Analysts expect banks to set aside more funds as US tariff risks mount
Canada’s major banks are bracing for heightened economic uncertainty as trade tensions with the US threaten to weigh on their upcoming earnings reports.
While analysts initially expected solid performances driven by rising net interest margins and strong capital markets activity, concerns over potential tariffs have cast doubt over credit risk and provisions for loan losses.
One of the biggest concerns heading into the banks’ earnings season is how they will account for potential economic headwinds. Rising provisions for credit losses (PCLs), funds set aside to cover potentially bad loans, have already put pressure on banks in recent years due to inflation and high interest rates.
“We had become increasingly convinced that credit losses were near a peak and that the banks could be in a position to release performing allowances sooner than later,” said Paul Holden, an analyst at CIBC World Markets. “We have less conviction in that view given the tariff risk.”
If trade policies disrupt the economy, banks may be forced to increase their reserves rather than releasing them.
“If tariffs against Canada are implemented, then our expectation for impaired PCLs would need to change significantly,” Holden added. “The outcome on tariffs is unknown, but it is now a risk that we need to consider in our outlook.”
Go on defence
The risk of a prolonged trade dispute has already led some analysts to revise their earnings expectations. Darko Mihelic, an analyst at RBC Capital Markets, lowered his earnings-per-share projections for Canada’s largest banks, citing the likelihood of higher PCLs.
“We expect all large banks … to build larger performing PCLs than we previously believed,” he told the Financial Post.
This shift in strategy would likely reflect a more cautious economic outlook, with banks adjusting their financial models to account for potential recessionary conditions.
“We expect the banks’ base-case economic scenarios to reflect more of a recessionary economy, and we also believe pessimistic scenario assumptions may become more pessimistic,” Mihelic added.
Loan growth may also take a hit, with demand from both retail and commercial borrowers expected to cool as economic uncertainty lingers.
“We expect banks to inject greater conservatism into their credit guidance,” said Gabriel Dechaine, an analyst at National Bank Financial. He noted that while a major spike in loan loss provisions similar to what occurred during the pandemic is unlikely, banks are likely to tread cautiously.
BMO, Scotiabank, TD under scrutiny
Two of Canada’s largest lenders, Bank of Montreal (BMO) and Scotiabank, are expected to be particularly affected by these concerns. BMO has already faced challenges in recent quarters, setting aside more money than expected for loan losses. Analysts will be watching closely for signs that credit deterioration has stabilized.
“We hope to see stage 3 PCLs at or below our estimate and, more importantly, other signs like delinquencies (formations) and declines in the watchlist,” Mihelic said.
Read next: Sticky US inflation sparks fears of higher rates – bad news for Canada
Scotiabank, meanwhile, could be among the hardest hit by trade tensions. Its North American growth strategy, which focuses on Canada, the US, and Mexico, may face new challenges if tariffs are imposed.
CIBC’s Holden downgraded the bank’s stock, noting that Scotiabank’s earnings exposure to Mexico makes it particularly vulnerable.
“We generally prefer not to change ratings this quickly … but the macro environment has changed significantly,” he explained.
Toronto-Dominion Bank (TD) is also under the microscope as it works to address regulatory issues tied to its US operations. After being sanctioned last year for failing to prevent money laundering at its branches across the border, TD has been restructuring its compliance programs, a process that is expected to increase expenses.
“TD expects expense growth during fiscal year 2025 to be about five percent to seven percent, but we worry that might climb due to the complexities linked to the anti-money laundering remediation,” Holden said.
The Big Six banks will begin reporting first-quarter earnings next week. Bank of Montreal and Scotiabank will release results on Tuesday, February 25, followed by National Bank of Canada on Wednesday. Royal Bank of Canada, TD Bank, and CIBC will round out the week with their reports on Thursday, February 27.
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