Canadian banks warn of a rise in credit impairments next year

Canadian banks are warning of a rise in credit impairments over the next year as the unwinding of government aid and loan deferral programmes in coming months expose lenders to the real damage to customers from the coronavirus crisis.

Bank executives say they are preparing for a long and choppy recovery from the pandemic, which has pushed the Canadian economy into a recession.

Customer relief measures have so far kept a lid on bad loans, and five of the top six banks reported better-than-expected third-quarter profits this week, helped by strong capital markets and trading activities.

“The real test of the recovery will come once government support programs start to wind down,” Dave McKay, chief executive officer of Royal Bank of Canada, the nation’s biggest lender, told an analyst call.

“It may take one or two years for us to get back to where we were before.”

banks have already ended mortgage deferrals for some customers and most banks reported declines in loan balances subject to deferral. So far, most customers who exited had resumed repayments, executives said on analyst calls, in large part assisted by extraordinary government aid.

The top six banks reported Canadian mortgage deferrals of 13.5% in the three months through July, from a peak of 16% at the end of the previous quarter.

Bank of Montreal’s Chief Risk Officer Patrick Cronin said on an analyst call he expects delinquencies of between 1% and 5% of total loans as deferrals end.

The six biggest banks have set aside C$17 billion over the past two quarters for expected loan losses, and most said they expect these to be sufficient to cover an anticipated increase in impairments, barring a worsening of economic conditions.

Banks expect most of the deferrals to end in October or November and Canada will replace its pandemic-related unemployment benefit program with an expanded employment insurance plan that requires people to be seeking jobs to qualify.

Even though banks’ reserves are far in excess of charge-offs and impairments seen so far, loan loss provisions are set to remain elevated relative to pre-pandemic levels in future quarters, Edward Jones analyst James Shanahan said.

“Our 2021 estimates (for earnings) are probably still, on average, 15% lower than what the banks reported for 2019.”

While this will be driven in large part by provisions, it is also due to slower loan growth and lower margins, he said.

Toronto-Dominion Bank and RBC said they have also given increased weighting to their pessimistic macro-economic scenarios, which envision elevated unemployment and lower home prices for longer, which is reflected in their reserves.

“In Canada, unemployment numbers are higher, GDP lower... that’s what’s driving our allowance (for losses) up,” TD Chief Risk Officer Ajai Bambawale told analysts on Thursday.

Meanwhile, Canada’s real GDP is likely to climb 3% in July, edging economic activity closer to pre-pandemic levels, Statistics Canada said in a flash estimate on Friday, as data continued to paint a picture of a sharp fall followed by a strong rebound.

Canada’s second-quarter annualized growth tumbled a record 38.7% even as June real GDP surged a record 6.5%, beating analyst expectations for growth of 5.6%. Economic activity still remains about 9% below pre-pandemic levels, StatsCan said. The better-than-expected economic growth in June builds on strong data across a number of indicators, buoyed by the reopening of more businesses from COVID-19 closures.

“For now it’s definitely a V-shaped” recovery, said Derek Holt, head of capital markets economics at Scotiabank.

“When I hear people tamping down the strength of the data, we have to put that in the context of how all the data has surprised to the upside,” he added. “Few people expected this magnitude of a rebound to begin with.”

Indeed, economists expect a “mammoth” increase in Canada’s third-quarter economic activity, predicting a rebound nearly twice that of the United States, reflecting Canada’s more stringent COVID-19 response and strong fiscal stimulus.

Canada’s budget deficit is forecast to top C$343.2 billion ($261.8 billion) this fiscal year, the largest shortfall since World War Two, amid billions in COVID-19 aid spending.

The government said on Friday that the deficit for April to June topped C$120.4 billion, as emergency transfers more than doubled programme expenses in the quarter.

Reuters