Canadian banks will give some insight into where they see the economy going when they start to report this week, with analysts watching for trends in key indicators like loan growth, capital raising, and how much banks are putting aside in case loans go sour. The Bay Street Financial District is shown in Toronto on Friday, August 5, 2022. THE CANADIAN PRESS/Nathan Denette

TORONTO - Canadian banks will give some insight into where they see the economy going when they start to report quarterly earnings this week.

Analysts will be watching for trends in key indicators like loan growth, capital raising, and how much banks are putting aside in case loans go sour.

The results for the period ending July 31 come at a time when decades-high inflation has pushed central banks to raise interest rates, including the Bank of Canada’s one percentage point hike in July – the highest increase in more than 20 years.

Higher rates have pushed up borrowing costs for mortgages and have caused a pullback in the real estate market, which is typically a big driver of bank loan growth.

The Canadian Real Estate Association said that national home sales fell by 5.3 per cent in July comparedwith June, and was down 29.3 per cent compared with July 2021, translating into lower loan activity for banks.

“I am expecting some slower loan growth given the rise in mortgage rates,” said James Shanahan, senior equity research analyst at Edward Jones.

Overall though, Shanahan said he’s expecting a pretty good quarter for the banks as higher interest rates also translate to higher margins on loans — though he pointed out with many loans at locked-in rates it can take some time to show up in earnings, with commercial loans generally faster to respond.

On the capital markets side, banks are expected to report a sharp drop in investment banking revenue as companies and investors become more cautious, but Shanahan said that trading revenue could help buffer the impact despite market pressures.

“That’s just basically been driven by higher market volatility, and so that could be a source of strength.”

That’s the trend that played out when U.S. banks reported, with the five largest American banks reporting a 50 per cent drop in investment banking revenues while trading revenues were up 22 per cent, he said.

Bank decisions on credit loss provisions will be another key area to watch as it shows what they see ahead for economic conditions and how they expect those loans will perform.

Shanahan said that with the economy still running at essentially full employment he’s not expecting any dramatic changes, but analysts are expecting banks to start to boost their reserves again after beginning to taper them down in the past year or so.

National Bank analyst Gabriel Dechaine said in a note that he expects a “tempered” credit cycle shift, with all banks adding to loan provisions, with larger ones from Scotiabank and RBC since they have released about 80 per cent of the provisions they had built up in the early months of the pandemic.

Credit loss provisions are counted as expenses, so they have a material effect on bank earnings.

The latest crop of results come as bank stocks have been under some pressure as part of the wider economic uncertainty.

Scotiabank analyst Meny Grauman said in a note that bank stock performance has reflected big swings in the wider economic outlook.

The ratio of bank stock prices compared with earnings fell as economic concerns rose in the spring on the fallout of Russia's invasion of Ukraine and China's COVID-19 lockdowns, but is now returning to a more balanced investor consensus, he said.

"Investors appear to be stepping back from the brink and realizing that while rising rates will weigh on economic growth by design, the outcome is not necessarily a deep and prolonged recession," said Grauman.

“At current valuation levels the market appears to be pricing in a mild recession with only limited impact on credit performance, which is in fact our base case scenario.”

Dechaine noted that the Big Six bank stocks are down about six per cent year-to-date, underperforming the market by about 1.4 per cent, which could be too much.

“At this point, we are wondering if too much negativity has been reflected.”

He said that for banks to expect better performance though depends on the outlook for rate hike activity.

“Market expectations need to shift to a more dovish stance from the Bank of Canada, which would deflate concerns related to the housing market (a primary sector overhang). We’re not there yet but could be getting close.”

Scotiabank starts the reporting on Tuesday, followed by RBC and National Bank Wednesday, CIBC and TD Bank on Thursday, and Bank of Montreal on Aug. 30.

This report by The Canadian Press was first published Aug. 21, 2022.

Companies in this story: (TSX:RY; TSX:BMO; TSX:TD; TSX:BNS; TSX:NA; TSX:CM)

News from © The Canadian Press, 2022