Canadian banks brace for uncertainties after mixed quarter

Bank of Montreal (BMO.TO) (BMO) closed out a mixed quarter for Canada’s biggest banks on Tuesday, with investors and analysts expecting some earnings drivers to ebb and economic uncertainties to increase in future quarters.

BMO missed analysts’ estimates for third-quarter profit and reported a decline in earnings from a year earlier as revenue from its capital markets business slumped and it increased provisions for credit losses.

Three of Canada’s Big Six banks have missed expectations driven in part by challenges in their capital markets operations. The other three beat expectations as loan growth remained strong and margins expanded.

Mortgages at the six banks grew nearly 10% in the quarter from a year earlier, while commercial loans jumped 16%, according to financial statements.

“Overall, it was a solid quarter for the banks, but we’re certainly seeing some storm clouds brewing,” said Rob Colangelo, senior credit officer at Moody’s Investors Service.

The Big Six mostly beat analyst estimates in the latter quarters of the pandemic thanks to strong mortgage growth backed by a red-hot housing market and robust trading and deals activity. Releases of loan-loss provisions set aside earlier in the pandemic also boosted earnings.

However, the tide appears to be turning, with investment banking fees drying up, funds under management falling and the banks again increasing provisions as economic headwinds grow and higher costs and interest rates squeeze consumers.

The Canadian banks index (.GSPTXBA) is down 4.3% since the lenders began reporting results last Tuesday. The broader Toronto stocks benchmark (.GSPTSE) has lost 2.5%.

While some deals and trading activity could return in coming quarters, revenue in these businesses is likely to remain muted for the next few quarters, said Steve Belisle, portfolio manager at Manulife Investment Management.

New mortgage lending – another growth engine – is also expected to sputter in coming quarters.

“The commercial side could stay strong from here, but mortgages are poised to decline because of the slowdown in activity we’re seeing in the housing market,” Belisle said.

The average Canadian home price has fallen more than 20% from its February peak as sales have plunged.

While higher loan-loss provisions mean the likelihood of an unexpected hit from bad loans is low, there could be a jump in borrower stress in a few years as those who took mortgages when interest rates were at record lows have to renew at the end of the typical five-year term at much higher rates, Colangelo said.

The pace of margin expansion could also slow, driven by declining long-term bond yields, said Philip Petursson, chief investment strategist at IG Wealth Management.

Many of the banks have also predicted some slowing in margin growth, crediting some of the third-quarter expansion to customers maintaining low-interest deposits instead of moving to term deposits.

The pace of moves to higher-paying deposit products has been “slower than our expectations, but we expect them to move higher for future rate hikes”, BMO finance chief Tayfun Tuzun said on a post-earnings analyst call on Tuesday, echoing a similar statement by his counterpart at Toronto-Dominion Bank (TD.TO) last week.