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Pedestrians walk past the Royal Bank Tower in Toronto.Louie Palu/The Globe and Mail

Canada’s two largest banks are signalling that the cooling economy and spiking expenses threaten to weigh on their growth and trigger further job cuts.

Royal Bank of Canada RY-T is trimming jobs in an effort to rein in expenses, even as the lender reported third-quarter profit Thursday that beat analyst expectations and exceeded the same quarter last year, boosted by a lower tax rate and fewer-than-expected reserves for sour loans. The same day, Toronto-Dominion Bank TD-T reported profit that was lower year-over-year and missed analyst estimates, as reserves and costs rose, offsetting higher revenue.

A breakdown of the big banks’ third-quarter earnings so far

Central banks have been ratcheting up interest rates in an attempt to slow the economy and temper heated inflation. As a result of this, Canada’s large lenders are facing several hurdles, including rising expenses, squeezed profit margins and the need to set aside larger reserves for potential bad loans. Senior bankers and analysts warned Thursday that these factors could create difficult conditions for the banking sector.

“We are seeing evidence of slowing labour markets, as evidenced by slowing wage growth, lower job postings and an increase in Canadian unemployment,” RBC president and chief executive officer Dave McKay told a conference call. “We are operating in a structurally uncertain macro backdrop.”

RBC reported that its number of full-time employees fell 1 per cent from last quarter, as workers left the bank. It said it expects to further decrease its work force by 1 per cent to 2 per cent next quarter, as part of a broader effort to constrain rising costs.

The bulk of the cuts were spread across the bank’s personal and commercial banking unit and its wealth management unit. Its capital markets unit was the only one to add roles. It gained more than 660 employees.

RBC has about 93,000 staff members. An additional 2-per-cent reduction would affect more than 1,800 jobs by the end of October.

The bank grappled with rising expenses in recent quarters as it ramped up hiring and salaries to compete in last year’s tight labour market. RBC expects its staffing cuts to result from employees voluntarily leaving the bank and other “targeted reductions,” as it continues to cut spending in other areas, Mr. McKay said.

The bank is also in the midst of closing its takeover of HSBC Bank Canada, which would further bump up costs in the coming quarters.

While RBC’s revenue rose by 19 per cent to $14.49-billion from the same period a year earlier, expenses spiked by 23 per cent to $7.86-billion, which the bank said was driven by higher staffing costs and professional fees. Salaries grew 17 per cent from the same period last year amid aggressive hiring and rising inflation.

The job reductions “are a component of an overall expense reduction exercise that’s much more significant,” Mr. McKay said. “It is part of a bigger program and a more ambitious program that you’ll hear more from us over the coming quarter.”

TD’s results were also weighed down by surging costs. Even as revenue rose 17 per cent in the quarter, year-over-year, expenses climbed 24 per cent, which the bank said was driven by higher staff-related costs and payments connected to its collapsed deal for Tennessee-based First Horizon Corp. and its takeover of New York-based investment bank Cowen Inc.

TD’s employee base grew about 1 per cent from the previous quarter. In an interview, TD’s chief financial officer, Kelvin Tran, did not comment on potential job losses. He said the lender is investing in niche specialties where it plans to grow its businesses, including technology and automation.

RBC and TD are the first major Canadian banks to report earnings for the three months that ended on July 31. Bank of Nova Scotia and Bank of Montreal will release results on Aug. 29. National Bank of Canada is set to report on Aug. 30, and Canadian Imperial Bank of Commerce will close out the week on Aug. 31.

RBC earned $3.9-billion, or $2.73 per share, in the quarter. That compared with $3.58-billion, or $2.51 per share, in the same quarter last year. Adjusted to exclude certain items, the bank said it earned $2.84 per share. That beat the $2.70 per share analysts expected, according to Refinitiv data.

TD earned $2.96-billion, or $1.57 per share, compared with $3.21-billion, or $1.75 per share, in the same quarter last year. Adjusted to exclude certain items, including costs related to the First Horizon deal, the bank said it earned $1.99 per share. That was below the $2.04 per share analysts expected.

The bank was left with a pile of surplus capital after the termination of the First Horizon takeover. It announced Thursday that it plans to repurchase 90 million shares. TD launched a buyback program for 30 million shares in May, a few weeks after the takeover collapsed. In the third quarter, it repurchased 14.3-million in common shares under that program.

“We have significant excess capital and we’re happy to return that back to shareholders,” Mr. Tran said. “This 90-million-share buyback will go a long way to absorb some of that excess.”

TD also said it expects to face penalties stemming from probes of its anti-money-laundering controls by regulators and law enforcement, including the U.S. Department of Justice. TD walked away from the First Horizon deal in May after difficulties with securing regulatory approvals delayed the closing timeline indefinitely. Media reports citing unnamed sources said the regulators’ concerns stemmed from issues with TD’s anti-money-laundering practices.

Analysts slashed their estimates in recent weeks as the Big Six banks prepared to report earnings, citing stubborn inflation that has pushed interest rates higher. While RBC overcame the lower expectations, its results were bolstered by lower-than-expected taxes and fewer-than-expected reserves for potentially bad loans. The levels of those reserves have been edging higher from lows in 2021.

In the quarter, RBC set aside $616-million in provisions for credit losses, which are the funds banks hold back to cover loans that may default. This was less than analysts had anticipated. Meanwhile, TD set aside $766-million in provisions, surpassing analyst estimates.

Rising risk related to commercial real estate helped drive reserves at RBC, which booked large provisions for financings in the office and multifamily residential segments. But RBC’s commercial real estate book makes up only about 10 per cent of all its loans.

“While we are now seeing the impairments of losses we have been expecting in the sector, we remain comfortable with our commercial real estate exposure,” RBC chief risk officer Graeme Hepworth said on the conference call.

At both banks, net interest margins – the differences between the amounts banks charge on loans and what they pay on deposits – narrowed, driven by their U.S. units, as customers moved their money into deposit accounts that offer higher interest rates.

RBC’s U.S.-based City National Bank posted a $12-million loss in the quarter, as expenses and provisions rose. Profit from TD’s U.S. arm was down 9 per cent year-over-year to $1.31-billion, weighed down by higher credit loss reserves and charges related to the cancelled First Horizon deal.

“While Canada is looking better than expected, the U.S. is proving more challenging,” Scotiabank analyst Meny Grauman said in a note to clients. “Certainly the early read-through to the rest of the group next week favors banks with less U.S. exposure rather than more.”

Bank stocks have floundered this year, underperforming the S&P TSX Composite Index. On Thursday, RBC’s share price rose 2 per cent while TD’s slumped 3.2 per cent.

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