Canada’s biggest banks are expected to report larger losses from commercial real estate loans in their first-quarter earnings this week, which will contribute to lower growth in profits, analysts say.
Expecting some pain in the first quarter, many analysts have cut their estimates – extending a trend seen throughout 2023. The analysts anticipate that earnings will drop as much as 12 per cent year-over-year, pressed by dampened loan demand and higher loan loss reserves driven by rising risk in commercial real estate, credit cards and auto lending.
In January, U.S. regional bank New York Community Bancorp slashed its dividend and stockpiled reserves, citing concerns with commercial real estate loans. Some banks in Europe and Asia also warned of significant losses in the sector, heightening concerns that a slump in commercial property valuations could have wide-reaching implications for global banks.
Last week, Canadian pension funds Caisse de dépôt et placement du Québec and the Ontario Municipal Employees Retirement System reported losses on their real estate investments.
“The recent turmoil with New York Community Bancorp serves as a stark reminder that we have not moved past the potential for elevated credit losses,” CIBC analyst Paul Holden said in a note to clients. “Commercial real estate (CRE) of course will be in focus for the Canadian banks, and we expect that there should be higher provisions for CRE loan exposure.”
Exposure to commercial real estate at Canada’s largest banks ranges from 7 per cent of the total loan book at National Bank of Canada to 12 per cent at Canadian Imperial Bank of Commerce, according to research from Scotiabank analyst Meny Grauman.
Executives at CIBC cautioned last year that the bank could be affected by losses in its commercial real estate portfolio, particularly in the United States. But commercial real estate in the U.S. makes up a relatively small portion of the lender’s portfolio – 6 per cent of total loans. Office property in particular makes up about 1 per cent to 2 per cent of total loans across the Big Six banks.
“True, CIBC is seeing bigger losses from its U.S. office portfolio than peers, but exposure here is small,” Mr. Grauman said in a note. “We expect those losses to remain quite manageable this year.”
But the banks have also been setting aside more money for loans that could default, known as provisions for credit losses, to help them absorb the impact of those losses.
While rising provisions have been driven in part by commercial real estate, higher interest rates boosted borrowing costs and increased the risk that clients across the bank’s businesses could default on their loans. Analysts expect risk in credit-card and auto-lending portfolios to prompt the banks to set aside more loan loss reserves.
Since 2022, the banks have been rebuilding their loss reserves from historically low levels in 2021. At the onset of the pandemic in 2020, banks set aside more provisions to hedge against an expected wave of defaults that never materialized, prompting them to release those reserves the following year.
Government stimulus slowed as pandemic restrictions eased and concerns of a mild recession mounted, increasing the risk of loan losses and boosting provisions. In 2023, gross impaired loans – loans the banks believe likely won’t be repaid – doubled to $4-billion from $2-billion a year prior, according to research from Jefferies analyst John Aiken.
On Tuesday, Bank of Nova Scotia and Bank of Montreal will be the first major banks to report earnings for the three months ended Jan. 31. Royal Bank of Canada and National Bank will release their results on Wednesday and Toronto-Dominion Bank and CIBC will close out the week on Friday.
Canadian bank stocks have fallen 1.6 per cent year-to-date, underperforming the S&P TSX Composite Index’s 2.2-per-cent climb as investors weigh expectations for a mild recession and lower interest rates with persistent inflation.
Investors are also waiting for updates from Canada’s two largest lenders. RBC’s pending takeover of Britain-based banking giant HSBC’s Canadian unit received approval from the Finance Minister in December, and is expected to close at the end of the first calendar quarter, when investors will get an update on the financial details of the deal. TD expects fines or other penalties stemming from probes by regulators and law-enforcement agencies related to its anti-money-laundering practices.
The big banks are expected to continue to grapple with threats to profit growth that are spilling over from 2023. Net interest margins – the difference between the amount banks earn on loans and pay on deposits – are under pressure as clients stash up savings in higher-interest accounts. And the higher cost of borrowing has dampened demand for mortgages and other loans.
Over the past year, Canada’s banking watchdog has required the banks to maintain higher capital levels. In December, the Office of the Superintendent of Financial Institutions decided to maintain the current domestic stability buffer – a capital reserve banks must build as a cushion against an economic downturn. But it had already raised the buffer twice in recent years, forcing the largest lenders to set aside billions of dollars.
Partially offsetting this, the surging expenses that the banks experienced last year because of inflation and higher salary and technology costs are expected to wane. Last year, the banks had layoffs and some relinquished some real estate premises to help reduce costs.
“Following last year’s staff cuts and restructuring activity, we expect a better trajectory for expenses in Q1, although the full benefits of those cost-cutting initiatives will take time to flow to the bottom line,” Keefe, Bruyette & Woods analyst Mike Rizvanovic said in a note.