Canadian banks face weaker earnings growth ahead of rate hike

Canadian banks are poised to report their weakest profit increases in a year and a half, before higher interest rates expected in the coming months are likely to revive profit growth.

According to analyst estimates compiled by Bloomberg, the country’s six largest lenders are expected to post a net income gain of 4.6% on average for the first quarter of the fiscal year. It would be the smallest increase since the third quarter of 2020, when profits fell 18% as banks hid capital to protect against possible loan losses during the pandemic. Earnings reports kick off Thursday with Royal Bank of Canada.

For Canadian banks, the three months to January could mark a transition from the post-crisis boom — when profits were fueled by soaring capital market activity, as well as the release of much of their capital stock — and the coming years, when rising interest rates promise to widen their lines of credit. Canada’s central bank is set to raise rates on March 2, when its next policy move is expected, with at least six more hikes likely over the next year.

“Higher rates benefit their margins, and a lot of that will come back to the bottom line,” Canaccord Genuity Group Inc. analyst Scott Chan said in an interview. “The current outlook, with the variant leaving and things reopening, looks very constructive for personal and business affairs.”

It would be a welcome change for financial firms which have seen their lending margins shrink and interest income stagnate as central banks cut interest rates to help the economy during the COVID-19 crisis. Net interest margins are expected to be little changed in the first quarter from the previous three months, after shrinking for most of the past two years.

And lending growth beyond mortgages — a business that has historically been strong, but with low margins — could also help profitability in coming quarters, according to Canadian Imperial Bank of Commerce analyst Paul Holden. .

“Residential mortgage growth in Canada remains robust, but other categories of loan growth are beginning to pick up,” Holden said in a note to clients. “We are seeing an acceleration in loan growth across loan types and geography. This is an additional tailwind for the net interest margin.

In the meantime, the trends that dictated bank results coming out of the early days of the pandemic may have come to a halt. Capital markets revenues for Canada’s six largest banks were little changed from a year earlier in the fourth quarter of the fiscal year and were down over the previous three months.

The eight-company S&P/TSX Commercial Banks Index is up 6.9% this year, compared with a 1.5% decline for the broader S&P/TSX Composite Index. The Canadian Imperial Bank of Commerce was the top performer in the bank index, rising 9.5%.

Revenue from M&A advisory, while still strong, may have plateaued towards the end of last year. Trading revenue, which had declined as markets stabilized throughout 2021, may have increased amid market volatility in January, but is unlikely to return to levels seen at the start. of the pandemic.

Similarly, the release of provisions for credit losses had supported earnings in recent quarters, but that trend may be coming to an end. Analysts expect the Big Six to pocket $943.6 million ($741.2 million) in provisions for credit losses, compared to $271 million in releases in the fourth quarter. While analysts have consistently overestimated potential reserves – and underestimated releases – projections signal that the tailwind is diminishing.

Another potential pitfall for banks will be expenses. Payroll costs for lenders rose last year to more than twice the average rate of the previous three years, and inflation that has topped economists’ projections threatens to drive up spending even further.

“The big banks have more or less suggested that inflation risk appears to be manageable,” Royal Bank of Canada analyst Darko Mihelic said in a note. “But the spending outlook could be one area where we might hear a change in tone from the big Canadian banks given recent inflation data and the results we’ve seen from U.S. banks.”