Canadian banks will give a preview of the direction they see the economy going when they start reporting their quarterly results this week.
Analysts will watch trends in key metrics such as loan growth, capital raising and how much banks are setting aside in case loans go bad.
The results for the period ending July 31 come at a time when decades-high inflation has prompted central banks to raise interest rates, including the Bank of Canada’s one percentage point hike. in July – the biggest increase in more than 20 years.
Rising rates pushed up borrowing costs for mortgages and caused a decline in the real estate market, which is usually a major driver of bank lending growth.
The Canadian Real Estate Association said national home sales fell 5.3% in July from June and 29.3% from July 2021, translating into lower l lending activity for banks.
“I expect loan growth to slow given rising mortgage rates,” said James Shanahan, senior equity research analyst at Edward Jones.
Overall, however, Shanahan said he expects a pretty good quarter for banks, as higher interest rates also mean higher spreads on loans – although he did pointed out that with many locked rate loans it can take a while to show up in profit, with commercial loans generally quicker to respond.
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 cushion the impact despite market pressures.
“It’s basically due to higher market volatility, so that could be a source of strength.”
This is the trend that was evident when US banks reported, with the five largest US banks reporting a 50% decline in investment banking revenue while trading revenue rose by 22%, he said.
Banks’ decisions on provisions for credit losses will be another key area to watch as they show what they expect for economic conditions and how they expect those loans to perform.
Shanahan said with the economy still operating at essentially full employment, he doesn’t expect dramatic changes, but analysts expect banks to start boosting their reserves again after starting to cut them at the start. course of the last year.
National Bank analyst Gabriel Dechaine said in a note that he expects a “moderate” change in the credit cycle, with all banks adding to loan provisions, with the Bank’s largest Scotia and RBC since they released about 80% of the provisions they had made. in the early months of the pandemic.
Provisions for credit losses are accounted for as expenses, so they have a significant effect on the bank’s income.
The latest crop of results comes as bank stocks have come under some pressure amid the broader economic uncertainty.
Scotiabank analyst Meny Grauman said in a note that the performance of bank stocks reflected big swings in the broader economic outlook.
The bank stock price-to-earnings ratio fell as economic worries rose in the spring following the fallout from Russia’s invasion of Ukraine and China’s COVID-19 lockdowns, but is now falling back to a more balanced investor consensus, he said.
“Investors seem to be taking a step back and realizing that while rising rates will weigh on economic growth by design, the result isn’t necessarily a deep and prolonged recession,” Grauman said.
“At current valuation levels, the market appears to be pricing in a mild recession with limited impact on credit performance, which is actually our base case scenario.”
Dechaine noted that shares of Big Six banks are down about 6% year-to-date, underperforming the market by about 1.4%, which could be too much.
“At this point, we wonder if too much negativity has been reflected.”
He said that for banks to expect better performance, it depends on the outlook for rate hike activity.
“Market expectations need to shift to a more dovish stance from the Bank of Canada, which would ease concerns about the housing market (a primary sector surplus). We’re not there yet, but we could get close.”
Scotiabank begins the report on Tuesday, followed by RBC and National Bank on Wednesday, CIBC and TD Bank on Thursday and Bank of Montreal on August 30.
This report from The Canadian Press was first published on August 21, 2022.