Canadian banks will give some insight into where they see the economy going when they start reporting quarterly earnings this week. Analysts will monitor trends in key indicators such as loan growth, capital outflows and how much money banks set aside in case loans fall through. The results for the period ended July 31 come at a time when high inflation in decades has prompted central banks to raise interest rates, including a one-percentage-point increase in July by the Bank of Canada – the biggest increase in more than 20 years years. Higher interest rates have pushed up the cost of borrowing for mortgages and caused a downturn in the housing market, which is usually a big driver of bank loan growth. The Canadian Real Estate Association reported that national home sales fell 5.3% in July compared to June and fell 29.3% compared to July 2021, translating into lower lending activity for banks. “I expect some slower loan growth given the rise in mortgage rates,” said James Shanahan, senior equity research analyst at Edward Jones. Overall, however, Shanahan said he expects a very good quarter for banks, as higher interest rates also translate into higher margins on loans – although he pointed out that with many loans at fixed rates it may take some time to show through to profits , with commercial loans generally responding more quickly. On the capital markets side, banks are expected to report a sharp drop in investment banking revenue as companies and investors become more cautious, but Shanahan said trading revenue could help offset the impact despite pressures of the market. “This is basically due to higher market volatility and so could be a source of strength.” That’s the trend that emerged when U.S. banks reported, with the five largest U.S. banks reporting a 50 percent drop in investment banking revenue, while trading revenue rose 22 percent, he said. Banks’ decisions on loan loss provisions will be another key area to watch as it shows what they see going forward about economic conditions and how they expect these loans to perform. Shanahan said that with the economy still operating at essentially full employment, he doesn’t expect dramatic changes, but analysts expect banks to start building up their reserves again after starting to reduce them over the past year or so. National Bank analyst Gabriel Dechaine said in a note that he expects a “moderated” shift in the credit cycle, with all banks adding to loan provisions, with the biggest ones being Scotiabank and RBC after about 80 percent of provisions have been released that they had created in the first months of the pandemic. Provisions for credit losses are counted as expenses, so they have a significant impact on bank profits. The latest crop of results comes as banking stocks come under some pressure as part of broader economic uncertainty. Scotiabank analyst Meny Grauman said in a note that the bank’s stock performance reflected wide swings in the broader economic outlook. The bank’s price-to-earnings ratio fell as economic concerns rose in the spring over Russia’s invasion of Ukraine and China’s COVID-19 lockdown, but is now returning to a more balanced investor consensus, he said. “Investors seem to be pulling back from the brink and realizing that while rising interest rates will weigh on economic growth by design, the result is not necessarily a deep and prolonged recession,” Grauman said. “At current valuation levels, the market appears to be pricing in a mild recession with only a limited impact on credit performance, which is actually our baseline scenario.” Dechaine noted that Big Six stocks are down about six percent year-to-date, underperforming the market by about 1.4 percent, which could be overstated. “At this point, we wonder if too much negativity has been reflected.” He said for banks to expect better performance however depended on the outlook for rate hike activity. “Market expectations should shift to a more dovish stance from the Bank of Canada, which will deflate concerns related to the housing market (primary sector overhang). We’re not there yet, but we could be getting closer.” Scotiabank begins reporting on Tuesday, followed by RBC and National Bank on Wednesday, CIBC and TD Bank on Thursday and Bank of Montreal on August 30.
