Slow economy expected to weigh on bank earnings

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Canada's big banks shrugged off a difficult operating environment in 2015, but the new year is bringing fresh concerns that bank profits will start to reveal the impact of low oil prices, slow economic growth and tapped-out consumers.

The banks will begin reporting their fiscal first-quarter results this week – Bank of Montreal and National Bank of Canada kick things off on Tuesday morning – and a number of analysts sound glum about what the year is going to look like.

"We do see the macroeconomic reality finally catching up with bank earnings in fiscal 2016," Meny Grauman, an analyst at Cormark Securities, said in a recent note. "Overall, we believe there is too much fear of a recession for the rest of the world, including the U.S., and not enough fear about a nationwide slowdown in Canada."

Mario Mendonca, an analyst at TD Securities, estimates that bank profits in the first quarter will fall 1 per cent from the same period last year. That marks a notable reversal from last quarter's 10-per-cent profit growth, after adjusting for some extraordinary items.

"We could easily see adjusted earnings per share coming in higher than our estimate," Mr. Mendonca said in a recent note. "However, similar to last quarter … we could see very poor earnings quality," referring to profits that get a boost from unusual adjustments rather than improving operations.

For sure, there are a number of issues specific to individual banks that are worth watching. Royal Bank of Canada will likely reveal more about its integration of Los Angeles-based City National, an acquisition completed at the start of November. BMO may say something about its purchase of General Electric's transportation unit. And National Bank will no doubt discuss the impact of its $165-million writedown on Maple Financial Group of Canada.

But bigger, sector-wide issues will likely dominate the discussion, given the turbulence in the stock market.

Earlier this year, the S&P/TSX composite commercial banks index slipped into a bear market, defined as a decline of more than 20 per cent. The decline followed steeper sell-offs among U.S. and European bank stocks because of the weakening global economy and the prospect of negative interest rates, but Canadian banks are also facing their own challenges closer to home.

The low price of crude oil is one of them. While concerns about the ability of energy companies to service their bank loans have been simmering for more than a year, they grew more urgent after oil fell below $30 (U.S.) a barrel – lower than the price used by some banks when conducting stress tests on their loan books.

Observers expect loan losses to rise, eating into profits at a time when banks are also dealing with slowing demand for consumer loans, rising funding costs and an economy that is expected to grow a mere 1 per cent in 2016, according to BMO Nesbitt Burns.

Sumit Malhotra, an analyst at Scotia Capital, said that the difficult backdrop means that the banks' rising provision for credit losses (PCL) will be "the key fundamental factor of interest for the sector in the coming year."

As he sees it, PCLs will rise to 35.8 basis points (there are 100 basis points in a percentage point) of total loans in 2016, up 24 per cent. That's still low relative to the spike in losses seen during the financial crisis, when PCLs peaked at more than 78 basis points, but it is high enough to pose a significant obstacle to bank profit growth when growth is hard to find.

"An increase in loan losses could very quickly erode the prospect of earnings growth for the sector in 2016, and, depending on magnitude and the ability to find offsets, 2017 as well," Mr. Malhotra said in a recent note.

RBC will report its results on Wednesday, followed by Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday. Bank of Nova Scotia concludes the first-quarter reporting season on March 1.