Canadian Banks 2021 Outlook: Entering A Crucial Phase Of The Credit Cycle With Good Resilience - Lidia Parfeniuk Shameer Bandeally Daniela ...
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Canadian Banks 2021 Outlook: Lidia Parfeniuk
Shameer Bandeally
Entering A Crucial Phase Of The Daniela Brandazza
Felix Winnekens
Credit Cycle With Good Resilience Dec. 8, 2020
Canadian Banks 2021 Outlook | 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 Q320 for all domestic systemically important banks (DSIBs); as of Q220 for Desjardins Group. References to averages include the big six DSIBs,
excluding Desjardins, due to its much smaller presence outside Quebec.
2
Fundamental Forecast | Strong Balance Sheets
Worsening Neutral Improving
We expect revenues to improve as the continued pressure on net interest income from
Revenues ultra-low interest rates is offset by stronger loan growth. We expect potentially lower
capital markets revenues.
Expenses will increase marginally, reflecting higher service costs and investments in
Expenses personnel and technology. Still, we believe positive operating leverage is likely at most
banks.
Net income will improve, reflecting lower credit loss provisions, higher revenue growth, and
Pre-tax income cost containment, with the possibility of operating performance for some DSIBs returning
to the 2019 level.
Provisions will decline as credit losses materialize while impairments rise and peak.
Asset quality However, the level of asset quality deterioration will depend on the effectiveness of the
government stimulus and the rebound in economic activity.
Our risk-adjusted capital (RAC) ratios will remain within our adequate range of 7%-10%.
Capital Our sensitivity analysis indicates that DSIBs' capital and liquidity have enough strength to
withstand adverse downside scenarios, characterized by credit losses of up to 1.8% (5x the
2019 average loss rate).
Funding will remain broadly stable and market access for DSIBs’ issuances will continue.
Funding & liquidity The various funding programs put in place by the central bank will continue to provide
support.
3
Canada's Economy Faces A Patchy Recovery
– S&P Global Economics forecasts real GDP in Canada will expand 4.5% in 2021 following a 5.6% contraction this year. The
economy will get back to its pre-pandemic level in late 2021.
– Recent gains in consumer spending and employment will likely slow as goods spending retreats and many services go on ice for
the winter amid re-imposed restrictions.
– While harsher-than-expected lockdowns tilt risks to our near-term baseline forecast to the downside, a broad investment
package outlined in the government's Fall Economic Statement on Nov. 30 (after we completed our forecast) implies a better
outcome than our baseline once the vaccine is widely rolled out.
– Monetary policy is poised to stay extraordinarily accommodative to support the transition to a full-employment economy.
Fiscal Response to COVID-19 Pandemic In Canada
Macroeconomic Outlook--Select Indicators
(As of Nov. 15, 2020)
Direct Spending Tax Deferrals, loans, and other credit measures
Unemploy MLS Home
Real GDP 10-yr 3-mth T-
CPI (% chg) ment rate price index 25%
(% chg) bond (%) Bill (%)
(%) (% chg)
20%
2019 1.96 1.66 1.59 5.67 1.66 1.31
15%
2020 0.71 (5.61) 0.76 9.53 0.50 7.63
10%
2021 1.80 4.55 1.21 7.65 0.23 (0.69)
5%
2022 2.15 2.89 1.63 6.82 0.23 0.13
0%
2023 1.99 2.32 1.82 6.24 0.23 2.90 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 a moderate house price correction in 2021 will 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, though we expect only a
modest decline in home prices in
2021.
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.
5DSIBs' RAC Ratios Remain Stable, Aided By Steady
Dividends And No Share Repurchases
DSIB Capital Metrics – Regulatory capital ratios improved in 2020 from 2019,
Q220 RAC 2020F RAC Q320 CET1 in part due to restrictions on shareholder and dividend
Adverse CET1 Severely Adverse CET1
payouts. We expect these restrictions will remain in
place for at least part of 2021, and regulatory capital
will remain stable.
14%
– Our base-case scenario assumes 2020 losses
(provisions for credit losses ratio) on average of 2.5x
12%
the 2019 losses in 2020, falling to about half this level
in 2021.
10% – Our sensitivity analysis indicates that DSIBs' capital
and liquidity levels have enough strength to withstand
8% our stylized adverse downside scenarios,
characterized by credit losses of up to 1.8% (5x the
average 2019 loss rate).
6%
– Even under our adverse stressed credit loss scenario
(which we believe is unlikely to occur), we project the
4% DSIBs' RAC ratios would decline meaningfully but still
remain in the adequate range of 7%-0%.
2% – While most credit challenges have been pushed into
2021, we expect banks’ capital levels and earning
0% capacity will sufficiently absorb incremental credit
BMO BNS CM NA RY TD losses.
Sources: S&P Global Ratings and company filings. 2020F RAC-- 2020 RAC (Base Case Forecast). RAC--Risk-adjusted capital.
CET1--Common Equity Tier 1 ratio. Adverse and severely adverse CET1 ratio projected at Q420.
6Profitability To Improve By Lower, But Still-
Elevated, Provisions
– Profitability will likely rebound in 2021, fueled by higher revenue growth and lower provisions for loan losses as the prospects for
the economy and credit environment improve. For some DSIBs, profitability could return to pre-pandemic levels by the end of
2021.
– We expect net interest margins to be somewhat under pressure in the ultra low interest rate environment. We believe that net
interest income will benefit in 2021 from growth in typically higher-yielding corporate loans.
– DSIBs' productivity ratios have improved (or declined) by, on average, 200 basis points (bps) year-to-date, while revenues rose by
4% on average. As revenue growth picks up, so will costs; however, we believe that positive operating leverage is achievable as
DSIBs maintain their focus on costs.
Low Rates The New Norm DSIB Profit Metrics
BoC Overnight Rate (LHS) Reported Return on Equity
10 year bond yield (LHS) 20%
BoC 5 years and over fixed mortgage rate (LHS)
18%
DSIB NIM (RHS)
16%
4.0% 2.65% 14%
2.60% 12%
3.0% 10%
2.55%
8%
2.50% 6%
2.0%
2.45% 4%
2.40% 2%
1.0%
0%
2.35%
2019 2020 2019 2020 2019 2020 2019 2020 2019 2020 2019 2020
0.0% 2.30% Q3 Q3 Q3 Q3 Q3 Q3
Q120
Q220
Q320
Q2 17
Q3 17
Q4 17
Q1 18
Q2 18
Q3 18
Q4 18
Q1 19
Q2 19
Q3 19
Q4 19
YTD YTD YTD YTD YTD YTD
BMO BNS CM NA RY TD
Sources: S&P Global Ratings and company filings. RHS-- Right-hand scale. LHS--Left-hand scale.
NIM -Net interest margin. BoC--Bank of Canada. NII--Net interest income.
7Asset Quality To Weaken, Though The DSIBs Have
The Capacity To Absorb Higher Losses
DSIB Asset Quality
Adj. NPAs (% Loans) NCOs (% Average Loans)
LLRs / Customer loans (%) – We believe that NCOs will rise, albeit from low
levels, and will peak in 2021 at about 60 bps.
2.0% – This rate slightly exceeds losses recorded during
the global financial crisis (58 bps) and reflects
exposure to high-risk sectors related to the
pandemic, including certain segments of
1.5% commercial real estate (CRE) and oil and gas, as
well as unsecured consumer lending.
– We believe expected losses will be manageable
from an earnings and capital perspective.
1.0%
– We expect peak losses to occur mostly in the
middle of 2021 as deferral programs have ended,
while borrowers' savings rates have increased,
0.5% benefiting from government stimulus.
– The average allowance is 90 bps of loans; however,
if we exclude low-risk insured mortgages, the
coverage improves to an allowance of 100 bps.
0.0%
2012 2013 2014 2015 2016 2017 2018 2019 Q320 2020F2021F
Sources: S&P Global Ratings and company filings.
8Exposure To High-Risk Sectors Seems Manageable
Higher-Risk Sector Exposure (% Total Loans)
CRE HL&E Retail & Trade Transport Oil & Gas
– DSIBs’ exposure to high-risk sectors is on
10.0%
average about 5% of total loans, including
8.0% certain segments of CRE, hospitality,
6.0% leisure and entertainment, retail and trade,
4.0%
transportation, and oil and gas, which we
view as manageable.
2.0%
– We expect significantly higher loan losses
0.0%
BMO BNS CM NA RY TD from these sectors, though we believe that
DSIBs are well-positioned to absorb much
Deferred Loans (% Total Loans) higher loan losses.
Commercial Other Personal
Credit Cards Residential Mortgages
– We believe losses from these sectors will
Deferred Loans % total Loans (RHS) be more lumpy and possibly higher than
12.0%
80.0 mortgage and consumer loan losses in
10.0%
2021.
60.0 8.0%
Bil. C$
6.0% – Deferrals, which have been concentrated in
40.0
4.0% residential mortgages, followed by
20.0
2.0% commercial loans, have slowed since early
0.0 0.0% April, with the vast majority of borrowers
RBC TD BNS BMO CM NA now current.
Source: S&P Global Ratings, company filings. CRE--Commercial real estate. RHS—Right-hand scale. HL&E--Hospitality, leisure, and entertainment. Deferred loans
statistics--Bloomberg.
9Mortgage And HELOC Loan Losses To Remain Low
DSIB Real Estate Secured Lending Portfolio (As Of Q3 2020)
NPAs (% RESL Loans) LHS NCOs (% RESL Loans) RHS PCLs (% Total PCLs) RHS
– We expect credit losses in DSIBs'
mortgage portfolios, which represent
0.7% 2.5%
40% of loans on average, will remain
modest.
0.6% – We expect credit losses, should there be
2.0%
a correction in home prices, will be
0.5%
cushioned by the substantial borrower
1.5% equity in uninsured residential mortgage
loans (conservative loan to values [LTVs]
0.4% of about 55%), and strong credit
1.0%
underwriting, including stress testing.
0.3% – We expect losses in the mortgage book
to remain low, given our view of flattish-
0.5% to-very moderate home price
0.2% appreciation after 2020.
– We expect home equity lines of credit to
0.0% show slightly higher loan losses than
0.1%
conventional mortgages; however, they
are mostly first lien and benefit from
0.0% -0.5% similar conservative LTVs.
BMO BNS CM NA RY TD DG
Sources: S&P Global Ratings and company filings. RHS-- Right-hand scale. LHS--Left-hand scale. NPAs--Nonperforming assets. NCOs--Net charge-offs. PCLs--
Provisions for credit losses. DG PCLs are not disclosed.
10Unsecured Consumer Losses Could Rise Sharply
DSIBs – Other Consumer Loan Growth
Other Consumer Asset Quality (As of Q3 2020)
(As of Q3 2020)
OC NPAs (% OC Loans) OC NCOs (% OC Loans) Credit Cards HELOC Other Personal
2.5% 15.0%
2.0% 10.0%
5.0%
1.5%
0.0%
1.0%
-5.0%
0.5%
-10.0%
0.0% -15.0%
BMO BNS CM NA RY TD DG 2012 2013 2014 2015 2016 2017 2018 2019 Q3 20
– We expect losses in unsecured consumer lending portfolios, including cards and auto, to rise, 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 a modest 4% increase from 2012, to year to date. So far, this year, consumers have been prudent and credit card
balances have declined meaningfully.
– Indirect consumer exposure to oil and gas-producing provinces is manageable, though we expect losses will be much
higher.
Source: S&P Global Ratings, company filings. NPAs--Nonperforming assets. NCOs--Net charge-offs. OC--Other consumer, which includes cards and auto loans.
11Higher-Risk Property Types In CRE Could Weaken
DSIB CRE Portfolio (As Of Q3 2020)
CRE Loans (% Total) LHS NPAs (% CRE Loans) RHS PCLs (% Total PCLs) RHS
– The overall exposure to CRE and
construction lending, at close to 10%
12% 2.5%
of DSIBs’ (on average) loans, is
manageable.
10% – Condo exposures are about 9%-10%
2.0%
of total CRE among DSIBs.
8%
– The CRE portfolios are also well-
diversified by geography and property
1.5%
type and exposure to construction
6% lending is limited.
– However, several CRE property types
1.0%
(such as retail, hospitality, and office
4%
space) remain at high risk from social
distancing for a relatively long time
0.5% and could weaken structurally. We
2%
expect to see higher loan losses,
particularly in these segments.
0% 0.0%
BMO BNS CM NA RY TD
Sources: S&P Global Ratings and company filings. RHS-- Right-hand scale. LHS--Left-hand scale. NPAs--Nonperforming assets. PCLs--Provisions for credit losses.
12Despite Modest Exposures, Oil And Gas Are
Contributing 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 2.3% of total
loans, in our view is very modest.
– Approximately 40% of the energy book is investment-grade, with the bulk of exposures in the exploration and production sector.
The credit profiles (exposure to higher-quality borrowers) of DSIBs’ oil and gas loan portfolios have improved since 2015-2016
when oil prices dropped sharply.
– As a result of the slew of oil and gas and other loan migrations in the DSIBs’ portfolios, overall provisions for loan losses rose
228% on average in the third quarter from the first quarter, though they were down 38% from the second quarter.
Oil & Gas Assets And Asset Quality Breakdown Of Oil And Gas Exposures
(As Of Q3 2020) (As Of Q3 2020)
Net O&G Loans / Total Loans Net O&G NPAs / O&G Loans (%) Exploration & Production Drilling & Services
Midstream & Downstream (RMD) Other
7.0% 120%
6.0% 100%
5.0%
80%
4.0%
60%
3.0%
40%
2.0%
1.0% 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 Has Improved And Liquidity Remains High
– Funding for DSIBs has improved, helped by the extensive measures put in place by the Bank of Canada earlier in the year to avoid
any disruptions in the funding markets and continued international receptivity for the Canadian banks’ issuances.
– DSIBs benefit from 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 increased by 20% on average year to date. We expect DSIBs to maintain their focus on deposit growth, but for the
growth level to decelerate in 2021 from 2020 as the economy strengthens, fueled by consumer spending and higher corporate
investments.
DSIBs' Funding Metrics DSIBs' Liquidity Metrics
Loans / Deposits (LHS) S&P Stable Funding Ratio (RHS) Liquidity Coverage Ratio (RHS) BLA / ST (LHS)
130% 1.35x 160%
109%
1.30x
125% 1.25x 150%
104%
1.20x
120% 140%
99% 1.15x
115% 1.10x
130%
94% 1.05x
110% 1.00x 120%
89% 0.95x
105%
0.90x 110%
100% 84% 0.85x
2012 2013 2014 2015 2016 2017 2018 2019 2020 0.80x 100%
Q3 2015 2016 2017 2018 2019 2020 Q3
Source: S&P Global Ratings, company filings. BLA / ST – Broad liquid assets to
short-term wholesale funding. RHS-- Right-hand scale. LHS--Left-hand scale.
14TLAC & ALAC: Banks Are Well Positioned On Both
Ends
TLAC Breakdown & Ratios – At third-quarter 2020, DSIBs’ average regulatory total
loss-absorbing capacity (TLAC) and TLAC leverage
CET1 Additional Tier 1 Tier 2 ratios were 21.9% and 7.5%, respectively.
Other TLAC TLAC ratio TLAC leverage
– We expect DSIBs will comfortably reach the minimum
140 26% requirements on TLAC of 22.50% (of risk-weighted
24% assets) and TLAC leverage of 6.75% by Nov. 1, 2021.
120 22%
20% – We continue to view the Canadian government as
100 18%
“supportive”; however, should our view change to
Bil. C$
16%
80 14% “uncertain,” we believe DSIBs would be well-positioned
60 12% to receive an ALAC notch equivalent to their notching for
10%
8% extraordinary government support, which would be
40
6% neutral from a ratings perspective.
20 4%
2% – S&P Global Ratings has not assigned resolution
0 0%
counterparty ratings to Canadian DSIBs.
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
ICR A+ A+ A+ A AA- AA- A+
Bail-in debt A- A- BBB+ BBB+ A A A-
Sources: S&P Global Ratings, company filings. TLAC--Total loss-absorbing capacity. ALAC--Additional loss-absorbing capacity. TLAC ratio and TLAC leverage on right-
hand scale.
15Canadian Banks 2021 Outlook
Related Research
– Canada's Growth Slows As The Pandemic Trudges Into Winter, Dec. 3, 2020
– Banking Industry Country Risk Assessment Update: November 2020, Nov. 24, 2020
– Despite Declining Loss Provisions, U.S. Banks Still Face Asset Quality Risks And Low Interest Rates,
Nov. 19, 2020
– Four Key Risks Could Make 2021 The Toughest Year For Global Banks Since 2009, Nov. 17, 2020
– Earnings Among Large U.S. Banks Rebounded In Third Quarter, But Uncertainty Remains High, Nov. 17,
2020
– North American Financial Institutions Monitor 4Q 2020: Finding Some Respite In The COVID-19 Storm,
Oct. 22, 2020
– Despite A Bounce In the Summer, Canada's Economic Recovery Is Far From Complete, Sept. 28, 2020
– Despite The Dual Shock Of Lower Oil Prices And A Pandemic, Canada's BICRA Economic And Industry
Risk Trends Stay Stable, July 14, 2020
– 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
– Canadian Banks Are Set To Face COVID-19 Related Headwinds From A Position Of Strength, April 16,
2020
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
a- Adequate Strong Adequate Avg. & Adeq. a Moderate A+/Stable
Desjardins du 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 Bank a- Strong Adequate Strong Avg. & Adeq. a+ High AA-/Stable
Source: S&P Global Ratings. SACP--Stand-alone credit profile. ICR--Issuer credit rating. Avg & Adeq.--Average & Adequate.
17Analytical Contacts
Lidia Parfeniuk Shameer Bandeally Daniela Brandazza
Director Associate Director Senior Director
Toronto Toronto Mexico City
+1-416-507-2517 +1-416-507-3230 52-55-5081-4441
lidia.parfeniuk@spglobal.com shameer.bandeally@spglobal.com daniela.brandazza@spglobal.com
Satyam Panday Felix Winnekens
Senior Economist Director
New York New York
+1-212-438-6009 +1-212-438-0313
satyam.panday@spglobal.com felix.winnekens@spglobal.com
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