Analysts focus on credit quality as Canadian banks report Q2 results marked by economic steadiness
Canadian banks are poised to report their results following a second quarter marked by economic steadiness, as reported by BNN Bloomberg.
This period stands in contrast to a year ago, when bank failures in the US and Switzerland sparked concerns of contagion, and the threat of an economic hard landing was prominent due to central banks' efforts to curb inflation with higher interest rates.
The recent quarter was relatively calm, despite high-profile issues at TD Bank Group concerning money-laundering controls, with promising data on inflation and historically low mortgage delinquencies.
Statistics Canada reported this week that inflation fell to 2.7 percent in April, down from 2.9 percent in March, raising the likelihood of a June rate cut to over 50 percent.
However, with uncertainty around the timing and pace of rate cuts, and many Canadian mortgages up for renewal at significantly higher rates, analysts are focused on the resilience of bank loans.
“We believe credit quality is still top of mind for investors,” RBC analyst Darko Mihelic stated in a note about the forthcoming bank earnings, which begin with TD on Thursday.
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The remaining banks will report next week. Mihelic anticipates a decline in earnings from the previous quarter and year due to challenging economic conditions.
Although his estimates on bank provisions for credit losses remain largely unchanged, Mihelic noted, "we continue to see signs of credit deterioration, and we are still keenly aware that mortgage renewal shock continues."
In a financial stability report earlier in May, the Bank of Canada highlighted that some borrowers would face renewals resulting in over 60 percent increases in payments, but homeowners have managed well so far.
Nonetheless, the strain on borrowers and banks is growing as high interest rates persist, especially for smaller banks that often cater to higher-risk borrowers. Residential mortgages more than 90 days past due were at 0.17 percent for large banks and 0.46 percent for small banks, compared to around 0.1 percent in 2022.
Despite managing well, the financial strain means analysts foresee a gradual reduction in credit loss provisions and subdued loan growth.
Canaccord Genuity analyst Matthew Lee indicated that analysts would look for positive signs in profit margins on interest and management commentary on net interest income and credit as expectations for rate cuts are delayed.
“While we do not expect any meaningful negative surprises in the numbers, we are most interested in inflections in management commentary around both (net interest income) and credit as rate cut expectations continue to be pushed out,” Lee said.
He anticipates a more cautious outlook from banks on credit as consumers navigate a “more daunting economic landscape,” expressing concerns about the health of Canadian consumers, particularly those in the lower half of the wealth distribution.
The broader concern remains the health of the consumer and the overall housing markets, as specific bank issues seem subdued.
Scotiabank’s Meny Grauman took a long-term perspective on the challenges faced by banks, noting they reflect broader economic issues in Canada.
“Between plunging productivity, unsustainable fiscal policy including exploding public sector job growth, and one of the world's most expensive housing markets, we believe that it is now fair to ask, 'Is the Canadian economic miracle over?'” Grauman stated in a note.
“The answer to this question will not determine the path forward for bank shares over the next few weeks or quarters, but it will certainly help determine their trajectory in the coming years.”
