What this week's big bank earnings say about the state of Canada's economy ahead of a possible recession

What this week’s big bank earnings say about the state of Canada’s economy ahead of a possible recession

The latest earnings reports from Canada’s major banks show signs that Canada’s economy is slowing ahead of a potential recession, with some hints of optimism.

The Big Six banks – RBC, TD, CIBC, Scotiabank, BMO and National Bank – all released their Q4 2022 reports this week. Five of the six reported a decline in earnings compared to last year and three missed profit expectations.

Michael Morrow, executive director of mergers and acquisitions and capital markets at financial firm BDO Canada, says high inflation, lower capital markets activity and rising loan loss provisions are putting pressure on big banks.

High inflation meant higher operating costs — including higher staffing costs in a tight labor market — which cut into their margins, Morrow said. Meanwhile, rising interest rates and economic uncertainty have slowed investment and led to less active capital markets.

“Capital markets activity continues to be a drag on all banks, particularly those with a higher concentration of capital markets activity versus regular retail-related activity,” Morrow said.

RBC chief executive Dave McKay said on Wednesday the bank was preparing for a “short and mild recession”.

In anticipation of an economic downturn, big banks are also increasing their loan loss reserves, which refers to the money set aside to cover bad loans.

“Because of the bank’s concerns about the economic performance of the Canadian economy, that could mean more loan losses. And so their provisions have been creeping up every quarter, including this quarter,” Morrow said.

“It’s definitely a leading indicator in terms of where we think the Canadian economy will be next year and where the risks are.”

Loan loss provisions particularly weighed on CIBC, which set loan loss provisions for the three-month period at $436 million, up from $78 million in the same quarter last year. CIBC missed profit expectations by more than 19 percent.

“Looking ahead to 2023, global economic growth is expected to be slower as central banks continue to tighten monetary policy to tame inflation,” CIBC CEO Victor Dodig said on an earnings call on Thursday.

“In response to these headwinds … we will continue to take steps to reposition our business to accommodate these new realities, but we will also continue to expand our client franchise and moderate our cost growth.”

But despite these so-called headwinds, Morrow believes there is still good news to be gleaned from these results. Most of the Big Six are increasing their dividend rates for shareholders, which Morrow said “gives us a view of confidence in the stability of the banks and their profitability profile”.

“If they’re raising dividend rates, then that’s certainly a sign that they feel the business and their capital ratios will be able to not only weather this downturn, but continue to thrive over the course of the year, into the second half of next year. year,” he explained.

In addition, RBC announced a $13.5 billion takeover of HSBC’s Canadian operations, pending regulatory approval. Morrow says he sees the purchase as a “positive vote of confidence for the Canadian economy,” especially given the fact that RBC is paying a premium price for the acquisition. The bank pays 9.4 times HSBC Canada’s adjusted earnings for 2024.

“Certainly, you know, it draws on the confidence that RBC has within the Canadian lending market. And if there was some doubt in the Canadian market, you wouldn’t see those participants paying market premiums at this point in the cycle,” he said.

With files from The Canadian Press and Reuters

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