Banks prepare for economic turbulence after mixed annual results

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Canada’s major banks wrapped up their fiscal year on an uneasy note, with a boost to profit margins from rising interest rates offset by inflated costs and gradual increases in loan losses as customers start to feel the strain from higher borrowing costs.

Five of the six largest lenders reported fiscal fourth-quarter profits that were flat or lower than a year ago, and three of them – Bank of Montreal, BMO-T Canadian Imperial Bank of Commerce CM-T and National Bank of Canada NA-T – fell short of analysts’ earnings estimates.

The outlier was Toronto-Dominion Bank, TD-N a lender that is rich in deposits and posted large increases in the margins it earned on loans – the difference between what it charges borrowers and pays on deposits. That helped drive retail banking revenues higher.

In the 2023 fiscal year, banks are expecting to be dealt a tougher economic hand. Several bank CEOs cited factors such as high inflation, forecasts of slowing economic growth, geopolitical tensions and continuing pressure on sectors like manufacturing as reasons why demand for new loans could slow. That has caused investors and banking analysts to put an intense spotlight on lending margins, which are the primary tailwind for banks when interest rates spike, and to zero in on banks’ ability to control spending.

“The economists’ view when we scan the market has turned a little bit more negative and a little bit more uncertain,” said Hratch Panossian, CIBC’s chief financial officer, in an interview. “Our base case doesn’t necessarily assume a recession in Canada, but certainly a slowdown of growth.”

CIBC reported fourth-quarter earnings on Thursday that were relatively weak when compared with its rivals, underscoring the mounting pressures banks are facing. Profit fell 18 per cent year over year as the bank set aside $436-million in provisions for credit losses – the money banks earmark to cover loans that may go bad. A 10-per-cent rise in costs outpaced increases in revenue, as the bank made investments in its operations that chief executive officer Victor Dodig said were essential.

Now, CIBC is pivoting, Mr. Dodig told analysts, reining in spending to strike a better balance between revenues and costs. “This quarter doesn’t really reflect the earnings power of the bank,” he said.

In the fourth quarter, CIBC earned $1.19-billion, or $1.26 a share, compared with $1.44-billion, or $1.54 a share, a year earlier. CIBC said it earned $1.39 a share on an adjusted basis, falling far short of analysts’ estimate of $1.72 a share, according to Refinitiv.

CIBC’s share price fell 7.7 per cent to $59.81 on the Toronto Stock Exchange on Thursday.

The challenges facing CIBC were common themes across the sector in the fourth quarter. All six banks reported loan-loss provisions that were substantially higher than a year ago, though still below prepandemic levels.

BMO’s adjusted profit slipped 4 per cent, weighed down by higher costs and loan-loss provisions. Loan margins in the bank’s Canadian retail division contracted when compared with the previous quarter, but its U.S. margins showed strong improvement. BMO expects to reap further benefits from rising interest rates over the coming year, but at a more moderate pace.

“There is a good amount of momentum in our net interest income, which is the largest portion of our revenues,” said Tayfun Tuzun, BMO’s chief financial officer, in an interview. And that “should bode very well for banks despite some normalization in provisions.”

Loans to commercial customers were a bright spot for BMO, rising 18 per cent in Canada in the fourth quarter, and for several of its competitors. But those rapid rates of growth are expected to come down in line with a slowing economy.

“Spending time with our clients, there’s still optimism, there’s still lots of good things going on out there, but there’s definitely a little bit less optimism than there was a year ago,” said Dave Casper, CEO of BMO’s U.S. operations.

BMO’s fourth-quarter earnings were inflated by a $3.37-billion gain from a hedging strategy tied to its pending $17.1-billion acquisition of California-based Bank of the West. BMO earned $4.48-billion, or $6.51 a share, compared with $2.16-billion, or $3.23 a share, a year earlier.

Excluding those items, BMO said it earned $2.14-billion, or $3.04 a share, whereas analysts expected $3.11 a share.

Mortgage lending, which was a major source of strength for banks over the last year, is also being squeezed as housing markets cool and competition for customers gets “really intense,” said Laura Dottori-Attanasio, CIBC’s head of personal and small business banking. Margins on mortgages for new customers are under “more pressure than we’ve ever seen before.”

Even as central banks signal they intend to continue raising interest rates to fight inflation, a slowdown in mortgages – which make up a large chunk of banks’ loan books – could have a noticeable impact.

“If rates continue to rise then you would expect that to be helping margins,” said Kelvin Tran, TD’s chief financial officer, in an interview. “But that also depends on the competitiveness of the loan pricing.”

TD earned $6.67-billion in the fourth quarter, or $3.62 a share – profits that were boosted in part by a $2.3-billion gain on an interest-rate hedging strategy tied to its US$13.4-billion acquisition of First Horizon Corp.

After adjusting for special items, TD said it earned $4.07-billion, or $2.18 a share. On average, analysts expected adjusted earnings a share of $2.07.

BMO, TD and Royal Bank of Canada, which announced a $13.5-billion agreement on Tuesday to buy HSBC Bank Canada from its British-based parent HSBC Holdings PLC, all stand to benefit when large, pending acquisitions close. But BMO and TD both bumped back their estimated closing times by up to three months on Thursday, and RBC expects to wait at least a year for approvals.