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Weak capital markets and a deteriorating economic outlook battered the Big Six banks in their fiscal third quarter, according to Fitch Ratings.

In a new report, the rating agency said that Canada’s domestic systemically important banks reported reduced aggregate earnings — down 7% year over year and 5% quarter over quarter for the period ending July 31.

Higher loan loss provisions, rising expenses and financial market headwinds combined to offset the positive impacts of robust loan growth and expanding net interest margins, Fitch noted.

“Capital markets revenues were down [year over year] at most banks as challenging conditions for debt, and equity issuances, along with trading revenues offset higher corporate lending income,” it said.

Royal Bank and Bank of Montreal experienced the largest drops in capital markets earnings, Fitch said, citing their large U.S. loan underwriting markdowns.

“Challenging market conditions also impacted many asset and wealth management segments as market depreciation and lower client activity generally resulted in flat-to-lower [assets under administration] and [assets under management] levels and related fees,” it added.

On the upside, the banks continued to enjoy strong loan growth, Fitch said, which boosted net interest income and margins.

Average net interest margins rose by 9% quarter over quarter, and this doesn’t reflect the effects of the Bank of Canada’s 100-basis-point rate hike in July, it said.

“Commercial loan growth was particularly strong, growing an aggregate of 19% [year over year], reflecting continued strong business investment coming out of the pandemic,” it noted.

Credit card balances also continued to rise due to consumer spending on leisure and travel.

“Although mortgage growth was resilient, softer home sales/prices and rising rates will likely mean lower growth in the quarters to come,” Fitch said.

While asset quality strengthened in the quarter due to tight labour markets and elevated liquidity, Fitch expects that trend to reverse in the near term “as a slowing housing market, inflation, and tighter monetary policy pressure debt capacity for borrowers.”

Ahead of the anticipated decline in credit quality, the banks took $1.6 billion in increased provisions against performing loans, which weighed on earnings, Fitch noted.

“Provisions were largely driven by negative economic outlooks coloured by supply chain disruptions, inflation, and increased geopolitical risks,” it said.