Rising Debt Service Costs and Bad Loans Pose Significant Risks for Big Six Banks
Veritas Investment Research financial services analyst Nigel D’Souza has warned that the Big Six banks in Canada are facing significant risks due to rising debt service costs and bad loans. In a recent note to clients, D’Souza pointed out that the banks’ price targets have been slashed by Veritas as the firm expects provisions for credit losses to run higher than previously anticipated.
Rising Debt Service Costs
The current economic environment has led to an increase in debt service costs for the Big Six banks. Rising interest rates and a potential recession are expected to hamper borrowing demand, putting pressure on the banks’ profitability. D’Souza noted that the banks have been enjoying outsized earnings and record stockpiles of excess capital during the pandemic, but this trend is unlikely to continue in the current economic climate.
Bad Loans Pose Significant Risks
The Big Six banks are also facing significant risks due to bad loans. The loan portfolio of some banks is heavily weighted towards commercial loans, which are considered riskier than personal loans. D’Souza noted that the Bank of Montreal (BMO) and the Canadian Imperial Bank of Commerce (CIBC) have a higher exposure to credit risks in the face of a recession.
Veritas Downgrades Big Six Banks
In response to these risks, Veritas has downgraded several Big Six banks. The Royal Bank of Canada’s (RBC) target price was revised from $129 per share to $124 as Veritas expects moderate downside for the bank heading into a recession. The National Bank of Canada received an upgrade to ‘Reduce’ and the revised target price edged down to $88 per share from $89.
Bank of Montreal and CIBC Receive Downgrades
Veritas downgraded BMO to ‘Sell,’ knocking its target price to $113 per share from $134. The firm considers BMO to be more exposed to credit risks in the face of a recession with a loan portfolio heavily weighted towards commercial loans. CIBC also received a downgrade to ‘Sell’ and its target price was taken down to $55 per share from $72.
RBC and National Bank Receive More Moderate Downgrades
D’Souza expects RBC to remain stable, but only experience low single-digit declines in earnings. National Bank’s loan-loss provision ceiling is lower than the other banks, making it a ‘low-risk, low-reward play.’
Big Six Banks’ Stock Performance
The Big Six banks have been underperforming this year as rising rates and concerns about a potential recession rise. The stocks of all six banks are in the red:
- Scotiabank: down 27% to $66.26
- TD stock: down 12% to $87.17
- RBC shares: down nearly seven percent to $127.37
- National Bank shares: down 10% to $89.37
- BMO is off 12% to $123.78
- CIBC’s stock fell 18% to $61.07
Conclusion
The Big Six banks are facing significant risks due to rising debt service costs and bad loans. Veritas has downgraded several banks, and their price targets have been slashed as a result. While RBC and National Bank may experience more moderate declines in earnings, the other four banks are expected to face substantial downside.
Recommendations
Investors should exercise caution when investing in the Big Six banks due to the risks posed by rising debt service costs and bad loans. Diversification and a thorough analysis of each bank’s financials are essential before making any investment decisions.
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