Veritas Investment Research cut its price target on Canada’s major banks on concerns the Big Six will have to set aside more cash to cover potentially sour loans.
In a note to clients, Veritas financial services analyst Nigel D’Souza said that rising borrowing costs and the potential for a recession could lead to an increase in credit loss provisions (PCL), raising downside risks for big bank stocks.
“We expect provisions for credit losses (PCL) in [fiscal year 2024] to run materially above pre-pandemic levels of sanctions with dovish pivots by central banks. “Historically, peak credit losses lag the increase in debt service costs by ~2 years,” he said.
“We expect debt servicing costs to rise to a record high in 2023 and expect PCL to accelerate and potentially peak in 2024 with inflationary pressures, rapidly rising rates and provisions for performing loans under IFRS 9 likely to pull forward PCL recognition.”
There are already signs banks will release more cash to cover potentially sour loans – provisions for credit losses rose by $1.54 billion across the Big Six in the fiscal third quarter, nearly 10 times the $166 million increase in the previous quarter.
D’Souza said that the increase in PCL combined with higher costs would more than offset the benefits banks get from higher rates, which typically expand lending margins.
“We forecast a high single-digit decline in adjusted earnings for Canada’s Big Six banks over the medium term with increases in PCL and higher expenses in an inflationary environment more than offsetting higher net interest income (NII) from margin expansion and loan growth, ” he said.
Although D’Souza lowered his 12-month price targets on all six banks, he upgraded Bank of Nova Scotia to buy and reiterated that TD Bank is his top recommendation in the sector, citing the bank’s higher leverage to rising rates. the environment.
Overall, shares in the big banks have struggled this year, with all of the Big Six trading lower on a year-to-date basis. Scotiabank has been a laggard, losing about 26 percent of its value in 2022 alone through early trading Tuesday.