Bank: Veritas cuts banking targets, citing sour lending issues

Veritas Investment Research is cutting its price targets on major Canadian banks amid fears the Big Six will have to set aside more cash to cover potentially sour loans.

In a note to clients, Veritas financial services analyst Nigel D’Souza said rising borrowing costs and a possible recession could lead to higher provisions for credit losses (PCL), increasing the downside risks to big bank stocks.

“We expect provisions for credit losses (PCL) in [fiscal year 2024] to be significantly above pre-pandemic levels, barring a dovish pivot from central banks. Historically, peak credit losses lag about two years behind rising debt service charges,” he said.

“We expect debt servicing costs to rise to a record high in 2023 and we expect PCLs to accelerate and potentially peak in 2024 with inflationary pressures, rising rates and provisions for performing loans under IFRS 9 likely advancing the recognition of PCLs.”

There are already signs that banks are hoarding more cash to cover potentially sour loans – provisions for credit losses rose by $1.54 billion in the Big Six in the third fiscal quarter, almost 10 times the increase of $166 million in the prior quarter.

D’Souza said the increase in PCLs combined with higher costs will more than offset the benefits banks derive from higher rates, which typically increase lending margins.

“We expect a high single-digit decline in adjusted earnings for the Big Six Canadian banks over the medium term, with higher PCLs and higher expenses in an inflationary environment that will more than offset the resulting rise in net interest income (NII). of margin expansion and loan growth,” he said.

Although D’Souza lowered his 12-month price target for all six banks, he moved Bank of Nova Scotia to a buy and reiterated that TD Bank is his top recommendation in the sector, citing the relatively higher leverage of the latter at a rising rate. environment.

Overall, big bank stocks have struggled this year, with all of the Big Six trading lower year-to-date. Scotiabank has lagged the pack, losing around 26% of its value in 2022 alone through Tuesday morning.