Big Six face headwinds from slowing economy

‘Moderation of earnings growth’ forecast in shadow of rising rates, housing rules

Canada’s big banks are about to close out another profitable year, but they are already facing expectations that they will lose some steam in 2019 and 2020.

Fortunately for the banks, they have a lot of steam. The Big Six — which begin reporting results for the fourth and final fiscal 2018 quarter on Tuesday — are on track to report an increase in their adjusted earnings per share of approximately 11 per cent over the previous year.

Earlier this month, CIBC Capital Markets analyst Robert Sedran pegged that 2018 growth figure at 11.6 per cent, but noted he expects it to ease to seven per cent in 2019 and 6.4 per cent in 2020.

“We enter the new fiscal year with what seems like a still good (albeit less so than last year) operating environment, though one that may begin to show its age,” Sedran wrote.

A Canaccord Genuity note predicted a deceleration in EPS growth for the Big Six as well, from 11 per cent for 2018, to six per cent for 2019, to five per cent for 2020.

One key headwind for banks may be the state of the Canadian economy, to which their performance is strongly tied.

An economic update from the federal government last week projected a rise of two per cent to the GDP in 2018 and 2019, followed by 1.6 per cent growth in 2020. All three years would be below the three- per-cent rate seen in 2017.

“While the Canadian banks can perform above GDP growth, it’s very, very difficult for them to massively outperform in that context,” said John Aiken, analyst at Barclays Capital. “And so, given the fact that we do see some headwinds on lending, a moderation of earnings growth is largely expected.”

A big surge from the U.S. or global economy could be a mitigating factor, yet controlling costs is another area where the banks may have a harder time continuing to wow.

“You can make the argument that a lot of the low-hanging fruit has already been plucked,” Aiken said. “While we do think that they are going to continue to be aggressive in managing their costs, it may not have the same impact.”

Rising interest rates, which have helped the banks’ margins in the shorter term, could also begin to weigh heavier on consumer borrowing and spending.

Furthermore, banks entered 2018 saddled with new housing regulations that a recent Bank of Canada staff note suggested could be nibbling at their business.

This revised B-20 guideline on residential mortgage underwriting, the BoC staff analytical note said, applies only to federally regulated lenders, not private ones.

“Areas with high house prices, such as the Greater Toronto Area (GTA), could therefore see more borrowers obtaining mortgages from private lenders because they might not be able to qualify with other lenders,” it added.

According to the BoC staff, the volume of new mortgage lending in the GTA fell year-over-year for all types of lenders in the second quarter of 2018, but private lenders, mortgage finance companies, credit unions and smaller banks all saw their market share increase.

The Big Six, however, saw their share of mortgage originations in the GTA slip, albeit to 72.6 per cent from 77.5 per cent.

The BoC note said it did not currently have data to verify whether this same trend was playing out in other provinces, but National Bank Financial analyst Gabriel Dechaine said in a November note on the banks that “(r)egulation and the risk of unintended consequences are important considerations.”

Bank of Nova Scotia will be the first of the Big Six to deliver its latest earnings on Tuesday, followed by Royal Bank of Canada on Wednesday, Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday, and then Bank of Montreal on Dec. 4 and National Bank of Canada on Dec. 5.