In this week's newsletter, we are sharing our latest economic update focusing on the Canadian Banking sector. We dive into the most recent earnings results, their implications, and how credit trends are remaining a conversation point. We also speak to the overall environment for Canadian banks and emphasize the importance of patience on the investor.
We are also sharing a webinar recap of RBC Royal Bank's 2023 Economic Outlook - And What it Means for Business Owners. In this recap, RBC Senior Economist Josh Nye provides insights into the economic landscape in the context of business ownership, as well as some inspiration on how business can thrive in challenging times.
Economic Update
For the past number of weeks, investors have been predictably preoccupied with the U.S. debt ceiling. Fortunately, a deal has been agreed upon with a bill being passed by Congress that buys the U.S. some time before it is likely to resurface yet again (in 2025). This has allowed most investors to shift their focus back to fundamental issues. In this breakdown, we offer some key takeaways based on recent results from the Canadian banks.
Canadian Banks as a measure of economic health
We periodically “check in” on the Canadian banks because they remain, by far, the largest weight in the domestic stock market. In many ways, it’s hard to have a view on Canadian equities without having thoughts on the banking sector. More importantly, the banks act as the primary lender to consumers, households, and businesses across the country. As a result, their operating results and commentary from management teams can offer us a glimpse into the health of the economy.
Recent results remain a mixed bag
As always, there were puts and takes with each bank’s earnings results in recent weeks. But, overall, they were underwhelming. Credit trends remain the biggest concern amongst investors.
When banks anticipate that clients may have more difficulties repaying loans in the future, they tend to set aside some capital (often referred to as “provisions”) to absorb those expected loan losses. Most investors expect the Canadian banks to steadily increase their provisioning to reflect an increasingly challenging backdrop. While the banks on average have indeed seen their provisions trend higher, the increases to date have been well within the range of expectations. Moreover, management teams have yet to issue any significant warning signs related to potential losses in areas like mortgages or commercial loans for example. In a nutshell, the actions and comments to date suggest the Canadian banks are preparing for but have yet to see meaningful and broad-based deterioration in credit trends.
Challenges within the banking sector
Despite credit issues being manageable thus far, the banks are currently dealing with their fair share of challenges. First, revenue growth is proving to be difficult. The banks generate revenue in a variety of ways, but two important sources are loan growth and net interest margins. The former is slowing as demand for loans has declined. That’s not surprising given interest rates have increased, making it more costly for consumers and businesses to borrow. Meanwhile, net interest margins had benefited over the past year from rising rates as banks were able to reprice their loans at a faster rate than what they were paying on customer deposits. That tailwind has faded with the Bank of Canada now on pause.
The second challenge facing the banks is on the expense front. Banks have been spending heavily on a range of things, from hiring new talent, to technology investments, acquisitions, and other discretionary outlays. But, this is coming under scrutiny from investors and management teams have acknowledged they have an opportunity to better manage expenses in the face of weak revenue growth.
Summary
Overall, the results and comments from the banks suggest the environment is gradually becoming more challenging, but the credit issues that investors are concerned about have yet to materialize. Nevertheless, we expect it’s just a matter of time before the cycle turns and presents broader challenges to the economy and the equity market. Meanwhile, with respect to the banks themselves, we believe they are well capitalized and continue to prepare for what lies ahead. Investors need to remain patient with the sector but can continue to depend on them as very reliable sources of income.
Economic Outlook for Business Owners
Interest rate hikes and rising inflation have put considerable pressure on Canadian households - and also affects business owners, who must continue to find ways to compete and thrive.
Being aware of the headwinds the Canadian economy is facing — and understanding the forecast for the future — can help owners prepare and adapt their business and processes for ongoing success, even during challenging times.
Read more by clicking this link.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
