Deteriorating credit conditions to weigh on banks

Rising credit provisions and higher expenses weighed on Canadian bank profits in the third quarter, and that’s expected to continue, says DBRS Morningstar.

Amid high inflation, rising interest rates and a weaker economic outlook, the Big Six banks faced a tough operating environment that resulted in flat earnings growth, the rating agency said in a new report.

“Financial performance was negatively affected by a significant increase in provisions for credit losses and an uptick in non-interest expenses, offsetting modest revenue growth,” it noted.

Revenues were up by just 3% quarter over quarter, led by a 6% increase in non-interest income. Net interest income was flat as margins were squeezed by rising funding costs.

At the same time, aggregate credit provisions rose by 29% quarter over quarter to $3.5 billion as provisions on both impaired and performing loans rose. DBRS noted that credit-loss provisions are now close to pre-pandemic levels.

Looking ahead, DBRS said it expects to see “further deterioration in asset quality metrics in ensuing quarters as interest rates remain elevated for a longer period.”

Further, the looming prospect of a recession and still-rising borrowing costs “may amplify credit deterioration” in the months ahead.

“Canada’s household debt as a percentage of its GDP is the highest of any G7 country and is the only one above 100%, making Canadians more susceptible to interest rate hikes and more vulnerable to any potential increase in unemployment,” DBRS reported.

Additionally, net interest income and margins are expected to face pressure, with weaker lending volumes, higher funding costs and tighter loan margins.

“Loan growth is expected to continue to be affected by materially higher borrowing costs, macroeconomic uncertainty including a potential recession, and tightening credit availability,” the report said.

Nevertheless, DBRS also said the banks are well-positioned to weather the tough conditions, with strong capital and liquidity positions.

“Capital levels at the Big Six remain sound and provide sufficient cushion to absorb potential losses,” the report said — adding that the banks are expected to bolster their capital positions further as regulators in both Canada and the U.S. seek to shore up the sector’s stability.

“Although the operating environment will continue to be challenging and pressure earnings, the Big Six Canadian banks remain well positioned with sound liquidity, stable deposits, and adequate capital levels,” it said.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.