­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. We share our takeaways below.

 

Throughout the year, expectations for the Canadian banking sector have been overwhelmingly negative. This explains 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 because of higher interest rates.

 

This quarter’s bank earnings suggest that credit trends are deteriorating, evidenced by delinquencies rising across various loan categories, including automotive loans and credit cards. Banks made sizeable additions to their provisions for future credit losses as they continue to prepare for challenges ahead. The turn in the credit cycle has been gradual compared to some investors’ expectations. Consumers and businesses have weathered higher interest rates as well as can be expected so far.

 

The banks face the ongoing challenge of expenses that are outpacing revenues. While banks have benefitted from higher interest rates, new customers and deposits, and growth in credit card balances, these gains have been offset by higher expenses related to staffing, regulation, and technology. In response, several 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.

 

Commentary from management teams painted a picture of reserved optimism. Banks are bracing for a continuing deceleration in growth, as higher interest rates continue to work their way through the economy. Management teams acknowledged that the wave of mortgage refinancings that are expected to intensify over the next few years. Some also suggested that renewals may not be painful if interest rates decline over the next few years as the market expects. Canadian major banks believe that 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 toward containing costs, which should strengthen future profitability.

 

Overall, we see the Canadian bank results as neither concerning nor inspiring. The results were not as dire as some anticipated, and banks have demonstrated prudence as they prepare for the range of economic scenarios that could develop. Pressures are likely to mount, with an increasing number of customers facing higher costs of living. Nevertheless, these headwinds are reflected to some degree in the current valuations of the bank stocks, which sit near historical lows.

 

In our view, Canadian banks reflect the broader economic issues that exist in Canada. Growth is sluggish, but not strongly negative. Higher interest rates are having an impact, but there are limited signs of significant stress currently. We continue to be patient and vigilant with the Canadian equity allocation of portfolios as we navigate through a challenging but manageable outlook for our domestic economy.

 

If you have any questions, please do not hesitate to contact us.