Investors seek clues to how Canada’s big banks will use billions in excess capital

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As Canada’s largest banks gear up to report their most recent quarterly earnings next week, many investors are already looking for clues to which lenders will bounce back first in a postpandemic recovery.

Some analysts expect banks’ earnings per share to be 5 per cent to 8 per cent lower in the three months ended Jan. 31, compared with the same period a year ago – before the pandemic arrived in Canada. But profits are likely to stabilize at levels similar to those of the last fiscal quarter of 2020, which ended Oct. 31.

Many investors are ready to look past those numbers and are eager to parse bank executives’ comments regarding the prospects for economic recovery in the United States and Canada – specifically, how soon the banks’ lending activities and fees will rebound. They also want to know how banks plan to deploy billions of dollars of excess capital built up under restrictions on dividend increases and share buybacks imposed by the federal banking regulator.

“The market continues to be less focused on the quarterly results themselves and much more interested in what earning power will be on the other side of this pandemic,” Scotia Capital Inc. analyst Meny Grauman said in a note to clients. “Investors remain convinced that vaccinations will lead us out of this health crisis and that growth is poised to bounce back with the force of a loaded spring.”

Bank of Montreal and Bank of Nova Scotia will be the first to report results, on Feb. 23, followed by Royal Bank of Canada and National Bank of Canada the next day and Toronto-Dominion Bank and Canadian Imperial Bank of Commerce the day after that.

Provisions for credit losses – the funds banks set aside to cover possible future losses from defaults – will likely rise modestly higher, as more loans are showing early signs of distress. But loans that are actually delinquent are not expected to spike in a meaningful way until later this year, because government support programs are still propping up struggling households and businesses.

And it seems unlikely that Canada’s banks will take back any of the billions of dollars in reserves set aside to cover potential loan losses just yet. Earlier this year, U.S. banking giants JPMorgan Chase & Co. , Citigroup Inc. and Wells Fargo & Co. released a combined US$5-billion in loan loss reserves, boosting their profits. But those banks use a different accounting standard than the IFRS 9 framework followed by Canada’s banks. The U.S. banks’ accounting model prompted them to stockpile larger reserves early in the crisis, but it has also made them quicker to reduce those buffers as conditions improve.

At Canada’s banks, “we’re not going to see any serious reduction in the allowances until we get better visibility as to how things are ultimately going to play out,” Barclays Capital Canada Inc. analyst John Aiken said in an interview.

Signs of a return to growth are unlikely in the fiscal first-quarter results. Demand for new loans still looks sluggish, and Mr. Grauman estimates that loan balances will rise by just 3 per cent on average this fiscal year. Residential mortgages in Canada are a notable exception, with December balances rising 7.7-per-cent year over year, according to recent regulatory data.

Low interest rates are eating into the profitability of those loans, however, and profit margins on lending are expected to have narrowed again in the fiscal first quarter.

On a positive note, the banks’ capital market arms have continued to do brisk business in trading and advisory work. Although some analysts predicted that trading and investment banking profits would retreat in 2021 after a hugely volatile and lucrative 2020, “what we’ve seen is greater activity [compared with] the fourth quarter [of 2020],” Mr. Aiken said.

Analysts expect an economic recovery to start sooner in the U.S., where vaccination efforts are more advanced than in Canada. That could give an advantage to Canadian banks with large U.S. operations, such as BMO and TD.

“Investors will definitely look at that. Our view is that the U.S. could recover faster,” Rob Colangelo, an analyst at DBRS Morningstar, said in an interview. “The year will play out in the tale of two halves. We still expect kind of a sluggish first half of 2021, and then it will accelerate.”

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