Canadian Banks Mid-Year Outlook 2020: Navigating Through The Pandemic Cautiously - Aug. 14, 2020 - S&P Global
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Lidia Parfeniuk
Canadian Banks Mid-Year Outlook 2020: Shameer Bandeally
Amit Tiwari
Navigating Through The Pandemic Cautiously Devi Aurora
Felix Winnekens
Aug. 14, 2020
Canadian Banks Mid-Year Outlook 2020 | Contents
Outlook 3
Macroeconomic View 4
Capital & Earnings 6
Asset Quality 8
Consumer Lending 10
Commercial Lending 12
Funding & Liquidity 14
TLAC & ALAC 15
Related Research 16
Data as of Q220 for all DSIBs, as of Q120 for Desjardins Group
2
Fundamental Forecast | Strong Balance Sheets
Worsening Neutral Improving
We expect revenues to decline by 5% year on year in 2020 reflecting pressure on net interest income from
ultra low interest rates, and headwinds for some fee income sources. Some offset could result if capital
Revenues
markets hold up in the remainder of the year or if there is partial offset from stronger overall corporate and
commercial lending.
We expect 2020 expenses to remain relatively stable as certain variable costs have reduced however DSIBs
Expenses are absorbing costs associated with COVID-19. Consequently, we expect negative operating leverage for
2020.
We expect material declines in profitability as net income declines by 30%-50% in 2020 reflecting
significantly higher provisions for loan losses. As the economy recovers in 2021, profitability could reverse
Profitability its decline, albeit to levels lower than in 2019.
We see asset quality metrics deteriorating as higher loan losses emerge particularly from the banks’
exposures to high-risk sectors related to the COVID-19 pandemic, including hospitality, restaurants, oil
and gas, and certain segments of commercial real estate (CRE) such as retail, and unsecured consumer
Asset quality lending with much of the deterioration occurring in 2021. However, the banks’ exposures to these sectors
in our view, are manageable.
We expect capital ratios to decline from current levels as earnings decline, and higher risk-weighted
averages (RWAs) in part reflecting draws on corporate lines and elevated market risk. Still, we expect the
Capital DSIBs ‘ risk-adjusted capital (RAC) ratios to remain within our adequate range of 7%-10% in our base case
and in our stylized adverse stress scenario.
We expect funding trends to remain more or less stable and market access for DSIBs’ issuances to
Funding & liquidity continue, and for them to maintain appropriate levels of liquidity in the downturn. The various funding
programs put in place by central bank helped support funding markets without any major disruptions.
3Canada’s Economy Faces A Patchy Recovery
– S&P Global Economics forecasts real GDP will contract 5.9% in 2020 before rising 5.4% in 2021, resulting in a peak-to-
trough contraction of more than 13%.
– We expect an economic recovery in two stages: a near term bounce in aggregate demand and employment activity,
followed by a more gradual protracted, and uneven improvement in the economy.
– We forecast a near-term correction in house prices down 8.7% year over year, in first-quarter 2021, before starting to
recover by the end of 2021 as the labor market finds its footing and the pandemic uncertainty fades
– We expect the economy to still be 2.5% smaller in 2023 compared with the pre-pandemic anticipated size.
Macroeconomic Outlook – Significant Fiscal Response To COVID-19
Select Economic Indicators Pandemic By Canada
2017 2018 2019 2020f 2021f Tax deferrals, loans and other credit measures
Direct Spending
Real GDP (%) 3.2 2.0 1.7 (5.9) 5.4
18
16
CPI (%) 1.6 2.2 2.0 (0.4) 1.2
14
(% of GDP)
12
HPI (% YoY) 8.9 2.1 2.4 (4.9) 3.3
10
8
Unemployment (%) 6.3 5.8 5.7 9.2 7.3
6
4
3 Month T-Bill (%) 0.68 1.36 1.66 0.51 0.23
2
0
10 Year Bond (%) 1.78 2.28 1.59 0.60 1.09
Total Federal Provincial*
Source: S&P Global Ratings, Statistics Canada, Bank of Canada, Oxford Economics, *provincial figures estimated from provincial finance departments
4Stable Trends On BICRA Economic and Industry
Risk Scores
– While downside risks associated with high consumer indebtedness and elevated house prices will
remain key areas of surveillance, we expect the impact on house price correction to be manageable
and short lived.
BICRA group ‘2’
– Economic Risk trend: 3/Stable
– Industry Risk trend: 2/Stable
Key strengths
– High-income, well-diversified,
competitive, and resilient economy
– Strong industry stability, unified
regulatory framework, and deep
capital markets
Key Weaknesses
– High household debt and real estate
prices. We expect a sharp decline in
home prices but short lived.
A BICRA (Banking Industry Country Risk Assessment) is scored on a scale from ‘1’ to ’10’, ranging from the lowest-risk banking systems (group ‘1’) to the
highest-risk (group ‘10’). ER – Economic Risk; IR – Industry Risk. Source: S&P Global Ratings. BICRAs as of July 2020.
5Capital Ratios Will Decline Slightly While
Remaining Appropriate For The Ratings
DSIB Capital Metrics
Q220 RAC 2020F RAC Q220 CET1 – Our base-case scenario assumes losses
on average of 3x the 2019 losses.
Adverse CET1 Severely Adverse CET1
12%
– Our sensitivity analysis indicates
that DSIBs' capital and liquidity levels
have enough strength to endure adverse
10%
downside scenarios, characterized by
credit losses of up to 1.8% (5x the
8% average 2019 loss rate).
– Under our adverse stress scenario,
6% DSIBs' RAC ratios would remain in the
adequate range of 7% - 10%.
4% – We could take widespread rating actions
if loss rates surpass this level, under our
2% severely adverse loss scenario (8x the
average 2019 loss rate).
0%
BMO BNS CM NA RY TD
Sources: S&P Global Ratings and company filings. RAC – Risk-adjusted Capital. CET1 – Common Equity Tier 1 ratio. Adverse & Severely Adverse CET1 projected at
Q420. BMO—Bank of Montreal. BNS—Bank of Nova Scotia. CM—Canadian Imperial Bank of Commerce. NA—National Bank of Canada. RY—Royal Bank of Canada.
TD—Toronto-Dominion Bank.
6Profitability To Remain Constrained By Sharply
Higher Provisions
– The big drop in earnings year to date is related to sharply higher provisions for loan losses. We don’t expect
profitability to return to pre-pandemic levels before end of 2021.
– We expect domestic NIMs to remain under pressure in the ultra low interest rate environment and for interest
rates to remain near zero. We believe that NII will stabilize by 2021 reflecting growth in high-yielding corporate
loans.
– DSIBs’ productivity ratios are holding up; however, there are fewer opportunities to reduce costs meaningfully to
offset the impact from lost revenues.
Low Rates The New Norm DSIB Profit Metrics
DSIB Domestic NIM (LHS) BoC Overnight Rate (RHS) Revenue Net Income Productivity
10 Year Bond Yield (RHS) Mortgage Rate (RHS) 14,000 80%
2.65% 3.50% 12,000 70%
3.00% 10,000 60%
2.60%
$CAD Mil.
2.50% 50%
8,000
2.55% 2.00% 40%
6,000
2.50% 1.50% 30%
4,000 20%
1.00%
2.45% 2,000
0.50% 10%
2.40% 0.00% 0 0%
Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2
Q2 17
Q3 17
Q4 17
Q1 18
Q2 18
Q3 18
Q4 18
Q1 19
Q2 19
Q3 19
Q4 19
Q120
Q220
BMO BNS CM NA RY TD
Sources: S&P Global Ratings and company filings. NIM – net interest margin.
BoC –bank of Canada. NII – Net interest income.
7Asset Quality To Weaken Though The Banks Have
Sufficient Cushion For Much Higher Loan Losses
DSIB Asset Quality
Adj. NPAs (% Loans) NCOs (% Average Loans)
– We believe credit losses will rise, albeit
from low levels, and will peak in 2021 at
LLRs / Adj. NPAs (%) (RHS)
about 70 basis points (bps).
1.2% 140%
– These rates exceed losses recorded
during the global financial crisis (58bps)
120% and reflect exposure to high risk sectors
1.0%
including oil and gas, CRE, as well in
100% unsecured consumer lending.
0.8%
– We believe expected losses will be
80%
manageable from an earnings and
0.6%
60%
capital perspective.
0.4% – Losses will be deferred to 2021 as most
40% deferral programs won’t end for another
0.2%
few months.
20%
– The average allowance is 80 bps of loans;
0.0% 0% however, if we exclude low risk insured
mortgages, the coverage improves to an
2012
2013
2014
2015
2016
2017
2018
2019
Q220
2020F
2021F
allowance of 90 bps.
Sources: S&P Global Ratings and company filings. NPAs – Nonperforming assets. NCOs – Net chargeoffs. LLRs – loan loss reserves. RHS – Right-hand side.
8High-Risk Sectors Will Generate Higher Losses,
But Should Be Manageable Overall
High-Risk Sector Exposure (% Total Loans)
CRE HL&E Retail & Trade Transport Oil & Gas
– DSIBs’ exposure to high risk sectors is on
12%
average under 5%-10% of their
10%
wholesale loan portfolios, including
8%
6%
media, entertainment, leisure, tourism,
4%
hospitality, retail, restaurants, oil and
2%
gas, retail CRE, and transportation.
0% – We expect significantly higher loan
BMO BNS CM NA RY TD
losses from these sectors though we
believe that DISBs are well-positioned to
Deferred Loans (% Total Loans) absorb much higher loan losses.
18%
16%
14% – Deferrals – which have been
12% concentrated in residential mortgages,
10%
8% followed by commercial loans – have
6% slowed since early April.
4%
2% – We believe that there is a possibility of
0%
BMO BNS CM NA RY TD further payment extensions as the banks
Source: S&P Global Ratings, company filings. CRE – Commercial Real Estate. HL&E
continue to work with their customers.
–Hospitality, leisure, and entertainment.
9Mortgages & HELOCs Loan Losses To Remain Low
DSIB RESL Portfolio
NPAs (% RESL Loans) LHS NCOs (% RESL Loans) RHS PCLs (% Total PCLs) RHS
– We expect credit losses in DSIBs’ mortgage
portfolios, which represent 40% of loans
0.7% 2.0%
on average, to remain modest.
– We expect credit losses from a potential
0.6% correction in home prices to be cushioned
1.5% by the substantial borrower equity within
0.5% the uninsured residential mortgage loans
(conservative loan to values (LTVs) of high
40% to mid 50% range), strong credit
1.0%
0.4% underwriting (including stress testing), and
sizable level of income- support from the
government’s generous fiscal support.
0.3%
0.5% – We expect losses in the mortgage book to
remain consistent with our view of a short-
0.2% lived correction phase in the housing
markets.
0.0%
0.1% – We expect HELOCs to show slightly higher
loan losses than conventional mortgages;
however, they are mostly first lien and
0.0% -0.5% benefit from similar conservative LTVs.
BMO BNS CM NA RY TD DG
Sources: S&P Global Ratings and company filings. NPAs – nonperforming assets. NCOs – net
chargeoffs. PCLs – provision for credit losses. DG PCLs not disclosed. . DG— Federation des caisses
Desjardins du Quebec (Desjardins Group).
10Unsecured Consumer Losses Could Rise Sharply
Other Consumer Asset Quality DSIBs – Other Consumer Loan Growth
OC NPAs (% OC Loans) OC NCOs (% OC Loans) Credit Cards HELOC Other Personal
2.5% 15%
2.0% 10%
5%
1.5%
0%
1.0%
-5%
0.5% -10%
-15%
0.0%
2012 2013 2014 2015 2016 2017 2018 2019 Q2 20
BMO BNS CM NA RY TD DG
Source: S&P Global Ratings, company filings. NPAs – nonperforming assets.
NCOs – net chargeoffs. OC – Other Consumer which includes cards and auto loans.
– We expect losses in unsecured consumer lending portfolios, including cards and auto, to rise meaningfully
because during times of stress consumers tend to wait to pay off their credit card bills and defer on auto loan
payments.
– Unsecured consumer loans represent on average 11% of DSIBs’ total loans, and the average compounded growth
rate was 4% from 2012 to 2019.
– Indirect consumer exposure to oil and gas producing provinces is manageable though we expect losses to be much
higher.
11Higher Risk Property Types Within CRE Could
Suffer
DSIB CRE Portfolio
CRE Loans (% Total) LHS CRE NPAs (% CRE Loans) RHS CRE PCLs (% Total PCLs) RHS – The overall exposure to CRE and
construction lending at about 9% of
DSIBs’ loans (on average) is manageable.
12% 2.5%
– Condo exposures are about 9%-10% of
total CRE among DSIBs.
10%
2.0% – The CRE portfolios are also well-
diversified by geography and property
type and exposure to construction
8%
lending is limited.
1.5%
– Non-performing assets have averaged
6% less than 1% of CRE loans and provisions
for credit losses (PCLs) are less than 2%
1.0% of DSIBs PCLs so far this year, with the
4% exception of BMO.
– However, several CRE property types
0.5% (such as retail, hospitality, and office
2%
space) will continue to remain at high
risk from social distancing for a relatively
long time and could suffer structurally.
0% 0.0%
BMO BNS CM NA RY TD
Sources: S&P Global Ratings and company filings. NPAs – nonperforming assets. NCOs – net
chargeoffs. PCLs – provision for credit losses.
12Despite Modest Exposures, Oil And Gas Contribute
Heavily To Credit Migrations
– DISIBs’ oil and gas exposures are the most immediately vulnerable from a credit standpoint.
– The very sharp decline in oil prices has severely affected the sector. However, DSIBs’ exposure to oil and gas at
2.2% of total loans in our view is very modest.
– As a result of the slew of oil and gas loan migrations in the banks’ portfolios, provisions for loan losses rose nearly
450% on average in second quarter from the first quarter.
– Roughly 40% of the energy book is investment grade with the bulk of exposures in the exploration and production
sector. The credit profiles of DSIBs’ oil and gas loan portfolios have improved since 2015-2016 when oil prices
dropped sharply.
Oil & Gas – Asset & Asset Quality Breakdown of O&G Exposures
Other Midstream & Downstream (RMD)
Net O&G Loans / Total Loans Net O&G NPAs / O&G Loans (%) Drilling & Services Exploration & Production
4.5% 120%
4.0%
3.5%
100%
3.0% 80%
2.5%
2.0% 60%
1.5% 40%
1.0%
0.5% 20%
0.0% 0%
BMO BNS CM NA RY TD BMO BNS CM NA RY TD
Source: S&P Global Ratings, company filings. O&G – Oil & Gas. NPAs –
nonperforming assets.
13Funding Is Stable And Liquidity Remains High
– Funding for DSIBs has been stable, helped by the extensive measures put in place by the Bank of Canada to avoid
any disruptions in the funding markets and continued international receptivity for the Canadian banks’ issuances.
– DSIBs entered the downturn with solid balance sheets with about half of their deposits viewed as core customer
deposits, and with conservative, highly rated, and liquid investment portfolios.
– DSIBs deposits grew as some corporates recycled a good proportion of their draws as deposits. We expect deposit
growth to remain relatively strong this year, but could decelerate next year.
DSIBs – Funding Metrics DSIBs – Liquidity Metrics
Loans / Deposits (LHS) S&P Stable Funding Ratio (RHS) Liquidity Coverage Ratio (RHS) BLA / ST (LHS)
130% 102% 1.30x 140%
100% 1.25x 135%
125%
98% 1.20x
130%
120% 96% 1.15x
1.10x 125%
94%
115% 1.05x 120%
92%
1.00x 115%
110% 90%
0.95x
88% 110%
105% 0.90x
86% 105%
0.85x
100% 84% 0.80x 100%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 Q2
Q2
Source: S&P Global Ratings, company filings. BLA / ST – Broad liquid assets to
short-term wholesale funding.
14TLAC & ALAC – Banks Are Well Positioned On Both
Ends
TLAC Breakdown & Ratios
CET1 Additional Tier 1 – At mid-year 2020, DSIBs’ average regulatory total loss
Tier 2 Other TLAC absorbing capacity (TLAC) and TLAC leverage ratios
TLAC Ratio (%) TLAC Leverage (%)
stood at 21% and 6.4%, respectively.
120 26%
24% – We expect DSIBs to comfortably reach the minimum
100 22% requirements on TLAC of 22.50% (of risk weighted
20%
18% assets) and TLAC leverage of 6.75% by Nov. 1, 2021.
80
$CAD Bil.
16%
14% – We continue to view the Canadian government as
60
12% “supportive,” however, should our views change to
10%
40 8% support “uncertain,” we believe DSIBs will be well-
6% positioned to receive an ALAC notch equivalent to
20 4%
2% their notching for extraordinary government support,
0 0% which would be neutral from a ratings perspective.
BMO BNS CM NA RY TD DG
BMO BNS CM NA RY TD DG
Anchor a- bbb+ a- a- a- a- a-
SACP a a a- a- a+ a+ a
Sys. Importance +1 +1 +2 +1 +1 +1 +1
Potential ALAC Uplift +1 +1 +2 +2 +1 +1 +1
ICR A+ A+ A+ A AA- AA- A+
Bail-In Debt2 A- A- BBB+ BBB+ A A A-
Sources: S&P Global Ratings, company filings. TLAC – total loss absorbing capacity. ALAC – additional loss absorbing capacity.
15Canadian Bank Mid-Year Outlook 2020 | Related
Research
– Canadian House Prices Are Likely To Decline Sharply Into Next Year; Strong Fundamentals Restrain
Broader Housing Market Risks For Now, July 16, 2020
– Canada’s Economy Faces A Patchy Recovery, June 29, 2020
– Banking Industry Country Risk Assessment Update, June 26, 2020
– Laurentian Bank of Canada Affirmed At ‘BBB’; Outlook Remains Negative on Weak Earnings Capacity,
June 10, 2020
– North American Financial Institutions Monitor 2Q 2020, May 15, 2020
– HSBC Holdings Ratings Lowered To ‘A-/A-2’ On Muted Earnings Prospects And Extensive
Restructuring; Outlook Stable, May 13, 2020
– Canadian Banks Are Set To Face COVID-19 Related Headwinds From A Position of Strength, Apr. 16,
2020
– U.S. Banking Outlook, Jan. 13, 2020
– Banking Industry Country Risk Assessment: Canada, Jan. 2, 2020
– Global Banking Outlook, Nov. 19, 2019
16Appendix: Ratings – Stable Ratings In Our Base Case
Adjustments from the Anchor:
Very Weak (-5) Weak (-2) Moderate (-1) Avg & Adeq (0) Strong (+1) Very Strong (+2)
Business Capital & Risk Funding & Systemic
Anchor SACP ICR & Outlook
Position Earnings Position Liquidity (F&L) Importance
Bank of Montreal a- Adequate Adequate Strong Avg. & Adeq. a High A+/Stable
Bank of Nova Scotia bbb+ Strong Adequate Strong Avg. & Adeq. a High A+/Stable
Canadian Imperial
a- Adequate Adequate Adequate Avg. & Adeq. a- High A+/Stable
Bank of Commerce
Fédération des
caisses Desjardins du a- Adequate Strong Adequate Avg. & Adeq. a Moderate A+/Stable
Québec
National Bank of
a- Adequate Adequate Adequate Avg. & Adeq. a- Moderate A/Stable
Canada
Royal Bank of Canada a- Strong Adequate Strong Avg. & Adeq. a+ High AA-/Stable
Toronto-Dominion
a- Strong Adequate Strong Avg. & Adeq. a+ High AA-/Stable
Bank
Source: S&P Global Ratings. SACP--Stand-alone credit profile. ICR--Issuer credit rating. Avg & Adeq.--Average & Adequate. *Holding company rating.
17Analytical Contacts
Lidia Parfeniuk Shameer Bandeally Amit Tiwari
Director Associate Director Ratings Analyst
Toronto Toronto Toronto
+1-416-507-2517 +1-416-507-3230 +1-416-507-3224
lidia.parfeniuk@spglobal.com shameer.bandeally@spglobal.com amit.tiwari@spglobal.com
Devi Aurora Satyam Panday Felix Winnekens
Analytical Manager Senior Economist Director
New York New York New York
+1-212-438-3055 +1-212-438-6009 +1-212-438-0313
devi.aurora@spglobal.com satyam.panday@spglobal.com felix.winnekens@spglobal.com
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