Recently, Canadian banks wrapped up second-quarter earnings season last week, with most reporting better-than-expected profits. They wrapped in large part by reducing the amounts of funds that have been set aside for future loan losses, raising questions among investors and analysts about whether they are too sanguine about looming risks.
Rising prices and the central bank’s rapid interest rate hikes are squeezing Canadians, who are already among the most indebted in the developed world, and concerns are rising about the extent to which rates must further increase to skirt an inflationary spiral.
Canadian banks are likely “releasing provisions on performing loans on over-confidence in their (positive) base case economic scenario and underweighting the likelihood of adverse scenarios, which is, in my view, no longer a tail risk.” Total allowances for credit losses at Canada’s Big Six banks fell 20% in the second quarter from a year ago to about C$23 billion ($18.1 billion), the lowest level of the past two years, according to the banks’ financial statements. Many banks also predict mortgage growth will slow from pandemic levels, although further business and credit card lending recovery are expected to help offset that.
Canadian Banks Share Index
The Canadian banks share index has gained 2.3% since the lenders began reporting results this week, compared with a 1.8% gain in the broader Toronto stocks benchmark.GSPTSE, shrinking their underperformance since the March peak. They remain below their historical average trading price relative to the forward earnings while offering higher dividend yields than U.S. peers.
While acknowledging that some conditions have worsened, many banks pointed to a firm economy and employment, and ongoing investment by businesses as drivers of earnings growth and high credit quality.
“It’s a strange world, right?” Laurent Ferreira, chief executive at National Bank of Canada NATO,” said on its analyst call on Friday. “You have a strong economic backdrop… and tons of pessimism about a potential recession.”