The Bank of Canada started slashing interest rates in June, after ratcheting them up for years to tamper inflation, which could shift the mortgage market outlook for 2025.Ashley Fraser/The Globe and Mail
Lower interest rates could prod Canadian banks into a mortgage competition next year as the cost of borrowing drops and swaths of fixed-rate loans come up for renewal.
Canada’s six largest lenders will report earnings for the industry’s fiscal year ended Oct. 31 next week, and analysts anticipate that the banks’ fourth quarter could be the final slump in a year of muted loan growth before falling interest rates are expected to spur demand next year. With more than half of all Canadian mortgages renewing in 2025 and 2026, the changing landscape could thrust the country’s banking sector into a mortgage war.
A wave of homebuyers made their purchases at historically low interest rates early in the COVID-19 pandemic. As the Bank of Canada ratcheted up rates in recent years to temper inflation, the country’s banking regulator expressed concerns that homeowners would face financial distress when renewing at higher borrowing costs.
But since the Bank of Canada started slashing rates in June, the mortgage market outlook for next year has shifted.
“Although payment shock is declining, a significant proportion of mortgagors will still have higher mortgage payments – creating a strong incentive to shop around for the lowest available mortgage rate,” RBC Capital Markets analyst Darko Mihelic said in a note to clients.
High interest rates have dampened loan growth over the past year, he said, and “the chance to grab market share from a competitor is significant.”
Central banks have been on a tear slashing the cost of borrowing. In October, the Bank of Canada dropped interest rates by 50 basis points, marking the fourth consecutive cut since June and following three prior quarter-point reductions. The U.S. Federal Reserve announced a 50 basis point drop in September – its first rate cut in four years – followed by a quarter-point reduction earlier this month.
While lower interest rates mean that banks earn less on the money they loan out, an easing economic downturn and cheaper borrowing costs could bolster bank earnings next year by spurring loan demand.
“The Bank of Canada’s attempts to ‘stick the landing’ with its easing monetary policy stance of four straight rate cuts in as many meetings, including the recent jumbo 50 basis point rate cut in late October, could reignite Canada’s sluggish housing market, spur consumer and business lending, and fuel capital markets underwriting and advisory activity,” Jefferies analyst John Aiken said in a note.
Analysts expect that fourth-quarter bank earnings will mark the transition out of a year marked by rising loan loss provisions, higher expenses and muted profits.
On Tuesday, Bank of Nova Scotia BNS-T will be the first major lender to release earnings for the three months ended Oct. 31. Royal Bank of Canada and National Bank of Canada will report results on Wednesday. Toronto-Dominion Bank TD-N, Bank of Montreal BMO-T and Canadian Imperial Bank of Commerce CM-T will wrap up earnings week for the Big Six lenders on Thursday.
The S&P/TSX Composite Banks Index – which tracks major Canadian bank stocks – has risen by 18 per cent this year, narrowly keeping pace with the S&P TSX Composite Index’s climb of 22 per cent. But shares of Canadian banks have been on a tear over the past three months as interest rates have continued to fall.
“The current rally is less about what the banks report in Q4, and more about their outlooks for next year and beyond across a number of different variables including loan growth, capital markets revenues and PCLs,” Scotiabank analyst Meny Grauman said in a note, referring to provisions for credit losses. “As we head into another earnings season investors need to focus a little less on the results themselves and much more on management commentary about the path ahead.”
Analyst expectations are wide-ranging for the fourth quarter, estimating that earnings could grow between 4 per cent to 11 per cent on average.
Provisions for credit losses – money that the banks set aside for loans that could default – have stifled profits at Canada’s banks as higher borrowing costs and inflation weighed on customer wallets. The provisions are a closely watched measure of financial stress among customers.
Some analysts expect higher impaired loans – debt that a bank believes will not be repaid – as delinquencies among retail customers rise.
Impaired loan provisions “are lumpy on the corporate/commercial side, but while we continue to expect some further provisions in those portfolios, a bigger driver going forward should come from retail (not mortgages, but cards and autos in particular), especially as the unemployment rate inches higher,” Mr. Grauman said.
Loan growth is also expected to continue to be dampened by higher interest rates. Loan balances decreased slightly by 0.2 per cent on average in the first two months of the fourth quarter, according to data from the Office of the Superintendent of Financial Institutions. But higher loan demand in September offset the decline in August, and some analysts expect that demand continued to edge higher in the final month of the quarter.
“We expect 2024 to end on a soft note in terms of loan growth,” CIBC Capital Markets analyst Paul Holden said in a note. “However, we expect to see an acceleration in F2025 premised on lower borrowing costs, improved economic certainty (i.e., lower recession risk) and conclusion of the U.S. presidential election. We are not sure that loan growth will fully recover to historical averages in F2025, but we are forecasting a better pace relative to the upcoming quarter.”