Banking sector worries ease ahead of Q1 results, but relief still a ways off

Stock markets may be hitting record highs in the U.S., Japan and Europe, but Canadian bank shares are not catching as much momentum as they head into first quarter earnings results. (Adrien Veczan / THE CANADIAN PRESS)

Stock markets may be hovering around record highs internationally, but Canadian bank shares haven't seen as much momentum as they head into first-quarter earnings results this week.

The sector has been lagging on concerns of sluggish loan growth, risks to existing loan portfolios and a range of other headwinds including changes to tax exemptions and capital requirements.

Some of the biggest fears are easing, but analysts say a turnaround isn’t expected any time soon.

“After many quarters of bearishness, we are getting much more constructive on the outlook for Canadian banks,” said Scotiabank analyst Meny Grauman in a client note.

“The only hitch is that from a numbers point of view we only see that happening in (fiscal) 2025.”

Slow loan growth, especially in the U.S., and the elimination of a tax deduction on dividend income from Canadian businesses will weigh on results this year, he said.

Earnings for the first quarter could come in six per cent higher than last quarter, but should be about 11 per cent below the same quarter as the prior year, said Grauman.

Profits will also be affected as banks continue to set aside money for potentially bad loans, said Carl De Souza, sector lead of North American financial institutions at Morningstar DBRS.

"We definitely think they're going to be negatively impacted by a continued ramp up in provisions for credit losses as the credit normalization continues."

While residential real estate shouldn't cause too much concern, commercial real estate will be one of the drivers for provisions, especially as the U.S. office market is seeing strain.

Canadian banks are affected by the pullback in the market, but are diversified enough to weather through it, said De Souza.

"There will be a little bit of pain there, but it should be manageable."

Overall, there hasn't been as much cause for concern in loan portfolios as some had feared, said National Bank analyst Gabriel Dechaine in a note.

“Aside from a few pockets of weakness (e.g., commercial real estate) the credit picture has been a benign one.”

For the year ahead, he expects to see significant improvement on the expense front, after banks took some big charges related to layoffs last year to adjust to lower activity. The benefits won’t likely show up in the first quarter though, as the cost-cutting measures aren’t immediately effective and later quarters will show a more dramatic swing from higher expenses last year.

The margins banks make on interest are also expected to expand, but again, not until the latter half of the year, said Dechaine.

The delayed boost, along with cautious commentary from management, helps explain why the Big Six bank stocks have underperformed the market by nearly three percentage points early into 2024, he said.

The economic picture is improving, though, with an encouraging slowdown in the inflation rate, at 2.9 per cent last month — a sharper deceleration in price growth than expected by forecasters.

The housing market also looks resilient, with home sales up 22 per cent in January from last year to mark a second month of rising activity, data from the Canadian Real Estate Association showed.

The jobs picture also looks good, with Canada's unemployment rate falling to 5.7 per cent last month, to mark the first decline since December 2022.

The encouraging economic data is helping ease fears around Canadian real estate, said Grauman.

“We are increasingly convinced in the resiliency of the Canadian housing market, even in the face of the coming mortgage renewal wave.”

Overall, the quarter looks to be one of low expectations, said James Shanahan, senior equity research analyst at Edward Jones.

The more alarmist takes on credit, especially on housing, are a little bit overdone, he said, but he does see the outlook for loan growth to be really poor.

With pressure on so many areas of the business, he said capital markets could be the best chance for upside potential.

“We're still hopeful that a recovery in capital markets activity, particularly (initial public offerings) and (mergers and acquisitions), could be a strong catalyst for earnings growth for the Canadian Banks," said Shanahan.

“Otherwise, if you're just looking for loan growth margin expansion, expense management, maybe lower credit costs, I think you're going to be disappointed.”

Scotiabank and BMO start the round of earnings on Tuesday, followed by RBC and National Bank on Wednesday and CIBC and TD Bank on Thursday.

This report by The Canadian Press was first published Feb. 26, 2024