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Profits for the Big Six totalled $14.6-billion in the banks’ fiscal fourth quarter, which ended Oct. 31, and were up sharply from low levels in 2020, rising anywhere from 20 per cent to 58 per cent.Fred Lum/the Globe and Mail

After passing mostly unscathed through nearly two years of upheavals and grinding uncertainty caused by COVID-19, Canada’s big banks are at last showing signs that the pandemic is taking a financial toll.

Fourth-quarter profits at three of Canada’s Big Six banks fell short of analysts’ estimates, while three others surpassed expectations in large part by reclaiming money from reserves they set aside against possible loan losses that never arrived. Overall, bank revenues also levelled off when compared with the previous quarter, as lending margins narrowed.

Make no mistake: The Big Six are still making lots of money. Profits totalled $14.6-billion in the banks’ fiscal fourth quarter, which ended Oct. 31, and were up sharply from low levels in 2020, rising anywhere from 20 per cent to 58 per cent.

But key sources of earnings that have propped up banks’ financial results through a difficult economic period, such as trading revenues from capital markets and fees from wealth management, were more modest this quarter. And growth in new loans, the core engine that drives banks’ earnings higher, is not yet back to its prepandemic pace, even as there are indications that demand from borrowers is starting to return.

“The earnings results for the group were reasonably solid but uninspiring,” John Aiken, an analyst at Barclays Capital Inc., said in an interview. “There’s nothing really disappointing or anything that would alter a generally positive outlook for 2022. But we’re still waiting to see that loan growth reignite.”

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Speaking to investors this week, bank executives cited two possible catalysts for earnings that give them added confidence about their prospects for 2022. But neither one is certain to arrive on schedule.

First, markets are anticipating that central banks in Canada and the U.S. will raise benchmark interest rates from current ultralow levels next year, which would fatten the thin margins banks are earning on loans. And consumers and businesses are still sitting on a huge amounts of deposits and savings they are eventually expected to spend or invest.

Yet the emergence of the Omicron variant of COVID-19, as well as persistent supply-chain problems and labour shortages, are clouding the chances of a swift economic recovery.

The pandemic’s continuing impact is most evident in the banks’ fourth-quarter revenues. Though they increased year over year, when compared with the fiscal third quarter, revenues were flat or lower at five of the six big banks – a 2-per-cent rise at Toronto-Dominion Bank was the lone exception.

For senior bankers, “it’s now going to be the real grind,” Ebrahim Poonawala, an analyst at Bank of America Securities, said in an interview. “Execution will matter a lot more than it has over the last 18 months.”

To the extent that loan portfolios are expanding, mortgages have been the driving force. Fourth-quarter mortgage balances rose 12 per cent to 15 per cent at several major banks amid hot housing markets. But banks expect somewhat slower growth in 2022, more likely in the range of 6 per cent to 8 per cent.

Commercial lending is picking up speed, and credit card balances increased 4 per cent from the third quarter at Bank of Nova Scotia and Royal Bank of Canada. But card balances are still significantly lower than they were before COVID-19.

As a result, the balance of banks’ new lending has shifted toward secured loans, which have lower risk of losses from defaults than unsecured debt, but are also less profitable. Margins earned on loans declined at most banks in the quarter, most notably at RBC and Scotiabank, though bankers expect they will stabilize and start to expand again next year.

“When it comes to consumer loans, it’s still very timid,” Laurent Ferreira, chief executive officer at National Bank of Canada, said in an interview. “The growth that we’ve seen in cards, for instance, the discretionary spend is not fully back.”

Rising interest rates could help. Rock-bottom rates reduced RBC’s revenue by about $1-billion in each of the past two years, according to CEO Dave McKay. A 25-basis-point increase to benchmark rates (100 basis points equal one percentage point) could add about $250-million to the bank’s revenue over the next 12 months, and $370-million in revenue for TD.

Scotiabank is already benefiting from rising interest rates abroad – in Mexico, Peru and Chile.

Even expectations of rate increases can be good for banks. Market yields on bonds reflect those expectations. “We’ve seen significant movements already in the yield curve,” Hratch Panossian, chief financial officer of Canadian Imperial Bank of Commerce, said in an interview. “And that starts impacting our [profit and loss statement] positively even before we see actual increases.”

As revenues levelled off in the fourth quarter, expenses spiked at some banks. CIBC’s costs increased 13 per cent from a year earlier, as employee pay and bonuses increased and the bank spent money to upgrade technology and revamp its retail banking arm. Each bank has levers it can pull to control its spending, but there are other factors driving up costs, such as rising inflation, that are beyond any bank’s control.

“Does it worry us? Yes,” said Scotiabank CFO Raj Viswanathan, speaking to reporters this week. “Because expenses are going to be higher, simply driven by inflation.”

A planned 3-per-cent corporate tax hike targeting the Canadian profits of large banks and insurers that the Liberals proposed during the summer election campaign could also eat into profits if the government implements it next year as expected. Ottawa expects to raise $2.5-billion annually from the tax and a special fee called the Canada Recovery Dividend.

But federal officials have released few specifics about how the tax would work, and banks’ finance teams have only tried “back-of-the-envelope” estimates, Mr. Viswanathan said. When Scotiabank’s board asked him about the tax this week, “I said, ‘I can guess a number, but it will be a pure guess.’ ”

On the whole, however, bankers are still bullish. “We’re excited about our prospects,” Bank of Montreal CFO Tayfun Tuzun said in an interview. “We are primed for next year to see accelerated lending activities.” But executives are still keenly aware that COVID-19 and emerging variants could pose unpredictable risks to that outlook. “I’m certainly not trying to downplay the health care risk that we may face,” he said.

When it comes to capital and reserves against loan losses, banks are still playing it safe. In the fourth quarter, four of the Big Six banks recovered provisions for credit losses – the funds banks set aside in case loans default in future – with RBC reclaiming $227-million. And actual losses are near historic lows.

But overall allowances for credit losses are still well above prepandemic levels – RBC and National Bank have only released about half of the extra allowances they built up during the crisis.

The banks also announced hefty increases of 10 per cent to 25 per cent to their quarterly dividends and plans to buy back tens of millions of shares after the federal banker regulator lifted temporary capital restrictions on those payouts imposed last year.

But banks are still holding billions of dollars of excess capital above regulatory minimums. TD’s common equity Tier 1 ratio is so high, at 15.2 per cent, it has fuelled speculation the bank could be preparing to make an acquisition.

The buffers provided by those plush capital levels and large loan loss reserves are a key reason why bankers are sounding more confident than they did a year ago.

“If this is what the impact of the pandemic is on the banks, I think everyone’s good with that – executives, shareholders,” said Mr. Aiken of Barclays. “We didn’t see a hole punched into earnings, let alone the balance sheet.”

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