Pedestrians on Front St. West walking past the green TD logo outside a future bank branch in Toronto’s Financial District on Mar 4, 2024.Fred Lum/The Globe and Mail
Canadian bank earnings will continue to be crimped by high borrowing costs and slower economic growth until central banks start cutting interest rates, analysts say.
The country’s largest lenders are expected to post slower profit growth in their second-quarter earnings this week, with analysts anticipating that earnings will drop as much as 4 per cent, year-over-year.
The banks are emerging from a tumultuous year marked by climbing reserves for potential loan losses, mounting costs and higher capital requirements – funds the lenders are required to set aside as a cushion against an economic downtown.
“We believe that the Canadian bank earnings trends are close to an inflection point; last year’s triple whammy of higher minimum regulatory capital requirements, credit reserve building, and negative operating leverage from double-digit non-interest expense growth should moderate starting this quarter and improve through fiscal year 2025,” Bank of Montreal analyst Sohrab Movahedi said in a note to clients.
Even so, Mr. Movahedi still expects some pressure from dampened loan growth, recovering but still stunted capital markets and wealth revenue, and persistent expenses as the banks await the full savings benefits from their restructuring plans announced last year – which included job cuts at each of the banks that amount to about 2 per cent of their work forces.
On Thursday, Toronto-Dominion Bank TD-T will be the first major lender to release earnings for the three months ended April 30. The rest of the Big Six banks – Royal Bank of Canada RY-T, Bank of Montreal BMO-T, Bank of Nova Scotia BNS-T, Canadian Imperial Bank of Commerce CM-T and National Bank of Canada NA-T – will report the following week.
Canadian bank stocks have edged higher by 1.5 per cent this year, underperforming the S&P/TSX Composite Index’s climb of 7.1 per cent, as investors weigh expectations for central banks to start cutting interest rates.
Canada’s lenders have been plagued by climbing provisions for credit losses – money that the banks set aside for loans that could default – as higher borrowing costs and inflation have strained customer wallets. The provisions have eaten into profits and weighed on earnings expectations.
The provisions are a closely watched indicator of the pressure building on customer finances. Lenders have been ramping up loan loss reserves since late 2022, and relief depends on interest rates falling, which is expected to happen later this year.
Analysts expect banks to ease up slightly on building provisions – setting aside more money than last year, but keeping increases stable from the prior quarter. The bulk of the increase is expected in impaired loans – debt that a bank believes will not be repaid – as credit-card delinquencies and business bankruptcies rise.
Homeowners are also preparing to weather a spike in their mortgage payments when a wave of loans come up for renewal with higher interest rates over the next few years.
“We are still keenly aware that mortgage renewal shock continues in Canada and although interest rates are expected to fall, there will not be significant relief for mortgage borrowers this year,” Royal Bank of Canada analyst Darko Mihelic said in a note.
Higher borrowing costs have also reduced demand for loans from retail and commercial clients. Data published by Canada’s banking regulator, the Office of the Superintendent of Financial Institutions, for February and March suggest that loan growth across the sector would sit at 3 per cent, according to research by CIBC analyst Paul Holden.
“Loan growth is muted and will likely continue that way as a result of a higher-for-longer interest rate environment,” Mr. Holden said in a note. “Lower affordability will continue to weigh on borrowers’ appetite/capacity to take on new debt and a deteriorating macroeconomic outlook could inhibit borrowers’ willingness to take on more leverage.”