Banks well-armed for uncertain economy: DBRS

There’s still a great deal of uncertainty in the economic outlook, but the big Canadian banks are well positioned to weather the year ahead, said DBRS Morningstar in a new report.

Aggregate earnings for the Big Six banks declined by 12% in fiscal 2020, largely due to increases in loan loss provisioning in response to the effects of Covid-19, DBRS said.

Total credit loss provisioning rose sharply to $23.7 billion in 2020, up from $8.9 billion recorded in the prior year. Yet most of this came on performing loans, it reported.

Gross impaired loans rose in 2020 too, largely driven by credit impairments in sectors most directly affected by the pandemic, DBRS said, particularly the oil and gas, retail, and hospitality sectors.

Nonetheless, the banks also generated still-solid loan growth of 5% year over year, it said.

Loan growth was largely powered by residential mortgage lending, amid low mortgage rates and strong housing markets.

“Conversely, other personal lending growth was muted during [fiscal 2020], with aggregate credit card balances declining a significant 13% year over year as consumers remained cautious and economic activity was muted,” said DBRS.

As well, commercial loan growth slowed to 5% from double-digit growth in prior years.

Looking ahead, gross impaired loans are expected to rise in 2021 as loan deferrals that were implemented in the face of the pandemic have since expired.

DBRS said the outlook for future loan loss provisioning “will largely be a function of loan growth and credit migration.”

The underlying economic outlook remains uncertain too, particularly in the short term.

Under its moderate scenario, DBRS forecast that Canadian GDP contracted by 5.5% in 2020. GDP is expected to by 5.0% in 2021, followed by 2.5% growth in 2022.

“The near-term economic outlook remains troubling and recovery prospects will likely depend on the severity and duration of the current coronavirus resurgence; however, we expect the outlook to brighten by mid-year as vaccines become more widely available,” said Robert Colangelo, senior vice president, global financial institutions group at DBRS Morningstar.

Given the uncertain economic outlook, DBRS said it expects “the earnings power of banks to continue to be constrained; however, their highly diversified franchises and demonstrated abilities to manage expenses should provide an offset.”

Additionally, the banks’ capital and liquidity levels will remain elevated and well above the regulatory minimums, it said.

The banks’ aggregate tier one capital ratio rose by 80 basis points in fiscal 2020 to 12.3% “largely driven by internal capital generation,” DBRS said. “This high level of capital provides these banks with a significant capital buffer to absorb higher credit losses.”

“Restrictions on dividend increases and share buybacks may be lifted once the path to economic recovery becomes clearer,” it said.

For now, DBRS has a stable outlook on the banks’ credit ratings. Upgrades remain unlikely due to the operating environment, whereas negative rating pressure could materialize if the banks “experience a sustained deterioration in asset quality or a significant weakening of profitability,” it said.