What profits at Canada's big banks are saying about the odds of a recession

Posted by Teresa Mardon on Tuesday, August 27th, 2019 at 6:42am.

If a recession is headed our way, the canaries in the economic coal mine that are most likely to sing its arrival will be Canada's big banks. That's because Canada's five biggest lenders — Royal Bank, TD, Bank of Montreal, Scotiabank and CIBC — have a hand in nearly every aspect of Canada's economy, from loaning businesses money for expansion to funding the mortgages that finance much of the housing market.

Those same banks are in the midst of revealing their quarterly earnings this week, and the numbers should offer a good glimpse of where the economy is headed.

Profits up

The Royal Bank of Canada was first to report last week, showing profits rising to a record $3.3 billion in the third quarter. CIBC was next, with a quarterly profit of $1.4 billion in the three months up to the end of July.

Both figures are up only slightly from last year's level, but in a world in which the financial media is warning of negative ratesinverted yields and huge stock market swings on a seemingly daily basis, rising profits are good to see at the banks. Because if the banks are making money, there's a good chance many of their customers are doing well, too.

The Bank of Montreal and Scotiabank will report their earnings Tuesday morning. TD's expected to show its hand on Thursday. 

While the forecast for the two banks we've already heard from was generally sunny, that's not to say there weren't a few clouds on the horizon — potential storms that investors will be on the lookout for in the other banks' outlooks.

Mortgages

Royal managed to grow their residential mortgage business by almost 6 per cent in the past year to $298 billion, an impressive feat considering how big a player they were in the market to begin with. As CBC News has reported, mortgage rates have been headed lower in recent months, a development that's a double-edged sword for banks — because each mortgage individually is less profitable for them, but they are also able to sell more of them because they appear to be cheaper.

Policymakers have spent years worrying about Canadians' debt loads, but Royal Bank's performance suggests there's room for more. Borrowers wouldn't be taking on all that new debt if they weren't feeling confident about their prospects, either. As TD Bank analyst Mario Mendonca put it, "We expect mortgage growth to make a healthy recovery this quarter, reflecting a reasonably strong spring selling season, particularly in Ontario."

The mortgage picture at CIBC, meanwhile, wasn't quite as rosy. Despite handing out $9 billion in new mortgages during the quarter, the total value of CIBC's mortgages actually shrank by a little more than one per cent to $222 billion.

Worse still for the bank is where many of them are. "CIBC is the most-exposed to mortgage loans in Ontario and British Columbia," Bloomberg analyst Paul Gulberg said. 

While Canada's housing market overall has shown signs of stabilizing, activity in Toronto and Vancouver is still causing worry, so it should be interesting to see what the other banks have to say about their mortgage businesses.

Other types of loans

Another possible dark cloud on an otherwise blue sky could be what the banks are saying about their loans to businesses. That's because both banks that reported higher credit loss provisions — money that banks set aside to write off bad loans. While it's still a tiny slice of their overall business, if more businesses are having trouble paying back their bank loans, that's a bad sign for the economy. 

At Royal, credit losses came in at $425 million, a 27 per cent increase year over year. At CIBC, the figure stood at $291 million for the quarter, a 21 per cent increase year over year.

The worst part is those credit losses seem to be spreading beyond certain problematic parts of the economy.

"It used to be oil and gas but it looks like it has spread ... to some other areas," said James Shanahan, a senior equity research analyst with Edward Jones.

The oil and gas sector has been hit hard and has been a black mark on Canada's economy for a while, but there's some evidence that weakness is spreading to businesses in forestry, agriculture, and other industries, he said.

"It's not too surprising given the tremendous growth, but this could be a problem for the banks," Shanahan said.

But more cash for shareholders

Loans going bad are a bad sign for any business — never mind the broader economy — but the two banks did give a surefire indication that they are feeling confident about their prospects: they raised their dividend.

No major Canadian bank has missed a dividend payment in more than a century, but with a track record like that, banks are incredibly careful not to promise any more cash than they are confident they'll be able to come up with.

Companies that have to snatch back a dividend payment tend to be punished heavily on the stock market, so the banks have been raising their payouts steadily, but cautiously, for decades. 

Based on Royal and CIBC not increasing their dividends during the previous quarter, Mendonca was expecting both banks to hike this time around. And that's exactly what they did — another three cents for Royal and four for CIBC. 

He's expecting a bump up at Scotiabank, too, but not for BMO since that bank already hiked last quarter.

Based on how much they are paying out, Shanahan says the banks have some capacity to keep the dividend hikes coming, but on the whole he thought the numbers at Royal and CIBC showed they are "in pretty good shape."

And as for the rest, "I think results will continue to come in similarly," he said.

 

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