Banks to report second-quarter results as credit concerns persist

While there’s still room for surprises, Canadian banks are set to report results after a second quarter that was notable for its economic steadiness.

The quarter marked a sharp contrast from a year earlier, when bank failures in the U.S. and Switzerland created worries of contagion. At the same time, the possibility of an economic hard landing loomed as central banks worked to tame inflation through higher interest rates.

By comparison, the latest quarter was fairly tame — despite the high-profile issues at TD Bank Group related to money-laundering controls — with encouraging data on the economic front for inflation and still historically low levels of mortgage delinquencies.

Just this week, Statistics Canada reported inflation fell to 2.7% in April, down from 2.9% in March, which boosted financial market odds of a June rate cut above 50%.

But with both the timing and pace of rate cuts uncertain, and the many Canadian mortgages up for renewal soon at significantly higher rates, analysts will keep focusing on the issue of how well bank loans are expected to stand up.

“We believe credit quality is still top of mind for investors,” said RBC analyst Darko Mihelic in a note on the upcoming bank earnings, which kick off Thursday with TD.

The rest of the banks report next week, and overall, Mihelic is expecting earnings will dip from both last quarter and last year as economic conditions hamper growth.

His estimates on bank provisions for credit losses haven’t changed much, but he said, “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 noted some borrowers face renewals that will mean a more than 60% jump in payments, but that so far homeowners look to be managing well.

Residential mortgages were at 0.34% gross impaired in the first quarter, compared with 0.43% at the end of 2019 or the 0.85% hit after the global financial crisis, the report said.

But strain is increasing on borrowers and banks as high interest rates persist, especially on smaller banks that sometimes specialize in higher-risk borrowers. Residential mortgages more than 90 days past due stood at 0.17% at large banks and 0.46% at small banks, while both were hovering around 0.1% in 2022.

Banks are managing well, but the overhang of financial strain means analysts still see a slow unwinding of credit loss provisions and subdued loan growth ahead.

Analysts will be looking for any encouragement on those fronts, as well as the outlook for profit margins on interest, said Canaccord Genuity analyst Matthew Lee in a note.

“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.”

He said he expects a more cautious view from banks on credit as consumers face a “more daunting economic landscape,” something he’s concerned about too

“We’ve become increasingly cautious on the health of Canadian consumers, particularly those in the bottom half of the wealth distribution.”

It’s the health of the consumer, and the overall economy, that is the bigger question as bank-specific concerns are subdued.

While several analysts pointed to the rate question, Scotiabank’s Meny Grauman also took a longer-term view about the potential of the banks, and how the challenges they face are many of the same issues the Canadian economy faces.

“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?’” he said 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 certainly help determine where they go over the coming years.”