Toronto-Dominion Bank, the last major bank to disclose third-quarter earnings, reported rising profit clouded by a note of caution, as Canada’s largest lenders face an uncertain outlook in the final months of the fiscal year.
Expectations for loan losses continued to edge higher, and loan margins narrowed as interest rates began to fall, just as analysts had predicted. Even so, Canada’s big banks managed to churn out higher profits, and are promising to stay vigilant as they await greater clarity on global economic trends.
On one hand, banks aren’t ruling out the prospect of a downturn as soon as next year, now that the yield curve has inverted and trade tensions appear to be escalating. At the same time, economic fundamentals such as gross domestic product growth and employment are still strong in Canada. And if the United States and China were to resolve their trade differences, and central banks stimulate their local economies, banks could see a rebound in their forecasts.
“That’s equally probable," said Louis Vachon, chief executive of National Bank of Canada, in an interview on Wednesday. “As a team, we’re getting ready for both, frankly. And at some point we’ll have to decide which scenario’s more likely in 2020. But right now, it’s pretty tricky making predictions and budgets."
What is clear is that loan losses are moving higher as a period of unusually benign credit begins to wane. Bank executives have described a sector-wide uptick in provisions for credit losses – or the funds banks set aside to cover bad loans – as a “normalization" of credit, as loss rates return closer to historical averages.
TD’s third-quarter provisions rose 17 per cent from a year ago, to $655-million, as the bank expects greater losses on loans in its Canadian retail and wholesale banking divisions, and adjusted its forward-looking models accordingly.
“I would say that we are continuing to see normalization in credit losses this year,” said Riaz Ahmed, TD’s chief financial officer, in an interview. “It feels more [like] business as usual to us.”
Yet, credit losses are expected to continue to creep higher, and early signs of losses on commercial loans across a range of sectors from agriculture to real estate could be cause for concern, according to Jim Shanahan, an analyst at Edward Jones & Co. “There could be one-offs, but it could also speak to a broader economic malaise," he said. “That makes me a little bit nervous. I don’t think it’s fair to say that credit was really good this quarter, because it wasn’t. Credit costs have moved higher."
If central banks slash interest rates over the coming year – markets are predicting as many as four rate cuts from the U.S. Federal Reserve – bank margins could come under further pressure. In the third quarter, TD’s U.S. margin fell 11 basis points (100 basis points equal one percentage point), even as its loans increased 6 per cent. Yet, interest-rate cuts bring some benefits that could offset some of the pressure.
“There are also mitigating factors that as interest rates come down, you might continue to see loan volumes grow faster and credit performance should be better," Mr. Ahmed told analysts on a Thursday conference call. "So you can see some very mixed conditions depending on which scenario you wish to outline.”
TD reported profit of $3.25-billion, or $1.74 a share, for the three months ended July 31, compared with profit of $3.1-billion, or $1.65 a share, in the same quarter last year.
Adjusted to exclude certain one-time items, TD said it earned $1.79 a share. Analysts had expected $1.80 a share, on average, according to Refinitiv.
In TD’s core Canadian retail banking division, profit rose a modest 2 per cent, to $1.89-billion, as gains from increasing loan and deposit volumes were partly offset by higher loan-loss provisions. Bank of Nova Scotia, Bank of Montreal and Canadian Imperial Bank of Commerce also posted modest increases in retail banking profit of 1 per cent to 3 per cent in the quarter, as banks endure a period of relatively sluggish domestic growth.
Faced with uncertainty, banks are expected to sharpen their focus on controlling costs, and to watch their underwriting standards in their credit portfolios carefully.
“What we heard from the banks is that they’re trying to take some steps to head off those headwinds," said Rob Colangelo, a senior vice-president at ratings agency DBRS Ltd. “It’s all predicated on that [macroeconomic] uncertainty, and how that uncertainty clears itself up.”
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