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Big banks brace for a downturn that hasn't fully arrived


Canada’s biggest banks are taking steps to prepare for a downturn, despite mixed economic conditions that have boosted some aspects of their business while pressuring others.

The Big Six reported earnings last week that reflected the choppy economic picture, with some beating expectations and others missing. On one side, higher labour costs and increased provisions for credit losses dragged on results; on the other, rising interest rates boosted net interest margins, a significant driver of profitability.

Dave McKay, president and chief executive officer at RBC, said elevated uncertainty has been prompting investors to stay on the sidelines, affected asset values and dampening capital markets revenue. He added that while he sees silver linings like a strong jobs market and inflation that has appeared to have peaked, the bank is still cautious on the economic outlook largely because of high house prices and associated levels of consumer debt, high energy prices, and political and geopolitical tensions.

Despite the looming threat of a recession, McKay said he believed the slow-moving impacts of monetary policy might mean that even as banks are feeling some effects of a downturn, the full dose may not hit for a while.

“Although higher interest rates are needed to preserve long-term economic stability, the lagging impact of monetary policy combined with strong employment and significant liquidity in the system has likely delayed what may end up being a brief and moderate recession,” McKay said during the RBC conference call on Nov. 30.

McKay pointed to the bank’s “crown jewel” — its deposit and payments franchise — and its deposit-funded balance sheet as a key driver of profitability and a buffer in a rising-rate environment. RBC’s Canadian banking segment’s seven per cent growth was driven by a nine per cent boost in loans and deposits over fiscal 2022. Deposits were also a low-cost way to drive gains in the U.S. wealth management segment and investor and treasury services segment through higher deposit margins.

RBC’s chief financial officer, Nadine Ahn, said the focus on deposit margins has helped smooth over interest-rate change while providing a benefit from past rate hikes.

“These deposit margins should continue to expand as maturing ladders of deposits from the past low-rate environment are reinvested at higher yield,” she said during RBC’s Nov. 30 conference call.

These same dynamics helped support Toronto-Dominion Bank’s net interest margin growth. TD’s average deposit volume grew by four per cent, bolstered by an eight per cent growth in personal deposits. Kelvin Tran, TD’s chief financial officer, said during the Dec. 1 conference call that the bank’s net interest margin grew by 11 basis points to 2.7 per cent, largely because of higher deposits margins from rising interest rates. The other Big Six banks pointed to higher growth on deposits and their spreads in a rising rate environment.

However, rising rates may have also dampened potential growth in mortgage loans as borrowing costs keep would-be homebuyers on the sidelines. The Bank of Canada has raised rates three-and-a-half per cent over the course of the year to 3.75 per cent in an effort to pull some demand out of the economy and give strained supply chains a chance to catch up. Housing has been the hardest-hit sector as mortgage demand has buckled under the weight of higher rates.

The banks are factoring this into their outlooks. Laura Dottori-Attanasio, the group head of personal and business banking at the Canadian Imperial Bank of Commerce, said the mortgage application pipeline has slowed.

“We expect to see, I’d say low single-digit growth for 2023,” Dottori-Attanasio said during a Dec. 1 conference call following CIBC’s results, adding there had been consistent growth in mortgage volumes and strong client retention.

“While we’ll see volume come off of 2022 levels, we do expect to continue to do really well on the franchising side, and to grow in other areas of the bank that I think are going to offset some of the decrease that we see in the mortgage side of the business.”

RBC’s mortgage volume grew by ten per cent in its fourth quarter, which McKay noted came down from its peak but remained in-line with pre-pandemic levels.

The Bank of Montreal’s residential mortgage lending volumes grew 12 per cent compared to the fourth quarter last year, while The Bank of Nova Scotia’s grew 11 per cent in the same timeframe and TD managed mortgage loan growth of 17 per cent.

TD’s chief risk officer Ajai Bambawale warned of elevated economic risks from persistent inflation and rising rates.

“While results may vary by quarter, I expect (provisions for credit losses) to be higher in 2023 in the range of 35 basis points to 45 basis points, as credit performance continues to normalize and the economic trajectory unfolds,” Bambawale said during the Thursday afternoon conference call.

Canada’s Big Six banks have been shoring up provisions for credit losses, or setting aside more funding for loans potentially going sour. The banks have been setting more aside over the year, putting more of a strain the banks’ fourth quarter and full-year results.

So far, the economic slowdown has not fully materialized. Third quarter gross domestic product growth came in hotter than expected at an annualized pace of 2.9 per cent, according to the latest read from Statistics Canada. The labour market has also remained resilient, with 10,100 jobs added to the economy in November, in line with economist expectations.

Despite the promising data, bank stocks have been battered this year as uncertainty sets in. On average, shares of the Big Six banks are down just over ten per cent year-to-date.

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