Canadian Banks Set for Q4 Earnings: Will They Shine Amidst Economic Uncertainty?

TORONTO — As the fourth quarter earnings season looms this week, Canada’s major banks seem to be riding the wave of optimism, as fears surrounding mortgage defaults and an imminent recession appear to be subsiding. Investors and analysts are hopeful that these institutions could surprise on the upside.

However, amid this positivity, analysts warn that banks will need to demonstrate solid earning growth to justify their current high valuations. “The banks now must prove their earning potential,” says Matthew Lee, an analyst at Canaccord Genuity. The S&P TSX bank index has seen a remarkable rise of approximately 12% since the last quarter, buoyed by impressive gains from Scotiabank and CIBC, which have jumped 19% and 17% respectively.

In stark contrast, TD Bank has faced challenges, notably dealing with a hefty US$3 billion fine and restrictions on growth in the U.S. stemming from anti-money laundering lapses. Consequently, its stock has experienced a slight decline this quarter as it navigates these turbulent waters.

Overall, the banks are trading at a high valuation of 12.1 times earnings, a figure that is deemed appropriate given the current growth environment and robust capital positions. Yet, they must demonstrate improved earnings margins to maintain investor confidence. “With valuations stretched, the next boost will likely come from tangible earnings growth,” Lee noted.

Eager investors have largely set aside concerns over deteriorating credit fundamentals and sluggish loan growth, focusing instead on the potential recovery on the horizon. Scotiabank’s analyst Meny Grauman indicated that the momentum enjoyed by Canadian banks since summer reflects a broader “soft landing” outlook for both the U.S. and Canadian economies. “The current rally hinges less on Q4 earnings and more on prospects for future growth,” he asserted.

Interestingly, despite TD’s challenges, Grauman sees promise in the bank due to strategies that include mortgage growth and a wholesale business in the U.S. Although regulators have imposed restrictions on TD's asset expansion, Lee anticipates that the bank will not substantially lag behind its competitors in the medium term.

As TD undergoes a leadership transition following CEO Bharat Masrani's announcement to step down next year, many analysts will be closely examining the bank's future guidance.

Shifting focus to the broader bank landscape, the perception of Canadian banks has markedly changed since earlier periods when they were under pressure due to fears of a spike in defaults tied to rising interest rates. Lenders have started to build up provisions for potential loan losses as central banks tightened monetary policy. Questions loomed regarding how borrowers would cope with renewing mortgages at higher rates.

Fortunately, the job market has only gradually softened, which has alleviated some of the concerns that beset the financial sector. Borrowers have proactively responded by increasing monthly payments and moderating spending to manage their debts more effectively. According to TD Economics, this prudent behavior helps explain why mortgage delinquencies remain below pre-pandemic levels.

Furthermore, interest rates have been on a downward trajectory, with the Bank of Canada cutting its key rate by 1.25 percentage points since June. This development, alongside fierce competition among lenders, is projected to reduce aggregate mortgage payments by 1.2% next year, a marked improvement over earlier expectations of a 0.5% increase.

Despite the improving landscape, some hurdles persist. Analysts will be keeping a keen eye on how provisions for credit losses are trending as we move forward. Recent reports indicate that banks have set aside $4.4 billion for potential loan losses, marking a 23% increase from last year. Jefferies analyst John Aiken expects provisions to peak in the first half of 2025, potentially constraining lending in the short term.

Looking ahead, Canadian banks may face challenges from lower immigration numbers and ongoing geopolitical uncertainties, including the unpredictable policies of the U.S. administration, which could affect tariffs on Canadian imports. However, banks with U.S. exposure could also benefit from a more favorable regulatory landscape.

The earnings season kicks off with Scotiabank reporting on Tuesday, followed by National Bank and RBC on Wednesday, with BMO, TD, and CIBC scheduled to unveil their results on Thursday. As all eyes turn toward these reports, the question remains: Can Canadian banks maintain their upward trajectory in the face of ongoing economic uncertainties? Investors will be anxiously awaiting these crucial insights.