Big Six banks’ outlook deteriorating: Fitch

With the economy slowing and financial conditions tightening, the outlook for the Big Six banks in 2023 is deteriorating, says Fitch Ratings.

In a new report, the rating agency said it expects the big banks’ financial profiles to decline in the year ahead as the tougher economic and financial conditions weigh on the banks’ asset quality, growth prospects and funding mix. At the same time, capital positions are expected to soften to pre-pandemic levels as pending acquisitions eat up the banks’ capital buffers.

“Bank profitability already evidenced moderation in the second half of 2022 and will remain pressured in 2023,” Fitch said.

Rising loan-loss provisions and weaker income from asset management and investment banking weighed on the banks’ fourth quarter earnings, it noted.

The six domestic systemically important banks reported $14.7 billion in aggregate adjusted earnings for the fiscal fourth quarter (ended Oct. 31). Earnings were up 0.4% from the previous quarter, but 2.0% lower than the same quarter last year, the rating agency said.

Fourth quarter earnings were pressured by higher credit provisions and lower non-interest income, Fitch reported.

“Provisions for credit losses increased more substantially, as banks factored in more pessimistic macroeconomic outlooks,” it said, noting that aggregate provisions increased to $2.3 billion in the fourth quarter, up from $1.5 billion in the prior quarter.

The increase in provisions came as credit quality measures deteriorated slightly at most banks after eight consecutive quarters of improving credit conditions, Fitch said.

“As a share of gross loans, impaired loan ratios increased to 38 basis points on average compared to 35 bps in the prior quarter,” it said, adding that aggregate impaired loans rose 1.4% year over year.

“Increased impairments were broad based, with little evident stress in mortgage portfolios,” it said.

“Banks guided to higher provision ratios next fiscal year, in line with or slightly lower than pre-pandemic levels,” Fitch said.

Alongside the rise in provisions, non-interest income was weaker in the fourth quarter, declining by 8% year over year.

“Asset management and investment banking fees, which had provided strong revenue contribution during the pandemic, were widely down, partly offset by moderate growth in trading and traditional deposit and credit fees,” Fitch said.

The weakness in these segments was also offset by loan growth and higher interest rates, which supported higher net interest income, up 14% on aggregate compared with the same quarter last year.

Aggregate loans rose by 15% year over year, and deposits were up 11%, Fitch reported, “reflecting momentum in reopening-related spending and business expansion.”

However, with the economy expected to weaken, “banks expect loan and deposit growth to slow,” Fitch said.

This is expected to translate into lower earnings next year.

Fitch said it expects that “a combination of slower loan growth, a rise in deposit betas, continued sluggishness in fees, and normalization in provisioning will result in weaker profitability across the banks in fiscal 2023.”

Net interest margins are expected to continue expanding next year, albeit at a slower pace.

Segments such as investment banking and wealth management “will continue to face revenue headwinds from reduced corporate appetite for issuance and M&A, along with unfavourable conditions for assets under management growth,” it said.

“Higher net interest income may be the only bright spot for Canadian bank revenues in 2023 and may not be sufficient to offset lower fee income and higher provisions,” said Mark Narron, senior director at Fitch, in a release.

“A key area to watch next year will be retail loan quality, particularly mortgage quality, as customer savings buffers decline in the face of a housing market correction, rising rates and persistently high inflation,” Fitch noted.

Nevertheless, the rating agency said it expects housing prices to stabilize in 2023, “with signs of a slowing housing correction now emerging.”

Additionally, the labour market will be a critical barometer for the banks next year.

“A rise in unemployment materially above pre-pandemic levels, or a terminal policy rate materially above Fitch’s assumption of 4.0%, would signal a more challenging operating environment for Canadian banks than expected, likely leading to higher than expected credit losses,” it said.