A potential interest rate cut from the Bank of Canada could benefit Canadian bank stocks, says one portfolio manager, but if rates stay where they are those same stocks will face headwinds.
Colin White, president and CEO of Verecan Capital Management, said in an interview with BNNBloomberg.ca last week that Canadian bank stocks trade as a “proxy for the Canadian economy.” He said that the impact of interest rates is less about the direct impact on the group of lenders and more about the impact on the overall economy.
“If we see the interest rates drop and that alleviates some of the pressure on defaults, that will be positive for them. It will also indicate they are trying to stimulate the economy, which will also be good for them,” White said.
“If interest rates stay where they are, I think they’re going to have a bit of a headwind because those defaults are going to stay where they are or perhaps ramp up. And the economy is not necessarily going to be going gangbusters in that environment.”
Amid higher interest rates all of Canada’s major lenders have moved to increase loan loss provisions, White said, including for loans currently in good standing.
“So the longer interest rates stay higher, the more pain that's going to be and more defaults we are going to see. So there is a time aspect to this as well,” he said.
In the first quarter, all of Canada’s Big 6 banks allocated more capital to cover bad loans compared to the previous year. The move was a sign that the lenders were wary of the economic health of clients.
In total Canada’s Big 6 banks put aside over $4 billion in loan loss provisions during the first quarter. White said the current loan loss ratios “may not be material in the bigger scheme of things,” but rather a sign of overall economic performance.
White said loan loss provision figures will be something to look for when Canada’s major banks report second-quarter results.
“It's difficult to quantify how much debt they have that's coming due in the next six months or next nine months and I think that loan loss provision numbers is going to be a bit of a window into that. And also will go into how fast they need to see rates begin to move in order to protect themselves from future write-downs,” he said.
Expected rate path
The Bank of Canada elected to hold interest rates at five per cent Wednesday, in line with unanimous expectations among economists tracked by Bloomberg. However, five of the 13 economists are anticipating a rate hold at the Bank of Canada’s June 5 meeting, with the others expecting a 25 basis point interest rate cut.
Notably last week, Bloomberg News reported that CIBC Chief Executive Officer Victor Dodig said he doesn’t anticipate a series of rate cuts this year.
“I’ve never been of the view that there’ll be multiple cuts this year,” Dodig said during the bank’s annual general meeting.
When looking at the most current economic figures, White said he doesn’t see rate cuts coming soon.
“There is another reality people aren’t talking about as much, (but) maybe this is where interest rates belong. This could be the new reality, this could be the level of interest that we need to keep inflation under control,” he said.
First quarter results
Canada’s Big 6 lenders saw mostly strong results in the first quarter, with most beating expectations. However, Bank of Montreal missed revenue and earnings per share (EPS) expectations.
“Canadian banks are good businesses and they're going to put up solid numbers,” White said.
“They always are challenged with hitting growth, because most of them to one degree or another have diversified outside of Canada and search for continued growth because they control the market here in Canada.”
With files from Bloomberg News.