages, credit cards, personal and business loans. In Canada, Scotiabank has 236,000 loans worth $41.5-billion on deferral, most of them mortgages, and a further 2,330 loans totalling $18.1-billion on pause abroad. BMO is still deferring more than 183,000 retail and commercial loans worth $29.4-billion in Canada, including 14 per cent of its mortgage portfolio, and a further 14,900 personal and commercial loans amounting to $1.7-billion in the United States.

Nearly all of those deferrals expire before October 31, and won’t be renewed, raising the risk of defaults. So far, at least 90 per cent of clients at both banks whose deferrals have already expired are making normal payments again, and Scotiabank chief risk officer Daniel Moore said he is “cautiously optimistic” that rate of recovery will continue. His counterpart at BMO, Pat Cronin, estimates that only 1 per cent to 5 per cent of deferred loans may become delinquent as grace periods expire.

Scotiabank and BMO were the two Canadian banks facing the lowest expectations heading into earnings season, in large part because of their respective reliance on Latin America and the U.S., where COVID-19 infection rates have stayed stubbornly high.

In Mexico, Peru, Chile and Colombia, where Scotiabank has concentrated its international ambitions, cases of COVID-19 surged later than in Canada, and that lagging effect was expected to drive the bank’s third-quarter provisions higher. Profit from international banking plunged 96 per cent year over year, to just $26-million, as provisions spiked and consumer activity slowed. But forecasts for economic growth in those countries are turning a corner, and the bank expects provisions will decline next quarter.

“We are at the high-water mark,” Mr. Moore said on a conference call. “We’re seeing the tide go out from here.”

BMO’s retail banking arm in the U.S. was more resilient as the most acute COVID-19 hot spots are outside the Midwestern states where the bank does most of its business, but profit still fell more than 28 per cent, to $263-million.

Domestic retail banking profits also plunged by more than 50 per cent at each bank, to $429-million at Scotiabank and $320-million at BMO, mostly because of higher provisions for credit losses. Lending margins tightened for the second straight quarter, under pressure from ultralow interest rates.

Yet both banks got a much needed boost from capital markets divisions that earned record profits, as volatile markets spurred a frenzy of client trading. Scotiabank’s global banking and markets division reported profit of $600-million, up 60 per cent, and BMO’s capital markets earnings climbed 36 per cent to $426-million. Resurgent markets also helped boost BMO’s wealth management profit 37 per cent higher, to $341-million.

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