Canadian Bank Stocks Surge Despite Economic Challenges

Despite economic challenges, Canadian bank stocks have surged, erasing earlier losses and providing a small profit for investors in 2023.

Canada’s economy is facing challenges, with rising unemployment and soaring housing costs putting pressure on households. Despite this, Canadian bank stocks have seen a surge in their shares, with a major index of Canadian bank stocks rising by 11 per cent since the beginning of November. This has erased most of the year’s earlier losses, and when dividends are included, investors have actually made a small profit so far in 2023. This is in contrast to the KBW Bank Index of U.S. lenders, which is still in the red.

The rally in Canadian bank stocks is a bet on a softer economic landing in 2024, with investors hoping that bank profits won’t be badly damaged by the financial squeeze that’s hitting Canadian households due to mortgage-rate resets and higher rents. However, the Big Six banks have seen a drop in earnings per share, with a decline of more than six per cent in the fiscal year that ended Oct. 31. Analyst forecasts compiled by Bloomberg suggest that earnings are expected to decline an average of 1.1 per cent in the current fiscal year.

In response to these challenges, banks are restructuring with urgency. Toronto-Dominion Bank is reducing the number of employees by three per cent, amounting to more than 3,000 positions. Royal Bank of Canada has installed new management at City National Bank, its struggling California-based unit. Bank of Nova Scotia, the most international of Canadian lenders, is set to unveil a new strategy during an investor day.

Residential mortgages are a major concern for Canadian banks, as they are the largest part of the banking business. About 2.2 million mortgages will be facing “interest rate shock” over the next two years, according to a report from Canada Mortgage & Housing Corp. This could lead to significant increases in monthly payments for mortgage holders.

Banks are trying to soften the blow by allowing some mortgage holders to spread out payments and extend the length of time it will take to pay off the loan. However, this creates its own problems, as rising rates have led to some households finding that their fixed contracted payments aren’t sufficient to cover the interest on the loan, let alone paying down any principal.

Despite these challenges, banks are making efforts to reduce mortgage risk, with some success. For example, Royal Bank has seen a reduction in the share of mortgages with amortization periods of more than 35 years, and Toronto-Dominion has also reduced the share of mortgages in that category.

Canadian banks are facing significant challenges due to the stalling economy, rising unemployment, and soaring housing costs. However, the surge in bank shares reflects investor optimism about a softer economic landing in 2024. Banks are restructuring with urgency and making efforts to reduce mortgage risk, but the road ahead remains uncertain.