Canada’s big banks weathering the storm as credit strain mounts

Canada’s big banks weathering the storm as credit strain mounts

All but one of the big six beat expectations despite growing loan loss provisions

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Canada’s largest banks took higher provisions for credit losses and classified more loans as impaired in their fiscal first quarters, but showed resilience in other areas, an indication that the country’s lenders are weathering a softening economy brought on by higher interest rates.

The quarterly results, released this week, showed some of the banks improved performance through cost-cutting and were able to blunt the impact of the higher provisions with loan and deposit growth.

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On Thursday, Toronto-Dominion Bank was the latest of the big banks to beat analyst expectations, joining Bank of Nova Scotia, Royal Bank of Canada, National Bank of Canada and Canadian Imperial Bank of Commerce (CIBC).

“Margin performance has stabilized and efficiency metrics have improved,” National Bank Financial analyst Gabriel Dechaine said in a March 1 note to clients about the sector’s results. But, he added, “the biggest source of uncertainty is still the credit cycle.”

Loan growth

RBC reported total bank provisions for credit losses of $813 million, more than the $754 million analysts had forecast, and provisions for credit losses on impaired loans of $685 million, which were attributed to the impact of higher interest rates and rising unemployment.

But Royal was also among the banks to report growth in loans and deposits in its domestic personal and commercial banking division. Canada’s largest bank reported average deposit volume growth of nine per cent, including 11 per cent in personal deposits, and five per cent growth in loans including double-digit growth in business lending and credit cards.

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And while Toronto-Dominion Bank posted a provision for credit loss ratio of 0.44 per cent, higher than analyst expectations of a 0.40 per cent ratio and up from 0.32 per cent a year earlier, Canada’s second-largest bank also posted seven per cent loan growth in Canada.

Matthew Lee, a bank analyst at Canaccord Genuity Corp., said TD is also expected to drive “above industry” U.S. loan growth — despite somewhat challenging economic and banking conditions there — by leaning on current consumer relationships in both the retail and commercial segments.

In a Feb. 29 note to clients, Lee said the bank’s loan performance in Canada “showed solid momentum, which … reflects TD’s ability to competitively deploy its excess capital to drive growth.”

CIBC, too, caught analysts’ attention by boosting revenue at its domestic personal and business banking division by 10 per cent in the first quarter compared to a year earlier, while reducing expenses by one per cent. The bank’s loan balance expanded by two per cent while deposits grew by three per cent. Net interest margin, the difference between interest paid on deposits and earned on loans, was also up, though results at Canada’s fifth-largest bank were partially offset by weaker performance at its capital markets and U.S. commercial banking divisions.

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Loan losses

Despite some rocky waters for Canadian banks that operate in the U.S., one trend is expected to buoy CIBC amid expected consumer losses in Canada, where credit card delinquency rates are on the rise, according to Dechaine, the National Bank analyst.

CIBC has US$3.5 billion of office-related commercial real estate loans, which, by Dechaine’s estimates, are responsible for nearly a third of the bank’s impaired loan provisions over the past year. However, in the first quarter, the ratio of gross impaired loans in this portfolio climbed by 160 basis points, the lowest sequential increase since this disclosure became available, Dechaine wrote in a Feb. 29 note to clients.

“More importantly, the bank is guiding to a declining GIL (gross impaired loan) ratio going forward, putting downward pressure on loan losses that will offset some expected increases in Canadian consumer loan losses,” he wrote.

Lee, the Canaccord Genuity analyst, also pointed out to his clients that improving U.S. commercial real estate loss rates should help CIBC “offset weakening Canadian credit throughout the year” particularly in its credit card and unsecured lending books.

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While Lee is forecasting provisions for credit losses of around $2.4 billion in fiscal 2024 and 2025, he noted that CIBC’s closely-watched CET1 capital ratio was 13 per cent at the end of the first quarter, giving the bank capital to fund growth including possible acquisitions.

“Looking forward, we expect CM (CIBC)’s organic cash generation to exceed the required levels for growth, giving its team the optionality to pursue M&A, increase the dividend, or repurchase shares,” Lee wrote.

The one miss

Bank of Montreal was arguably the worst performer in the quarter among the country’s six largest banks, with a big miss on revenue expectations due to lower insurance revenue, lower capital markets revenue, hedging costs and net interest margin compression from deposit pricing pressure including a move to term deposits.

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Paul Holden, a bank analyst at CIBC Capital Markets, said loan growth at BMO is unlikely to exceed low to mid-single digits until the economy improves.

“Rate cuts and less economic uncertainty, particularly in the U.S., should result in a better loan growth outlook for BMO,” he wrote in a Feb. 27 note to clients. “This is a plausible scenario for 2025.”

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The analyst said existing bank loans performed fairly well during the first quarter, given current economic conditions. But he doesn’t think the worst has materialized.

“Credit to date is performing better than we would have assumed, but we still expect higher credit losses within the next 12 months based on the economic impacts of rate tightening,” the analyst wrote.

“We remain cautious on the credit outlook as business bankruptcies are rising faster than consumer delinquencies.”

In his March 1 note to clients, Dechaine said many of the banks are suggesting peak losses could be reported during first half of 2024, with improvement during the balance of the year, a scenario he finds “too optimistic… especially in light of the rise in delinquency rates.”

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That scenario can only play out if interest rates come down, Dechaine said, adding that around 23 per cent of mortgages held by the Big Six banks are renewing in 2025 compared to 11 per cent in 2024.

“To be bullish on the banks requires conviction that central banks will deliver rate cuts this year,” he wrote. “In our opinion, such cuts will not only reduce risks that already exist on bank balance sheets, but will lessen the likelihood of a severe recessionary level of loan losses.”

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