Canadian banks benefit from credit tailwinds, reserve releases
All of the large Canadian banks reported positive year-over-year earnings growth for the third consecutive quarter, reflecting tailwinds from reserve releases in light of the macroeconomic recovery and cyclically low impaired loans, as well as continued strength in non-interest income, Fitch Ratings says.
Canadian bank results for the fiscal quarter ended July 2021 (3Q21) signal banks’ continued recovery from the pandemic-related downturn, and support Fitch’s reversion of bank rating Outlooks to Stable for the majority of banks this year.
Lower than normal provisioning continued to exert a significant influence on bank results. As a share of net loans, provisions remained well below pre-pandemic levels. With the exception of Bank of Nova Scotia (BNS), the six largest banks reported net recoveries of credit losses during the quarter. Desjardins Group (DESJ) also reported a net negative provision for its quarter ended June 2021.
The banks added approximately CAD13.7 billion in reserves for credit losses during the pandemic in aggregate from February to October of last year. Of these additional reserves, the respective banks have drawn down 18%-58% to date, providing opportunities for further reserve releases over the coming quarters.
Earnings should also benefit from a base case of an improving revenue environment, a more favorable business mix and higher rates (in Canada by the end of 2022 and in the U.S. by the end of 2023).
Revenue growth across the sector remained positive on a year-over-year basis, helped by continued strength in mortgage origination, wealth management and capital markets segments across most institutions.
Canadian Imperial Bank of Commerce, National Bank of Canada and DESJ reported positive commercial loan growth on a year-over-year basis, reflecting green shoots in real estate and construction, particularly in Quebec. At the other large banks, however, commercial loan balances remained moderately down YoY. Similarly, higher-yielding credit card balances remained low across the sector, as recovering purchase activity was offset by higher customer payment rates.
Positively, across most banks YoY deposit growth mostly trended below the double-digit levels seen during the pandemic period, which should relieve some pressure on net interest income. In Fitch’s view, near-term revenue growth will depend on the timing of recovery in demand for unsecured consumer loans and commercial credit, on the one hand, and moderation in wealth management and capital markets outperformance on the other.
The weaker USD relative to the CAD also impacted the reported earnings of banks with large US operations such as Bank of Montreal and The Toronto-Dominion Bank.
In terms of asset quality, banks reported cyclically low loan impairments and net charge offs, comparing favorably even to the pre-pandemic period. BNS’s net chargeoff ratio remained moderately higher than the prior year but declined sequentially, largely reflecting expiring forbearance in its international loan portfolio. Continued uncertainty over operating conditions in core Latin American markets underpins Fitch’s maintenance of BNS rating on Negative Rating Outlook.
Downside risks related to coronavirus variants remain. However, according to Fitch’s base case, Fitch anticipates manageable deterioration in credit measures over the medium term as government relief programs expire and loans that benefitted from forbearance season.
Capitalization across banks remained elevated relative to historical levels, benefitting from continued restrictions on capital actions and depressed loan growth. Excluding DESJ, banks’ CET1 ratios improved 50 bps-200 bps YoY and will likely decline to historical levels over the medium term through higher dividend payout, expansion of customer assets and the full expiration of transitional regulatory arrangements for expected credit losses.
Regulatory leverage ratios also remain elevated, supported by exclusions of sovereign securities and central bank reserves. Authorities recently confirmed the permanent exclusion of central bank reserves from this ratio. A recently proposed 3% surtax on bank profits over CAD1 billion would have limited impact on earnings and internal capital generation, in Fitch’s view.