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Economic headwinds weigh on bank results as more money set aside for bad loans

TORONTO — The effects of heightened inflation and central bank efforts to rein it in by slowing the economy are showing in the second-quarter results from Canada's big banks.
Bank towers are shown from Bay Street in Toronto's financial district, on Wednesday, June 16, 2010. THE CANADIAN PRESS/Adrien Veczan

TORONTO — The effects of heightened inflation and central bank efforts to rein it in by slowing the economy are showing in the second-quarter results from Canada's big banks.

Four out of the Big Five banks have reported earnings that missed expectations as they set aside more money for bad loans and struggle to contain rising costs, and several see their revenue take a hit from slower loan growth.

CIBC was the lone outlier as its results Thursday came in better than analysts had expected.

While Canadian mortgage loan growth has slowed to a trickle, with several banks reporting flat results from the previous quarter, much of the focus these days is on what's going on with the banks' U.S. operations following several high-profile bank failures.

Several bank executives have noted the more challenging economic conditions, while TD Bank Group warned of tougher days ahead as it said it no longer expects to meet its medium-term earnings growth target because of the "deterioration in the macroeconomic environment."

The recent collapse of TD's proposed $13.4-billion takeover of First Horizon bank was also a key factor in the expected miss, but the extra capital the bank now has on hand because of the failed deal is helpful given the outlook, said TD chief executive Bharat Masrani on an earnings call.

"We are going through an uncertain period here from an economic perspective ... so to have the level of capital we have, that is a good thing."

His comments came as the bank reported a second-quarter profit of $3.35 billion, down from $3.81 billion in the same quarter last year. TD said its provisions for credit losses amounted to $599 million, up from $27 million a year ago.

RBC chief executive Dave McKay told investors on a conference call that while the immediate financial risks related to U.S. banking have eased, there are wider shifts going on that will have more long-term implications.

"Markets are facing structurally different circumstances following the end of an era of low inflation, low interest rates and increased globalization," he said.

Cost inflation has been a challenge for Canadian banks as competition heated up last year to secure employees, especially those with tech expertise. The trend has since reversed, but higher salaries are still being reflected in higher expenses, and sometimes higher head counts than necessary.

RBC, which reported expenses up 16 per cent from a year earlier, didn't anticipate high attrition rates to normalize "almost overnight," McKay said.

"We overshot. We overshot by thousands of people. It's a real drag in our cost structure."

The bank attributes about half of its expense growth to costs around acquisitions and macro-related factors, while it plans to get the other half down through slower hiring and attrition, among other levers. 

"One of my top priorities is an increased discipline around costs," McKay said.

The bank reported a profit of $3.65 billion in the quarter, down from $4.25 billion in the same quarter last year. Its provisions for credit losses amounted to $600 million compared with a recovery of $342 million a year earlier.

On an adjusted basis, RBC said it earned $2.65 per diluted share in its latest quarter, down from $2.99 last year, while analysts had on average expected an adjusted profit of $2.79 per share, according to estimates compiled by financial markets data firm Refinitiv.

Barclays analyst John Aiken said in a note that while the higher provisions may seem at first to be the top factor weighing on RBC earnings, it was higher than anticipated costs that drove the miss.

While RBC has yet to solve its persistently high expenses, it was also challenged on the revenue side, noted Scotiabank analyst Meny Grauman, adding that for thr whole group, revenue is "looking less than stellar." 

Revenue was a big reason for TD missing expectations, with adjusted earnings of $1.94 per diluted share in its latest quarter falling below the $2.07 per share analysts had expected.

The banks have faced pressure from narrower interest profits as customers looked to higher interest paying term deposits and banks generally faced higher funding costs. 

CIBC managed to post gains on its net interest margins and to keep expense growth to one per cent from last year, or seven per cent adjusted, as it came off a major expansion program, helping drive profits to $1.69 billion, up from $1.52 billion last year.

The bank was also an early mover to set money aside for bad loans, so its $438 million for credit losses only increased from $303 million a year earlier.

On an adjusted basis, CIBC said it earned $1.70 per diluted share in its latest quarter, down from $1.77 per in the same quarter last year, while analysts on average had expected an adjusted profit of $1.63 per share. 

Like other banks, CIBC looked to reassure analysts that their commercial loan exposure, especially to U.S. office space, was under control as concerns mount over potential valuation drops ahead. 

Chief executive Victor Dodig said office loans make up about two per cent of the bank's overall loan portfolio and that the current situation will not last. 

"We recognize the volatility. We'll manage through it. We'll get through this. And I'm convinced that values are surfacing and investors will start showing up to snap up these properties, and people will start coming back to the office more."

On Wednesday, both BMO and Scotiabank also tried to reassure on commercial loans as they reported lower profits compared with last year because of higher expenses, provisions for credit losses and slowing loan growth.

Looking ahead, banks say that credit conditions are returning to historic norms after the pandemic years left many consumers with extra cash that they're only now starting to run through. 

Various factors such as higher interest rates, continued inflation, and other headwinds could mean risk appetites and revenue growth could taper ahead, CIBC chief financial officer Hratch Panossian said. 

"We do understand that the environment is normalizing. Cost of credit will go up, revenues may slow down. We're controlling the things we can control."

This report by The Canadian Press was first published May 25, 2023.

Companies in this story: (TSX:TD, TSX:RY, TSX:BNS, TSX:BMO, TSX:CM)

Ian Bickis, The Canadian Press