Canadian banks beat earnings estimates but uncertain COVID recovery brings challenges

Canadian banks are likely to see slower growth from their core retail and business banking divisions in the next few quarters due to an uncertain economic recovery, but overall earnings could get a boost as lenders claw back some of the $20 billion of provisions they took last year.

Thanks to government pandemic aid, Canadian banks' have kept a lid on bad debts, which allows them to gradually release some of the money set aside to cover loan losses.

Canada's top six banks wrapped up their first-quarter earnings on Thursday, beating street estimates and lifting profits to pre-pandemic levels helped by lower-than-expected bad debt provisions and strong capital markets and wealth management businesses.

But that has masked challenges in their personal and business banking units, which saw earnings decline or post sluggish growth excluding the impact of provisions.

“It's easy to make the headline numbers look better than the underlying numbers ... but under the surface it's much more of a mixed bag,” said Avenue Investment Management portfolio manager Bryden Teich.

Royal Bank of Canada, Toronto-dominion Bank, Bank of Nova Scotia, Bank of Montreal, and Canadian Imperial Bank of Commerce set aside about $1.6 billion to cover potential bad loans in the three months through January, less than half the amount expected.

The banks have flagged higher loan losses in the next few quarters, but said that their current allowances are sufficient to cover them.

Investors and analysts warned the sluggish performance in the banks' core operations could continue for longer than expected if risks linger, such as another wave of coronavirus infections or delays in vaccination rollouts.

“Until the vaccination program in Canada accelerates, there is still that overhang,” said Robert Colangelo, senior vice-president for credit ratings at DBRS Morningstar.

“Things could get delayed by a quarter or two and the recovery could be later this year and into early next year.”

The Canadian banks index has risen 2.1 per cent since Monday's close before they began reporting first-quarter results.

If business closures continue, higher-margin areas like credit cards and commercial lending will stay constrained, with lower-margin mortgages remaining the biggest source of loan growth, investors said.

But rising long-term bond yields indicate markets are optimistic about a recovery. If this continues, it could help offset some of the margin challenges posed by increased mortgage exposure, Colangelo said.

“The big question across the board is what the real number (of bad loans) is, because there's so much government stimulus in the system,” said Greg Taylor, chief investment officer of Purpose Investments. “The government is in no rush to take that back.”