Photo by Michelle Spollen on Unsplash
One needs to look no further than the commercial banks to understand the credit difficulties that lie ahead as the banks contend with a deteriorating economy. The most recent quarterly results for the Canadian banking industry reveal a sector that has experienced a steady decline for the past year, down some 12% from its most recent high in February. Year-over-year results indicate a significant deterioration in the key metrics used to judge performance. Profits have declined, in some instances by 50%, largely reflected in the rise in actual and expected bad loans. Banks have slashed thousands of jobs, especially in their capital markets divisions. As for an understanding of what lies ahead, bank shareholders need to focus only on the provisions for credit losses (PCL) to get a sense of how much the Canadian banking industry is bracing for a continuation of this weak performance.
TSX Bank Index
The Canadian economy shows every symptom of financial stress increasing on the horizon. From a macro perspective, the key components of national income are all moving in the wrong direction. Third quarter GDP declined at an annualized rate of 1.1%. Residential investment is under stress in response to higher mortgage rates; homeowners face sharp increases in mortgage refinancing over the next two years. Non-residential investment has been an underperformer for about a decade. Retail sales reflect higher prices, rather than any improvement in volume sales. Household consumption has stagnated for the last two quarters in a row. Most importantly, labour productivity growth continues to slide, as Canadians fail to experience any increase in real living standards. Whether this performance qualifies, technically, as a recession is beside the point. The Canadian economy is in for a rough ride.The most serious re-adjustment facing Canadians can be found in the residential mortgage market. Scotiabank, for example, is setting aside loan losses in response to the bank’s delinquency rate having surged from 0.15% in 2022 to 0.25%. Scotiabank reports that the percentage of its mortgage portfolio that is delinquent 90+ days has jumped from 0.9% to 0.16% over the past twelve months. Since a third of Scotiabank’s mortgage borrowers use variable rates, the bank expects household discretionary expenditures to suffer in the wake of meeting higher monthly payments. The full adjustment process has yet to take place. Scotiabank explains that 10% of its mortgage portfolio comes up for renewal in 2024, 20% in 2025.  Banks are in the business of making loans, and here the pace of lending has slowed considerably in the third quarter, approximately half of that generated a year ago. With the Bank of Canada seemingly reluctant to entertain the need for a lower policy rate, there is little reason to expect any meaningful growth in bank assets. Each bank needs to assess its loan loss provisions from two perspectives: those loans that are currently performing, but are at risk of becoming delinquent and those loans that have already missed payments and are not likely to paid back in full. The Big Six banks have put aside close to $C 4 billion in their PCL accounts as they brace for continued stress, especially in the household sector.So, what can turn the financial conditions around to avoid a much worse economic downturn? Unmistakably, the Bank of Canada needs to acknowledge that it has taken a much too aggressive stance– it simply overshot with rate hikes—and must start preparing for rate cuts, as early as the first quarter of 2024. Time is not on the side of the Bank in delaying that decision.More By This Author:The Bank Of Canada Is Finished Raising Rates Now For When To Consider Cutting Rates As The Bank Of Canada Searches For The Perfect Rate Conditions The Bank Of Canada’s Anti-Growth Policies Are Coming To Fruition