NON-RATING ACTION COMMENTARY

Canadian Banks’ 1Q23 Provision and Expense Growth Offset Rate Benefit

Mon 06 Mar, 2023 – 12:31 PM ET

Fitch Ratings-New York/Toronto-06 March 2023: Canadian banks’ recently reported results reflect incremental normalization of performance measures post-pandemic, as incorporated in Fitch’s ratings and outlook. The largest Canadian banks’ January fiscal first quarter earnings were materially down yoy on a reported basis, driven by a one-time windfall tax, litigation-related provisions at Canadian Imperial Bank of Commerce (CIBC) and Toronto-Dominion Bank (TD) and costs related to recently closed or upcoming acquisitions by Bank of Montreal (BMO) and TD. Excluding these, and other adjusting items, results were largely flat yoy. Adjusted return on average assets across the seven largest banks, including Desjardins Group (DESJ) which reported as of December 2022, averaged 0.8%, unchanged from the year-ago quarter.

Loan growth remained strong, at or near double digit levels yoy, particularly in commercial portfolios. However, on a qoq basis, the pace of loan growth slowed significantly, especially in personal lending, as credit demand responded to the 425 bps in cumulative rate hikes since March 2022. A number of banks reported quarterly contractions in credit card balances and consumer loans for the first time since 2021.

With the exception of National Bank of Canada (NBC) and Desjardins Group, yoy loan growth outpaced deposit growth, which together with an unfavourable mix shift in deposits, compressed net interest margin across most institutions. Average firmwide net interest margins declined by approximately 6 bps qoq and 5 bps yoy. More asset sensitive TD was the exception, having progressively expanded its adjusted margin by 25 bps relative to 1Q22.

Average bank provisions for credit losses, as a share of loans, were 22 bps as of quarter end, largely flat versus the prior quarter, after stepping up from single digit levels from mid-2021 to mid-2022. Banks continued to guide to normalization of credit losses over the near term, and are expected to close the gap with pre-COVID provision ratio levels over the coming quarters (approximately 12 bps). Impaired loan ratios also ticked upwards modestly qoq, by roughly 2 bps on average, in line with Fitch’s expectations.

Mortgage quality remained largely benign, notwithstanding a housing market correction and materially higher debt service costs for renewing borrowers. Year-over-year non-interest expense growth outpaced adjusted revenue growth at most institutions, reflecting personnel costs and an elevated pace of technology investment. However, many banks guided to peaking expense growth and recommitted to positive operating leverage for the full fiscal year.

In terms of segment performance, revenue growth was broad based, with strong performance in Canadian personal and commercial banking (growing approximately 12% yoy on aggregate). Capital markets revenues also ticked upward by 2% yoy, as recovering sales and trading helped offset continued weakness in investment banking. Wealth management revenues similarly increased broadly yoy, benefitting from higher net interest income in private banking, which helped offset lower net sales and fee income from the market-driven contractions in assets under management.

Common equity Tier 1 (CET1) levels continued their rapid normalization to pre-COVID levels, as anticipated. Bank of Montreal, which closed its acquisition of Bank of the West after the end of 1Q23, guided to a CET1 ratio of 11.5% by 2Q23, and 12% by fiscal year-end. TD, which reported a pro forma 15% CET1 ratio following its Cowen acquisition on March 1, similarly guided to a CET1 ratio well in excess of 11% after it closes on its expected acquisition of First Horizon Corporation (FHN).

TD disclosed that a delay in regulatory approval had extended closing on FHN beyond the May 27, 2023 horizon of its merger agreement. In terms of Basel III regulatory capital reforms, which will be implemented as of fiscal 2Q23, banks guided to a small or moderately positive benefit to CET1. Royal Bank of Canada’s estimated benefit from the new rules was at the higher end, at 70 to 80 bps.