A new “normal” appears to be setting in for Canada’s biggest banks that is driving up the amount of money they need to put away for bad loans — and helping to put a dent in their bottom lines.
The change in credit conditions was on display in the latest round of quarterly results, which wrapped up Thursday when both Toronto-Dominion Bank and the Canadian Imperial Bank of Commerce reported year-over-year declines in fourth-quarter profits of four per cent and six per cent, respectively.
Those pullbacks in profit followed declines in earnings at Royal Bank of Canada and the Bank of Montreal that were reported earlier in the week, as the major lenders ended their fiscal 2019 “with a bit of a whimper,” in the words of DBRS Morningstar analyst Robert Colangelo.
Aggregate earnings among the Big Six banks were down six per cent quarter-over-quarter and five per cent year-over-year, Colangelo said. Provisions for loan losses, meanwhile, were up 17 per cent over the previous quarter and 36 per cent from a year earlier, weighing on the lenders’ bottom lines.
“Credit losses needed to normalize from the historically low level that they’ve had,” Colangelo said.
While the banks are still reporting billions in profit, buying back millions of their own shares and paying out enticing dividends, investors are nevertheless likely to be watching the loan loss figures closely.
They were put on alert earlier this year when money manager Steve Eisman, one of the stars of the book The Big Short, told the Financial Times that he was betting against some of the Canadian banks and “calling for a simple normalization of credit that hasn’t happened in 20 years.”
The banks were already facing their fair share of challenges. Trade-related uncertainty has hurt their capital markets operations and lower interest rates put pressure on what they can charge customers. Furthermore, recent years of big profits have heightened expectations.
RBC, Canada’s biggest bank, reported this week that earnings fell one per cent year-over-year for their fourth quarter, to $3.2 billion. And while the lender reported some severance costs, it also noted provisions for credit losses rose around to $499 million for the three months ended Oct. 31, up around 41 per cent from $353 million a year earlier.
The next couple of years are likely to be challenging given interest rate trends, uncertainty around global growth, trade tensions and normalized credit conditions
Dave McKay, CEO, RBC
“Based on what we’re seeing today, the next couple of years are likely to be challenging given interest rate trends, uncertainty around global growth, trade tensions and normalized credit conditions, amongst other factors,” RBC CEO Dave McKay told analysts during a conference call on Wednesday.
Credit provisions can rise as banks increase their loan books. They can be volatile, too, with provisions taken for both “performing” and “impaired” loans, as well as when the economic conditions warrant them. There may also be large one-off provisions required for a single big loan, such as, for example, one that’s been given to a company that suddenly goes bankrupt.
RBC’s chief risk officer, Graeme Hepworth, said their provisions had increased over the prior quarter partly because of unfavourable changes in their portfolio mix, “including seasonal factors related to our cards portfolio and credit migrations.” Those migrations are when borrowers have their credit ratings changed, either downgraded or upgraded, but RBC’s were also offset somewhat by a better forecast for the Canadian housing market.
Toronto-Dominion Bank, Canada’s second-largest lender, reported similar phenomena for the fourth-quarter results it announced on Thursday, with earnings down around four per cent year-over-year to approximately $2.9 billion, and provisions for credit losses shooting up 33 per cent to $891 million.
During a conference call, the bank’s chief risk officer, Ajai Bambawale, said that “looking to the year ahead, the period of cyclically low loss rates are likely behind us.”
TD said the rise in provisions for credit losses (PCL) was partly due to volume growth, seasonal trends in its U.S. auto and credit card portfolios and credit migration in the bank’s Canadian retail and wholesale divisions.
“PCL for impaired loans rose by 32 per cent driven by normalization in commercial, higher insolvencies in the other personal lending and credit card portfolios and volume growth,” wrote Citi analyst Maria Semikhatova.
Banks have made assurances they can handle the return to normalcy, and, as a percentage of their average net loans and acceptances, PCLs remain relatively small. RBC’s rose to 0.32 per cent for the quarter from 0.23 per cent a year ago, while TD’s went to 0.51 per cent from 0.41 per cent.
“While credit losses were within expectations, and we continue to be comfortable with the quality of our portfolio, you’re now seeing the effects of normalizing PCLs this quarter and for the year as a whole,” TD chief financial officer Riaz Ahmed told the Financial Post.
Canadian Imperial Bank of Commerce reported Thursday that its profit for the quarter ended Oct. 31 was nearly $1.2 billion, down six per cent year-over-year. Credit provisions, though, rose 52 per cent, to $402 million from $264 million.
“While provisions have increased, we remain confident in the quality of our loan portfolio going forward,” CEO Victor Dodig said.
Colangelo said the credit environment for the banks also remains “relatively benign,” with low levels of unemployment and growing wages.
“So until we see a significant increase in unemployment or … wage compression, credit losses will continue to normalize to more of a historical average over the last, probably, five years,” he said.