Canadian banks to report strong quarter amid housing stability, interest rate hikes

“We believe the earnings environment sets up well for a strong second half… With the Canadian housing market behaving itself, investors can turn their attention away from that and towards earnings, which have been supported by (profit) margin expansion, operating leverage, and growth in the expansion segments,” said Robert Sedran, an analyst with CIBC Capital Markets in a research note.

Canadian Imperial Bank of Commerce (CIBC) will be the next to report its earnings for the three-month period on Thursday, followed by Bank of Nova Scotia and Bank of Montreal on Aug. 28, National Bank of Canada on Aug. 29 and Toronto Dominion Bank on Aug. 30.

One factor looming over the banks’s earnings for most of the fiscal year has been housing activity and mortgage originations after tighter lending guidelines were introduced at the beginning of the year.

National home sales in July were down 1.3% compared to a year earlier, smaller than the double-digit declines seen in previous months. The Canadian Real Estate Association said that the new stress test for uninsured mortgages “continues to weigh on home sales but its effect may be starting to fade slightly in Toronto and nearby markets.” However, fewer sales in major urban centres in British Columbia weighed down the overall home sales figure.

Some analysts say they expect banks’ earnings performance to be driven in part by improvements in housing market stability, particularly in the Greater Toronto Area, but others are advising caution.

In the fiscal first and second quarters, most Canadian banks got a bump from a spike in mortgage origination at the end of the calendar year as homebuyers rushed to lock in home loans before the new rules took effect on Jan. 1.

“As this phenomenon fades, we are expecting to see a sharp drop-off in origination volumes in the second half,” said Gabriel Dechaine, an analyst with National Bank of Canada. Dechaine estimates that for banks to fall in line with their forecast of a 5% drop in uninsured mortgage origination volumes, originations will need to fall by 20% in the second half, he said in a research note.

Still, Canada’s Big Six banks and Quebec’s Desjardins Group have built up a capital buffer and are better prepared for a housing crisis at home than they were in 2016, Moody’s Investor Service said in a recent report.

Plus, economic fundamentals and a rising interest rate environment on both sides of the border may be poised to offset the impact of slowing mortgage lending growth.

During the quarter ended July 31, these banks were already benefiting from growing net interest margins — or the profit made on loans — as interest rates rose on both sides of the border in previous months. Net interest margins are the difference between the money banks earn on the loans they make and the interest they pay out to savers.

In July, the Bank of Canada hiked its trend-setting interest rate for the fourth time in a year to bring the benchmark from 1.25 to 1.5%, further bulking up those profit margins.

Last quarter, RBC’s chief financial officer Rod Bolger said that even if the bank’s mortgage growth halves, the impact would be offset by the benefit of one central bank rate hike.

The country’s recent string of strong economic data — such as July inflation rising to its highest reading since September 2011 and strong jobs numbers — raises the likelihood of another potential rate hike in October.

The Bank of Canada can use interest rate hikes as a tool to help prevent inflation from climbing too high.

Rising interest rates, however, have been an additional hurdle for many potential first-time and move-up homebuyers, and slowed demand for credit.

“With additional rate hikes likely in coming months, housing activity in the second half of this year and 2019 will remain well below the booming pace of the prior five years,” wrote Sherry Cooper, chief economist for Dominion Lending Centres, in a research note.

Additionally, with each interest rate hike, pressure mounts for banks to pass on those benefits to depositors.

Still, mortgages are set to have a “limited impact” on earnings and “recent data points point to a stabilizing, albeit lower, growth rate.”

“Offsetting this will be margin expansion, benign credit conditions, positive operating leverage, and the expansion segments,” said Sedran. “We are still at a point in the economic cycle where rate hikes benefit the banks and so could see recent actions by the Bank of Canada and Federal Reserve extending the margin expansion trend.”