Loan loss provisions piled up at Canada’s big banks in their most recent quarter. Now the question is, ‘How high can they go?’

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While the Big Six recorded a total of $3.54 billion in provisions for credit losses (PCLs) for the three-month period ended July 31 — more than double the $1.54 billion registered in the same quarter in 2022 — analysts expect the figure to continue to climb as the weight of higher borrowing costs settles in.

“We’re gonna see higher PCLs on impaired loans only because we’re just at the starting line of pressure on companies and households. Right now, we wait and see how the economy unfolds,” Barclays PLC senior analyst John Aiken said.

PCLs are funds set aside by banks to cover potential losses on loans. The reserve protects them should negative economic events, such as a potential recession, arise, leading to more defaults.

PCLs are a key credit metric for measuring the health of a bank’s loan book, and by extension the ability of households and businesses to pay their debts. Each quarter, the banks must assess not only the potential losses stemming from borrowers who have fallen behind on payments, but also take into account any changes to their economic forecasts, and whether those changes are more likely to push borrowers into default in the future. If the economic picture becomes brighter, banks can release the reserves.

Aiken said that with households and commercial balance sheets flush with cash, PCLs had been running at “historically low levels.” But as interest rates have risen amid persistent inflation, borrowers have started to burn through those reserves.

“We’re starting to see some stress on the system and ergo … we’re seeing the uptick in provision for credit losses,” he said.

The average PCL ratio passed the pre-pandemic average in the third quarter, hitting 35 basis points (bps) versus an average of 33 bps in the years proceeding the pandemic. That was the first time PCLs had surpassed “normal levels” in the current cycle.

Credit normalization has now played out and the question is how much above normal will losses move?

Paul Holden

In a Sept. 5 note to clients, CIBC Capital Markets analyst Paul Holden said his team is assuming an average PCL ratio of 37 bps for 2024, which it categorizes as a soft landing or mild recession.

“Credit normalization has now played out and the question is how much above normal will losses move?” Holden wrote, adding that losses seem to be trending higher for commercial loan exposure ahead of consumer loans.

Among the major Canadian banks, Canadian Imperial Bank of Commerce saw the biggest jump in total PCLs in the third quarter, both on a quarter-over-quarter and year-over year basis, largely due to provisions in its U.S. operations.

The bank’s total provision for credit losses increased to $736 million, up 203 per cent from $243 million in 2022 and up 68 per cent from the previous quarter. Analysts had been expecting PCLs of $444 million.

CIBC said the increase in total provisions for the quarter was primarily due to “a more unfavourable change in our economic outlook” and higher impairments across all business units. Most of this came from provisions on performing loans.

“We continue to operate in an uncertain macroeconomic environment due to concerns related to higher levels of interest rates and inflation, geopolitical events and slower economic growth,” the bank said in its earnings report on Aug. 31. “There is considerable judgment involved in the estimation of credit losses in the current environment.”

The Bank of Montreal’s PCLs of $492 million were up 261 per cent year over year in the third quarter, but now include results from U.S.-based Bank of the West, the acquisition of which was completed in February. Excluding the contributions of the U.S. bank, the annual increase was 190 per cent, while the increase over the second quarter was 34 per cent.

BMO’s total provision for credit losses as a percentage of average net loans and acceptances ratio was 30 basis points, compared with 10 basis points in the prior year.

National Bank and Royal Bank of Canada saw their PCL ratios rise the least, but still substantially. National Bank had $111 million in PCLs in the third quarter, up 95 per cent from $57 million in the previous year. RBC reported $616 million in the quarter, up 81 per cent from $340 million in the previous year.

For Toronto-Dominion Bank, provisions for credit losses in the third quarter checked in at $766 million, a 118 per cent jump from $351 million the year prior. Bank of Nova Scotia reported $819 million in provision for credit losses for the quarter, almost double the $412 million reported a year ago and up from $709 million in the previous quarter.

Aiken said that while levels are just getting back to recent norms, they are still below what he considers average, which he said is “quite surprising,” given concerns about the potential for a recession. He added, however, that he believes the banks are adequately reserved at the moment.

The consensus call for the next fiscal year is that losses will continue to climb higher given that the weight of higher borrowing costs is just starting to hit, Holden said.

Holding steady doesn't change anything

Doug Hoyes

Meanwhile, consumers who fail to qualify at more conservative lenders such as banks are resorting to alternative lenders and more expensive forms of credit, said licensed insolvency trustee Doug Hoyes, co-founder of Ontario-based firm Hoyes, Michalos & Associates Inc.

“It’s gonna get worse for a number of reasons,” said Hoyes. “Expenses are going up faster than income, pretty much as simple as that.”

Hoyes said the Bank of Canada’s decision to hold its benchmark interest rate at five per cent on Sept. 6 as economic growth slowed and job markets cooled would not make any difference for consumers in the short term.

“Holding steady doesn’t change anything,” he said. “I’m still paying the same high rates as I was paying last week.”

If rates remain elevated, the pressure will only grow on those living beyond their means.

Bank watchers will be keeping an eye on PCL growth for signs that things are getting worse.

“It does look like the banks were taking a very conservative stance this quarter,” said Aiken. “Whether they believe they need to become more conservative at the end of this quarter, we’ll have to wait and see.”

• Email: dpaglinawan@postmedia.com