Banking headwinds just getting started, so hold off buying the Big Six

Banking headwinds just getting started, so hold off buying the Big Six

Slowing pace of mortgage growth one of the early signs

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Canada is still in the early innings of a credit cycle that could weigh on the Big Six banks for the remainder of the year, according to analysts at the Bank of Nova Scotia.

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In a note earlier this month, analyst Meny Grauman and associate Felix Fang said that despite better-than-expected job numbers and consumer credit metrics, it’s too soon to get excited about the Big Six.

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“The reality is that this credit cycle is still in the early innings/first period/first quarter — whatever your favourite sports analogy it is still not the time to go overweight the sector,” Grauman and Fang said in the June 5 note.

The credit cycle is at a point where rising interest rates have started to limit credit availability and slowing overall growth has dented demand.

The slowing pace of mortgage growth, which slipped into the single digits in the second quarter, is one of the early signs, the bank said.

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If rates rise further, Grauman and Fang said credit risk would increase, putting more borrowers in jeopardy of default and forcing the banks to grapple with more impaired loans.

The banks have been setting aside more money for loan loss provisions. While Grauman and Fang called the credit risks “benign,” they also noted that earnings estimates fell by three per cent for the rest of the year and are expected to fall two per cent next year.

The banks expect that loan-loss provisions, already a major theme in the second-quarter earnings season, will increase further and weigh on results.

In the quarter ending April 30, Canadian Imperial Bank of Commerce, National Bank of Canada and Laurentian Bank of Canada were the only reporting banks that beat Bay Street expectations. All others fell short due to rising costs and loan loss provisions.

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Grauman and Fang said Toronto-Dominion Bank’s robust balance sheet after the First Horizon Corp. deal fell through put it in the best shape to weather any storm.

In March, DBRS Morningstar analysts Shokhrukh Temurov, Josh Veenkamp and Michael Driscoll made the case that despite their exposure to higher credit costs, medium-sized banks could be more resilient in a tightening credit environment.

“The (medium-sized banks) would likely be exposed to higher credit costs compared with the Big Six because they are less diversified and have exposures to riskier asset classes,” the analysts said in a March 6 note. “However, supported by good levels of earnings and capital buffers, they remain resilient against rising credit pressures.”

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  1. Total mortgage volume growth was in the single-digits at most of the Big Six banks in quarter ended April 30, down from double-digit levels last year.

    Mortgage growth slowing, but Canada’s big banks aren’t worried yet

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    Canadian banks’ bottom lines getting squeezed

  3. Bank buildings in Toronto's financial district. Canadian bank stocks may have further to fall.

    Canadian bank stocks may have further to fall

The banks they were looking at included Canadian Western Bank, Equitable Bank, Laurentian Bank and Manulife Bank of Canada.

They added that most of these banks have maintained their profitability and kept net interest margins — or the difference between what banks earn in loan interest and what they pay out to customers — stable.

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