Borrower stress in focus as banks set to report third-quarter results

Bay Street in Canada's financial district is shown in Toronto on Wednesday, March 18, 2020. (THE CANADIAN PRESS/Nathan Denette)

TORONTO -

While interest rates have started to come down, borrowers, and lenders, are still feeling the strain.

Just how much stress they're under will be a main focus for analysts as the big banks gear up to report third-quarter results.

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"Our key focus for the quarter will be on credit as pressure mounts from both commercial and personal banking customers," said Canaccord Genuity analyst Matthew Lee in a note.

The upcoming results, which kick off Thursday when TD Bank Group reports, will cover the three months to the end of July.

The timing overlaps with the first two Bank of Canada interest rate cuts that brought its key rate down half a percentage point to 4.5 per cent, a reduction matched by the banks that dropped their prime rates to 6.7 per cent.

Despite the cuts, it still makes for much higher mortgage renewal rates and continued challenges for those exposed to variable rates.

Banks have framed the credit environment as a normalization to pre-COVID levels, but Lee said he'll be looking closely at whether bank provisions for loan losses indicate worse to come.

"Outside of commercial banking challenges, we are focused on the weakening Canadian consumer, particularly in the card and auto books," he said.

The latest Bank of Canada survey of consumer expectations, released last month, showed financial stress had worsened from the first quarter, including Canadians seeing a higher probability of missing debt payments or losing a job.

The central bank has also warned that mortgage payments are set to see increases next year and in 2026.

More relief is on the way though, with many economists expecting at least two more rate cuts this year plus generally another full percentage point cut next year.

But even if borrowers keep making loan payments, analysts think the various economic challenges -- like elevated borrowing costs and the risk of a recession weighing on consumer sentiment -- will keep some downward pressure on loan growth, said Jeffries analyst John Aiken.

"While the Bank of Canada continues on its easing monetary policy stance ... lending volumes could be challenged and stay modest over the near term."

With loan growth subdued, there will also be some focus on the expense side of the equation. But expectations are that banks will see a positive bump from last year when several took restructuring charges related to staffing cuts heading into the economic slowdown.

Analysts are looking to 2025 as rates keep dropping to see a notable uptick in loan growth, as well as for banks to start to unwind the large credit loss provisions they've made because of default risks.

"While the impact of decreasing rates should be immaterial in Q3, we believe that the pull-forward of cuts make loan growth acceleration a more tenable possibility in the first half of (fiscal 2025)," said Lee.

For now, those provisions are largely expected to stay stable, though National Bank analyst Gabriel Dechaine revised his outlook for provisions to be slightly more negative heading into the quarter.

"These adjustments are justified simply by a general sense of conservatism, given rising insolvencies in Canada, potential commercial impairments and losses in some consumer categories," he said in a note.

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Dechaine however still sees banks achieving their own soft landing through this tricky stretch.

"A sufficient level of rate cuts should allow Canadian banks to avoid a sharp uptick in loan losses, as we've seen in previous downturns."

Overall, bank stocks are likely to still be under some pressure and underperform the wider market, until there's more clarity on those loan losses, and the potential for more profit growth, said Aiken.

"There will need to be much stronger-than-anticipated earnings to fuel support for the banks, and we believe that it will be difficult for them to break out to the upside this earnings season."

Toronto-Dominion Bank kicks off earnings on Aug. 22. The other major banks follow in the next week, with Scotiabank and BMO reporting Aug. 27, RBC and National Bank on Aug. 28, and CIBC wraps earnings on Aug. 29.

This report by The Canadian Press was first published Aug. 20, 2024.