Uncertainty over Bank of Canada interest rate cut dragging on Big Six, say analysts

Expectations are low for Canada’s big banks as earnings season starts Tuesday

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Uncertainty over how long interest rates will remain elevated is posing a risk to growth and credit quality at Canada’s big banks, according to analysts who will be keeping an eye on those metrics when quarterly earnings are released this week.

Bank of America securities research analysts said higher rates could serve as an overhang on stock valuations, with the potential downside to earnings acting as a drag.

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The five-year government bond yield, a key benchmark for mortgage pricing for around 45 per cent of loans, is above the levels it was trading at in late November, when banks reported the last quarterly results, wrote BofA analysts Ebrahim Poonawala, Gabriel Angelini, Isiah Austin and Brandon Berman.

The problem could get worse if the job market deteriorates, they said, noting that economists are forecasting that the unemployment rate could reach 6.5 per cent by year-end 2024, up from the current 5.8 per cent and pre-pandemic 5.7 per cent.

National Bank industry analyst Gabriel Dechaine, meanwhile, said there are low expectations heading into the quarter as the “Big Six” bank stocks have underperformed the market by nearly 300 basis points early into 2024.

“Shifting rate cut expectations have been a primary drag on performance,” Dechaine wrote in a note to clients.

He added that commentary from bank management teams since the start of the year has been generally cautious.

While most banks delivered stable or rising net interest margins to end fiscal 2023, Dechaine said he expects flat sequential net interest margin performance from the Big Six this quarter.

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That’s largely due to deposit growth still being heavily skewed toward higher cost term deposits and a likely deceleration of higher margin commercial lending, he said.

Dechaine said the risks facing the Big Six include the potential that GDP growth turns negative and/or a shift in credit growth. Another risk involves the intensifying regulatory pressure on business activities and/or regulatory capital requirements, he added.

Recent acquisitions are also on the radar for analysts, with the Bank of America team eyeing Royal Bank of Canada and Bank of Montreal following acquisitions of HSBC Canada and Bank of the West, respectively.

RBC is expected to close its HSBC Canada transaction at the end of March, with systems conversion expected over that long weekend.

They said the two banks have defensible pre-tax, pre-provision earnings driven by those deal synergies.

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The street will also be watching for updates on the ongoing Department of Justice investigation into Toronto Dominion Bank’s anti-money laundering controls in its U.S. banking business, the Bank of America analysts said.

Bank earnings season starts on Feb. 27, with Bank of Nova Scotia and BMO reporting first-quarter results on Tuesday, RBC and National Bank of Canada on Wednesday, and CIBC and TD Bank on Thursday.

EQB Inc., Laurentian Bank of Canada and Canadian Western Bank are also set to report earnings this week.

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