In this week’s economic update, we’re looking at the most recent quarterly results for the Canadian banks and exploring the factors impacting their stock performance throughout 2023.
In a similar vein, we are also sharing an article from RBC Economics that sheds some additional light on the upcoming Bank of Canada policy decision around interest rates and where their policies may be leading.
Economic Update
The month of November finished on a high note, marking one of the best months this year for global equity and fixed income markets. This strength reflects growing confidence that inflationary pressures are easing, central banks are largely finished with their rate hikes, and economic growth is moderating in an orderly fashion, even in the face of tight financial conditions. This week, we shift our focus to the Canadian banks, all of which recently reported quarterly results.
Debt repayments a continued factor in stock performance
Throughout the year, expectations for the Canadian banking sector have been overwhelmingly negative. That helps to explain the group’s lackluster stock performance year-to-date. The anticipated turn in the credit cycle is a key factor, with a growing number of households and businesses expected to struggle with debt repayments as a result of higher interest rates.
Rising delinquencies but credit cycle turn has been more gradual than expected
This quarter’s bank earnings suggest credit trends are deteriorating, evidenced by delinquencies rising across various loan categories, including automotive loans and credit cards. Banks also made sizable additions to their provisions for future credit losses as they continue to prepare for challenges that may lie ahead. However, the turn in the credit cycle has been gradual compared to some investors’ expectations, suggesting consumers and businesses have, on average, weathered higher interest rates as well as can be expected so far.
Higher expenses triggering long-term cost saving measures
Elsewhere, the banks face the ongoing challenge of expenses that are outpacing revenues. While banks have benefited from higher interest rates, new customers and deposits, and growth in credit card balances, these gains have been offset by higher expenses related to things like staffing, regulation and technology. In response, a number of banks initiated restructuring efforts aimed at long-term cost savings, incurring charges related to these actions this past quarter that should prove to be temporary in nature.
Banks making preparations for the next few years of growth deceleration
Commentary from management teams painted a picture of reserved optimism. Banks are bracing for a continued deceleration in growth as higher interest rates continue to work their way through the economy. Management teams acknowledged the wave of mortgage refinancings that are expected to intensify over the next few years. But, some also suggested it may not be as painful should interest rates decline over the next few years as the market expects. Regardless, the banks believe they are prepared to weather the storm as they have bolstered their balance sheets by allocating increasing amounts of capital to their reserves. They have also started to make progress towards containing costs, which should strengthen future profitability.
Summary
Overall, we see the bank results as neither concerning nor inspiring. The results weren’t as dire as some anticipated and banks have demonstrated a level of prudence as they prepare for a range of economic scenarios that could develop. Pressures are indeed likely to mount with an increasing number of customers facing higher costs of living. Nevertheless, these headwinds are reflected to some degree in the valuations of the bank stocks, which sit near historical lows.
In many ways, the banks reflect the broader economic issues that exist in Canada: first, that growth is sluggish, but not terrible. Secondly that higher interest rates are having an impact but there are limited signs of significant stress at this time.
We continue to be patient, vigilant, and proactive with our allocation of equities within our Canadian portfolio as we navigate through a challenging, but manageable outlook for our domestic economy.
BoC to deliver 'dovish hold' next week, interest rate decision unlikely to be a surprise
The Bank of Canada is widely expected to hold the overnight rate steady at 5% for the third meeting in a row. But the statement will be watched closely for signs that a slowing economy and easing inflation pressures are shifting future interest rate cuts into focus.
In this article by RBC Economics, inflation measures are examined and we look to the future to understand what policy direction the BoC may choose to pursue to continue keeping inflation under control.
Read the full article here.
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.