Canadian banks set for strong results as trade, housing risks loom

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Bullish expectations for Canada's banks are carrying into reporting season for the first fiscal quarter, dampened just a little by uncertainty over global trade and Canada's volatile housing markets.

Broadly speaking, the stage is set for banks to report strong quarterly results. Economic growth in Canada is still strong, despite signs of moderation, and rising interest rates could give banks' margins a modest boost. Returns from capital markets are expected to be softer than a year ago, when the U.S. presidential election sent markets surging, but should still improve compared with the final quarter of 2017.

The banks' outlook is not without risks. Growth in Canada's mortgage market is expected to slow, household debt keeps climbing to new heights and a conclusion to fraught negotiations over the North American free-trade agreement is still uncertain. Banks will also need to keep a close eye on expenses in case revenue growth begins to soften.

Yet the anticipated benefits from U.S. tax cuts to banks with American operations, combined with rising interest rates on both sides of the border, are "turning what was already expected to be a good year into a better one," said Robert Sedran, an analyst at CIBC World Markets Inc. "At this point, the positives outweigh the negatives."

Canadian Imperial Bank of Commerce will report its results first on Feb. 22, followed by Royal Bank of Canada on Feb 23. Bank of Montreal and Bank of Nova Scotia both report on Feb. 27, National Bank of Canada on Feb. 28 and Toronto-Dominion on March 1.

Analysts predict as many as four banks – CIBC, Scotiabank, RBC and TD – are likely to hike their dividends.

Here are three themes worth watching this quarter:

New mortgage rules

Mortgages are still under scrutiny, as lenders and home buyers begin to digest the impact of a new stress test introduced by Canada's banking regulator, which will make it harder for some borrowers to qualify for uninsured home loans.

Growth in banks' mortgage portfolios is expected to pull back somewhat as a result. But banks' fiscal first quarters wrapped up on Jan. 31, only a month after the new rules took effect. And many buyers were likely preapproved for loans without meeting the stress test before the new year. So it may be too soon to gauge the full affect on banks' loan portfolios.

"We remain on real estate watch although [the new rules'] impacts will likely be modest this quarter – in our view, [the second quarter] will be the litmus test," said Darko Mihelic, an analyst at RBC Dominion Securities Inc.

U.S. tax fallout

Sweeping changes to the U.S. tax system passed just before Christmas by American legislators will force some Canadian banks to endure short-term pain in their first-quarter results.

TD and BMO both expect to take writedowns of roughly US$400-million, largely attributable to adjustments to deferred tax assets. RBC's writedown will total US$150-million writedown and CIBC's will be US$100-million.

But make no mistake: There are long-term gains to come.

Canadian banks with U.S. operations can expect earnings per share to rise between 1 per cent to 3 per cent, according to research by analysts at Citigroup Global Markets Inc. RBC predicted it will earn back that US$400-million by the third quarter as lower taxes lift earnings. With U.S. tax reform resolved, companies that had held off on borrowing from banks as they awaited the outcome may feel empowered to take more loans.

"BMO is expected to be the largest beneficiary," Mr. Sedran said. "We expect any writedowns to be more than fully offset by new tax savings as well as strong organic capital generation."

Accounting for loan losses

The start of banks' first fiscal quarters on Nov. 1 coincided with the introduction of a new accounting standard, known as IFRS 9, that puts more emphasis on banks' expected losses over the life of a loan.

The first quarter of 2018 will be the first time they frame their results within the new rules. The banks already disclosed so-called "day one" impacts after the fourth quarter and the only change is in the accounting. The result will be that provisions for credit losses – or the money banks set aside to cover bad loans – will be more volatile over time.

Because banks' loan books are healthy at the moment, and loan losses are low, the impact on provisions should be muted for the time being. "As for those underlying actual losses, we expect little change from quarters past," Mr. Sedran said.