Are resilient bank earnings masking growing pressure on heavily indebted Canadian households?
Given that it took place against the backdrop of the Iran war, tariff tensions and continuing economic uncertainty, the last quarter appears to have gone reasonably well for Canada’s banking giants.
Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), Bank of Nova Scotia (Scotiabank), Canadian Imperial Bank of Commerce (CIBC), Bank of Montreal (BMO), and National Bank of Canada (NBC) all posted second-quarter earnings this week, beating analysts’ expectations for the most part and putting up sturdy numbers in the face of the economy’s volatility.
That’s not to say the results were uniformly excellent – adjusted aggregate earnings saw a modest quarter-over-quarter decline – but there’s little sign yet that the nation’s top banks are taking a big hit from any of the broader issues facing the Canadian and global economies.
“Considering the lingering tariff uncertainty, the upcoming CUSMA [Canada-US-Mexico Agreement] negotiations, and the onset of the Middle East conflict which started early in Q2, it’s quite resilient performance,” Carl De Souza (pictured top), senior vice president and sector lead for North American financial institution ratings at Morningstar DBRS, told Canadian Mortgage Professional.
He said the results are best understood on a quarterly basis rather than year over year, since last year’s second quarter included a hefty $1.8 billion in aggregate provisions set aside by the Big Six for tariff-related concerns after the US launched its wave of global levies – making that a high bar for comparison.
Quarterly, revenue was down by 2.7% across the top banks, with net interest income falling by 1.4% (although that can be partly explained, De Souza said, by three fewer calendar days in the quarter compared with Q1).
Loan growth remained soft, at just above 1% quarter over quarter, while aggregate average net interest margins (excluding trading) fell by three basis points.
Non-interest income remains elevated relative to historical norms, although it declined by roughly 4% compared with the prior quarter, and costs have held the line. Non-interest expenses were down 2.6% from Q1, spurred by lower staffing expenses and the shorter quarter.
Provisions for credit losses – the funds set aside by the banks to cover potentially souring loans – slipped by 3% quarterly, and impaired PCLs (which relate to loans whose credit quality has already deteriorated) moved 7% lower.
The Big Six’s mortgage books also remain well collateralized, even despite a wider trend of rising insolvencies.
“The probability of default is going up for certain borrower segments,” De Souza said, “but the loss given default – with that equity cushion – is not going up.” Credit bureau scores on the banks’ mortgage portfolios are approaching 800, with loan-to-value ratios around 60%, giving borrowers roughly 40% or more in equity – a significant buffer even in a stressed environment.
Insolvencies on the up
Still, that jump in insolvencies, reported earlier in the week by Equifax, remains a trend worth watching. Spiking insolvency numbers in Ontario and British Columbia have pushed the national rate to its highest since 2009, and tariffs are clearly weighing against those provinces.
“There are pockets of stressed borrowers and elevated unemployment in Ontario driven by sectoral tariffs, like in auto,” De Souza said. “Those pockets have little capacity for anything: higher inflation, gas, food, unexpected car or home repairs. They don’t have a lot of disposable income left.
One mitigating factor: a greater share of insolvencies is flowing into consumer proposals rather than outright bankruptcies, meaning borrowers are still trying to work through their challenges and retain assets, rather than walking away entirely.
Capital levels across the Big Six are still comfortably above the regulatory threshold of 11.5%, inclusive of the domestic stability buffer, and the banks also continue to deploy excess capital into share buybacks.
Plenty of wider uncertainty remains, particularly with Statistics Canada reporting on Friday that the national economy has slid into a technical recession after two consecutive quarters of stalled growth.
Are rate hikes back on the table?
The prospect of stagflation also remains – bringing with it the possibility of Bank of Canada rate hikes in the months ahead if inflation numbers continue to worsen.
But the nation’s banking giants still appear well capitalized to handle current and impending turbulence, with their second-quarter numbers more resilient than some smaller financial institutions.
“They had a good result for sure. The performance remaining resilient – that’s not the case for some of the non-Big Six,” De Souza said.
For the rate outlook, meanwhile, much will depend on how long the US-Iran war drags on, and whether price pressures worsen as a result.
“Without the Middle East war, economists wouldn’t be factoring in a probability of interest rate hikes. We don’t know how long the conflict is going to last – and even if it resolved today, [oil] flows wouldn’t start until October. So higher prices in the interim, and whether that translates into transitory or embedded inflation remains to be seen.”
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