Canadian banks reduce their future bad debt cushion even as economic risks increase

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Rising prices and rapid Central Bank interest rate hikes are squeezing Canadians, who are already among the most indebted in the developed world, and concerns are mounting about how much more rates need to rise to avoid a inflationary spiral.

“Recessions start when the economy is at its peak,” said Brian Madden, chief investment officer at First Avenue Investment Counsel.

Canadian banks are “probably releasing provisions on performing loans due to overconfidence in their base (positive) economic scenario and underweighting the likelihood of adverse scenarios, which I believe is no longer a extreme risk”.

Total provisions for credit losses at Canada’s big six banks fell 20% in the second quarter from a year ago to around C$23 billion ($18.1 billion), the lowest level two-year lows, according to the banks’ financial statements.

Already, there is evidence that consumers and businesses are feeling the pinch, with insolvencies https://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br04638.html#t1 en 24% increase in March to February.

Many banks also expect mortgage growth to slow from pandemic levels, although the continued recovery in business and credit card lending should help offset this.

Royal Bank of Canada reported the biggest drop in allocations, down 30% from a year ago. Chief risk officer Graeme Hepworth told analysts the bank had adjusted its provisions to reflect increased economic headwinds, but that was offset by pandemic-related reserve releases.

The Canadian Imperial Bank of Commerce, which missed estimates in part on higher provisions, and the Toronto-Dominion Bank saw the smallest year-over-year declines in LCAs.

“We like the messages we’ve heard” from TD, which has withheld “a fair amount” of macro risk provisions, CIBC capital markets analyst Paul Holden wrote in a note Thursday. “Credit trends are benign, but TD still takes a cautious view of the future.”

Despite the downward trend of recent quarters, ACLs remain approximately 21% above pre-pandemic levels.

“They’re building up provisions … maybe it’s not building up as quickly as you might expect,” said Rob Colangelo, senior credit manager at Moody’s Investors Service.

The Canadian bank stock index has gained 2.3% since lenders began reporting results this week, compared to a 1.8% gain in the broader benchmark Toronto stock index, reducing their underperformance since the March peak.

They remain below their historical average trading price relative to forward earnings, while offering higher dividend yields than their US counterparts.

While acknowledging that some conditions have deteriorated, many banks pointed to the strength of the economy and employment, as well as continued business investment, as drivers of earnings growth and strong credit quality. .

“It’s a strange world, isn’t it?” Laurent Ferreira, managing director of the National Bank of Canada, said Friday during his call with analysts. “You have a strong economic backdrop…and tons of pessimism about a possible recession.”

($1 = 1.2742 Canadian dollars)

(Reporting by Nichola Saminather in Toronto; Editing by Chizu Nomiyama)

By Nicholas Saminather

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