U.S. bank results hint at what awaits Big Six

Piles of cash set aside for losses

Canada’s biggest banks are right in the thick of a tough quarter, judging by the rocky results their American cousins are posting this week.

JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. all reported big drops in earnings for the three months ended March 31, as the lenders were forced to set aside piles of cash in case consumers and businesses are forced to default on their loans because of the coronavirus crisis.

The parallel isn’t perfect, but the biggest U.S. lenders can herald what’s to come for Canada’s Big Six.

All of the largest Canadian banks have operations south of the border, and the trends in the results from JPMorgan, the biggest bank in the U.S., are “also very relevant to the Canadian marketplace,” National Bank Financial analyst Gabriel Dechaine wrote Tuesday.

“We expect to see similar outcomes in terms of credit performance, margin compression, trading revenue generation and loan growth” in Canada, Dechaine wrote in a report. “On the latter item, we are hearing of the same trend in Canada.”

Like their counterparts in the U.S., Canadian banks are facing interest rates that have been lowered to essentially zero, squeezing what they can charge for loans. Customers are also losing their jobs, threatening their ability to keep up with debt payments.

Still, loans have been growing, with JPMorgan’s corporate clients borrowing more than US$50 billion from existing lines of credit as the crisis ramped up and companies scrambled to get cash. Growing loan balances could mean growing revenue from interest payments on those loans, but during the current crisis, the ability of some borrowers to repay has suddenly come under threat because of the closure of non-essential businesses and a drop in consumer demand.

Banks must also hold a certain amount of capital relative to the size of their loans, and set money aside for possible losses.

JPMorgan reported provisions for credit losses of almost US$8.3 billion for its first quarter, which included US$6.8 billion it put into reserves.

For the same quarter of 2019, the bank’s credit costs had been about US$1.5 billion, with the additional money socked away this quarter reflecting “deterioration in the macroeconomic environment as a result of the impact of COVID-19 and continued pressure on oil prices,” the lender said.

If the biggest bank in the U.S. feels the need to set aside a massive amount of money to cushion the blow of the COVID-19 recession, then Canada’s banks likely will too, as their accounting requires earmarking funds for expected loan losses.

“So you can take a look at the U.S. banks and say, ‘this is a roadmap for what the Canadian banks are going to have to put up in similar fashion,’” Barclays analyst John Aiken said in an interview.

Exactly how much Canada’s banks will have to set aside could vary given the uncertainty about the duration of the pandemic and the recession. But credit provisions are “the biggest swing factor in bank earnings,” Aiken said, because they can be big and there is no offset for them. Items such as trading revenue do have offsets, though, such as bonuses paid to the people actually doing the trading of stocks and bonds.

“The benefit they receive from trading is not going to be enough to stabilize earnings,” Aiken said.

Big Canadian banks will report results in May for the quarter covering February, March and April, meaning there is likely to be a heavier COVID-19 influence on the results than those of the U.S. banks, which still booked profits. Canadian households and businesses were also carrying a relatively higher level of debt going into the crisis.

“As such, it is very likely we will see a rise in bankruptcies and a permanent decline in economic activity and a prolonged increase in unemployment,” wrote Charles St-Arnaud, chief economist at Alberta Central, the central banking facility and trade association for the province’s credit unions, in a report published Wednesday.

Nevertheless, the expectation is that the large Canadian lenders will be able to weather the storm, even if their near-term profits take a hit. The Bank of Canada said in the monetary policy report it released on Wednesday that the stress-testing it does on the big lenders shows they are “well positioned” to ride out a sharp economic and financial downturn.

Canadian regulators are also giving banks a break when it comes to deferred loan payments, which the lenders are granting to customers facing financial hardship during the pandemic. Those deferrals could keep borrowers from defaulting on their obligations.

While there is going to be an increase in loan-loss allowances, “I don’t think it’s going to be the fire and brimstone that some investors may be envisioning,” Aiken said.