Banks head into Q3 results with high valuations, overhang of economic uncertainty

Hey there, time traveller!
This article was published 22/08/2025 (388 days ago), so information in it may no longer be current.

TORONTO – Canadian bank stocks are riding high after largely shrugging off economic concerns, but analysts are starting to wonder if their third-quarter results coming next week will test optimism around the sector.

After losing ground along with the rest of the stock market in early April following U.S. President Donald Trump’s tariff announcements, the sector has been on the climb.

National Bank analyst Gabriel Dechaine said the Big Six bank stocks have outperformed the wider market by a percentage point so far this year, leaving price-to-earning valuations some 15 per cent above the historical average. He said this raises concerns of a disconnect with the wider economic trends.

“This combination is at odds with what has traditionally been a bad thing for bank stocks: weak domestic GDP growth and rising unemployment,” Dechaine said.

The contrast between Canadian, and global, concerns about the fallout of a trade war and bank valuations has him “neutral on the sector, at best” as the pricing relies on an economic turnaround ahead that’s far from guaranteed.

But while he’s not as confident as some investors, he also doesn’t think it’s likely there will be any big negative swings in the third quarter.

“While the outlook remains highly uncertain and while rising Canadian unemployment bodes poorly for future credit performance, we do not believe a single event during Q3/25 would spur another period of elevated performing provisions.”

The banks raised their provisions for potentially bad loans last quarter as economic risks grew, but how much they decide to adjust their provisions is generally one of the harder financial measures for analysts to peg down. Dechaine said provisions remain the biggest source of forecast uncertainty for the quarter.

While banks might not see big builds in provisions, they also aren’t expected to see the same trading gains they made last quarter.

“Fewer tailwinds this quarter suggests some downside risk,” Scotiabank analyst Mike Rizvanovic wrote in a note.

He said an improved earnings per share outlook for next year is a potential upside, but he’s doesn’t think it’s likely given the moderation in capital markets earnings compared with the first half of this year.

The banks are also dealing with subdued loan growth, a very gradual unwinding of provisions for bad loans and reduced margins if interest rates fall as expected, all further challenging earnings growth ahead, he said.

Analysts say the lofty bank valuations are in part based on better economic conditions forecast for fiscal 2027, where some see notable gains.

“Investors appear to be getting more comfortable with the risk level and are looking through near-term challenges into F2027,” CIBC analyst Paul Holden said.

He has released his own first estimates for how fiscal 2027 might look, and predicts earnings per share could be up 14 per cent by then, while return on equity could be up to 14.2 per cent, compared with an estimated 13.6 per cent for fiscal 2026. 

For the third quarter, he said he’s expecting a small uptick in impaired loans, the category where banks aren’t confident they’ll be paid back, while provisions for performing loans, where there’s less concern, should stay stable. 

BMO and Scotiabank report on results next Tuesday, followed by Royal Bank and National Bank on Wednesday. CIBC and TD Bank Group round out results on Thursday.

This report by The Canadian Press was first published Aug. 22, 2025.