What do the Big Six's Q3 earnings say about the Canadian economy?

Further uncertainty is on the way – but the banking giants appear poised to weather any coming storms, says analyst

What do the Big Six's Q3 earnings say about the Canadian economy?

The third-quarter earnings performance of Canada’s Big Six banks reflect continuing uncertainty in financial markets – but sound liquidity and adequate capital levels leave those banking giants well positioned to manage through the challenging economic environment, according to a leading market observer.

While RBC, BMO, and National Bank reported higher Q3 profits than the same time last year, earnings season was once again marked by rising provisions for credit losses at each of the country’s leading banks, a list that also includes Scotiabank, TD and CIBC.

That formed part of a turbulent landscape for major financial institutions, DBRS Morningstar senior vice president and team lead, banking, Carl De Souza (pictured top), told Canadian Mortgage Professional.

“The Big Six banks continue to face a challenging operating environment characterized by persistent inflation and higher interest rates, macroeconomic uncertainty, and the US regional banking developments,” he said.

“So all of that taken into account, the Q3 sequential aggregate adjusted earnings were relatively flat and financial performance was negatively affected by a significant increase in provisions for credit losses (PCLs), as well as an uptick in non-interest expenses.”

Provisions on performing loans and impaired loans climbed higher across the top financial institutions – and while net interest margins posted modest quarterly expansion, they took a hit in the banks’ US segments and business lines, De Souza noted, reflecting the recent market turmoil there.

With a potential recession in the cards, the reality of materially higher borrowing costs for creditors would probably amplify credit deterioration at top lenders, he added, while net interest income and net interest margins could also face pressure from milder lending volumes, tighter margins, and higher funding costs.

“In a nutshell, when you look at the situation and how things are developing, there’s still a lot of uncertainty in the market,” De Souza said. “We expect to see further deterioration in those assets or credit quality metrics, especially considering that interest rates are staying higher for longer.”

High household debt levels continue as a challenge in Canada

Household debt levels in Canada remain elevated, with that metric as a percentage of GDP the highest of any G7 country – and the only one above 100%.

That means Canadians are more susceptible to rate hikes and any potential increase in unemployment, with rate-sensitive households and businesses continuing to face more pressure as loans reprice with steeper costs.

“That’s why we still expect to see an uptick in those credit quality metrics and further deterioration there,” De Souza said. “But I think when you look at the large banks, they maintain sound liquidity and adequate capital levels. So they’re well positioned to manage through the challenging operating environment that we’re currently in.”

Loan loss provisions expected to remain high in coming quarters

Those rising loan loss provisions among major banks have been a prominent theme in recent earnings results – and if storm clouds continue in the macroeconomic forecast, that trend would likely continue.

“Normally, that goes on the provision on the performing loans, and then as we move through the credit cycle, as things go delinquent and impaired, the provision is increased on that side, too,” De Souza said.

“So we do expect to see an uptick to continue in provisions. But it’s hard to predict how much at this point in time until the macro uncertainty plays out a little further.”

Top banks are also bulking up on capital levels after a recent decision by Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), to raise minimum threshold levels by 50 basis points to cover potential losses, effective November 1.

With OSFI’s next semi-annual decision set to take place in December, it “remains to be seen” whether that minimum threshold will be hiked even further, De Souza said – while the regional banking chaos that impacted the US in the spring is also seeing regulatory upheaval south of the border.

“The banks are looking at this, and there’s heightened capital requirements coming in some way, shape or form,” De Souza said. “So you’re seeing those capital levels up.”

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