As interest rates rise, Canadian banks are likely to remain undaunted as their earnings drivers shift from reserve releases and capital markets activity to lending and net interest income.
In a new report, DBRS Morningstar said the 2022 outlook for banks remains “cautiously optimistic” despite the uncertainty surrounding the pandemic, high inflation, supply chain struggles, and the prospect of rising interest rates.
While the banks’ earnings in 2021 were driven by strong capital market activity and declining provisions for credit losses, those drivers are expected to shift this year.
DBRS said it expects higher net interest income and higher-margin commercial lending activity in 2022 to offset weaker contributions from capital markets and reserve releases.
“An increasing interest rate environment in both Canada and the United States should bolster net interest income and earnings,” said Carl De Souza, senior vice-president, North American FIG, at DBRS Morningstar, in a release.
The report said asset quality and credit loss provisions are expected to deteriorate modestly from “unsustainably low levels” in the year ahead.
“However, the magnitude and pace of interest rate increases may have a larger impact on credit quality, particularly if the tightening cycle leads the Canadian economy into recession,” it said.
At the same time, the firm is also expecting the banks to pursue share buybacks, acquisitions, or both, based on their elevated capital positions.
“Going into 2022, DBRS Morningstar expects the banks to effectively deploy capital in order move their [common equity tier 1] ratios closer to the 11% to 12% range,” said De Souza.
While capital may be used to drive share buybacks, DBRS said that future dividend increases “will depend on the robustness of earnings.”