Economic headwinds threaten to dampen outlook for Canada’s big banks, analysts say

Canada’s biggest banks could feel the pinch from a weakening domestic economy, but analysts say it is too early to determine how severe that impact might be.

On Wednesday, theBank of Canada announced it was holding its key interest rate at 1.75 per cent, saying an anticipated economic slowdown in the fourth quarter had been “sharper and more broadly based” than expected.

“After growing at a pace of 1.8 per cent in 2018, it now appears that the economy will be weaker in the first half of 2019 than the Bank projected in January,” the BoC said.

Canada’s big banks are already coming off a quarter that saw their capital-markets businesses hit hard by market volatility, affecting profit for the three months ended Jan. 31.

DBRS Ltd. warned Wednesday of what a cooler Canadian economy could mean, noting that the Big Six lenders saw their collective earnings increase 4.9 per cent in the first quarter year-over-year, but decrease 7.8 per cent quarter-over-quarter.

“For the balance of 2019, DBRS expects earnings growth for the large Canadian banks to be tempered given the weaker-than-expected start to the year and slowing economic growth, which is likely to constrain income growth,” the credit-rating agency said. “However, despite challenging market conditions, Q1 2019 results reflected the highly diversified core earnings power of the large Canadian banks.”

The Bank of Canada had said Wednesday that consumer spending and the housing market had been “soft” in the fourth quarter, although there had been “strong growth” in employment and labour income.

National Bank Financial analyst Gabriel Dechaine had said Tuesday that “the clearest indicator of a weakened (or a more cautious) consumer” had been the slowdown in residential mortgage growth in the latter half of 2018, which had continued in the banks’ first quarter.

“Other consumer lending categories (e.g. cards, autos) are either treading water or decelerating,” Dechaine wrote. “The big question we believe investors are asking is whether this trend of decelerating consumer spending (and borrowing) represents a manageable topline headwind for the banks or a precursor to a shift in the credit cycle. For now, we believe it is a case of the former.”

A weaker economy could see some clients struggle to repay their loans as well.

DBRS said that it expects the banks “will continue to modestly increase their allowance on performing loans for the remainder of the year given ongoing headwinds related to slowing economic and credit growth.”

CIBC World Markets analyst Robert Sedran said Sunday in a note on the first-quarter that, “while credit trends seem reasonably benign, loan losses were nevertheless an issue as commercial and corporate losses on impaired loans picked up and most banks decided that provisions on performing required a boost as well.”

“Nothing too concerning (especially on delinquency trends that are largely stable),” he added, “but another sign of the economic cycle’s age.”

Sedran also noted that bank stocks had rallied to start the year, but that they may need some good economic news to boost them even further.

“Better results and better signs on the macroeconomic environment are required for that to happen, which means this can take some time,” he wrote. “In the meantime, we look for the stocks to be range-bound absent some move in the markets more broadly in either direction.”

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