Recession fears plunge Canadian banks into 20% drop from record

Canadian banks fell more than 20% from their record high set in early February as recession fears send investors fleeing.

The S&P TSX Financials Sector Index and the S&P/TSX Commercial Banks Index, which tracks the country’s eight largest lenders, both dropped Thursday, adding to another day of losses after inflation in Canada surged to a four-decade high and US data pointed to rising unemployment and slumping manufacturing and services activity.

Office towers light up in the evening in the financial district of Toronto, Ontario, Canada, on Friday, May 22, 2020. Whether the PATH, a subterranean network that provides connections between major commuter stations, over 80 properties, including the headquarters of Canada’s five largest banks, and 1,200 retail spots, can return to its glory days will depend initially on how quickly Bay St. firms return workers to their offices. Photographer: Cole Burston/Bloomberg

Cole Burston/Bloomberg

Toronto-Dominion Bank, Canada’s second-largest lender, led losses as it dropped as much as 3.6% to its lowest point in nine months. Canadian Imperial Bank of Commerce and Bank of Nova Scotia fell as much as 3.4% and 3.3%, respectively.

The commercial banks index hit its high on Feb. 8 and was one of the S&P TSX Composite Index’s strongest performers before spiraling as Russia launched its war in Ukraine on Feb. 24 and central banks warned of a potential economic downturn.

Analysts are warning that profits may not be as strong going forward. Canadian bank earnings estimates for 2023 could fall by 16% on average in the case of an economic downturn, according the RBC Capital Markets. Scotiabank and CIBC are among the Big Six bank stocks leading losses this year. Both banks, Canada’s third- and fifth-largest banks, could have further to fall as they rebuild loan loss provisions previously released as pandemic restrictions unwound earlier this year.

Scotiabank’s core earnings per share for 2023 could decline the most out of the group by 22.5%, RBC analyst Darko Mihelic said in a note to clients Tuesday. The bank has released the most performing reserves of the group, while Bank of Montreal and National Bank of Canada would be the least impacted, with each bank’s core EPS estimates falling by 12.6%.

“NA and BMO would be good defensive stocks to own heading into a recession,” Mihelic said. “BNS and CM would likely suffer under bigger earnings declines and some consternation around housing in Canada and generally higher loan loss concerns.”

Inflation in Canada climbed to 7.7% in May, reaching its highest point in 40 years, Statistics Canada said on Wednesday. The jump bolsters expectations that the Bank of Canada will deliver aggressive rate increases next month.

Even so, Canada’s banking regulator left a key capital requirement for large lenders unchanged on Wednesday, indicating that it believes that the banks can absorb potential losses even as economic risks mount.

Investors prefer banks that get a head start on building up their reserves, Mihelic said.

“The banks that begin to proactively build reserves ahead of peers will be rewarded as long as there are not bank specific issues causing the reserve build,” he said. 

As recession fears mount and Canada’s housing market cools, analysts including those at Barclays and Desjardins, have been cutting their price targets on the country’s largest lenders. Since early March 4, the average price target on the commercial banks index fell 6.3%, with CIBC’s target dropping 9.7%.

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