COVID-19 has Canada's banks worried about sickly loans, but they're still raking in the cash

If Canada's big banks are the canary in the coal mine for the economy as a whole,then there was some good news this week, and some less good news.

While the COVID-19 pandemic wreaked havoc on Canadian society, Canada's five biggest lenders Royal Bank, Bank of Montreal, Scotiabank, CIBC and TDremained profitable even as they set aside billions of dollars to offset possible losses from loans that might go bad in the coming months.

It was expectedthat measures to contain the pandemic, such as school and business closures, border shutdownsand travel restrictions, wouldgrindeconomic activityto a halt,but the banks' quarterly financial results for the three-month period up to April 30 were hotly anticipated because they are a deep dive into just how bad the economy was really doing.

If businesses like manufacturers, oil and gas companies, retailers and tech startups are having trouble paying their bills, that tends to show up at the big banks, which lend them money.

Analysts say one of the best ways of gauging how companies are doing is by paying attention to a banking metric known as loan loss provisions. That's a complicated-soundingterm for a fundamentally simple concept: how much banks setaside to pay for loans on their books they think mightnot get paid back.

Not all those loans will turn into losses. But paying attention to how much the banks are setting aside just in case is an excellent proxy for how worried they are.

Combined, Canada'sbig five lenders set aside almost $11 billion last quarter to cover loans that aren't currently being paid off as planned. That's almost five times as much as they had set aside for bad loans in the same three-month period last year.

That's the bad news. The good news? "They were bad,but not as bad as feared," said Jim Shanahan, an analyst with investment firmEdward Jones who covers Canada's big banks.

Considering the massive number of layoffs, business closures and the glacial pace of trade flows across the Canada-U.S. border due to COVID-19, there were fears that loan losses could have been "at levels that we would never have contemplated," Shanahan said.

But that didn't happen.

It's equally important to note that even in all this, the banks are still making money. Collectively, the banks raked in nearly $5billion in profits over thethree months. That's well below their usual pace, but Shanahan said there was "almost a collective sigh of relief" that the banks were still profitable.

Art Johnson, the founder of Calgary-based SmartBe Wealth, is one of the few money managers in Canada who doesn't think shares in Canadian bank stocks are always worth buying, but even he admits their week went a lot better than it could have gone.

"When I look at the numbers, they're bad," he said in an interview."There's no two ways around it, these numbers are bad, [but] marketsdon't look at bad or good, they look at better or worse."

That explains what the banks' stock prices did this week. Typically lower profits would have sent bank shares tumbling, but shares in all five were sharply up as investors breathed thatsigh of relief that Shanahan was talking about.

"People were expecting a lot worse, and they were better than worse in all facets," Johnson said.

Not out of the woods yet

While he understands why the bank stocks rallied with relief, Johnsonthinks that exhalemay be premature as the real pain in the economymay not show up on the banks' books for another few months, once mortgage payment deferrals run out, and massive government progams supplementing income to laid-off workers expire.

"We'll start to see the real impact of this three [or]four months down the road, and that'll be where ... it'll be interesting for markets," he said.

One of the best ways of gauging how optimistic the banks are about their future is to look at their dividend payments.

Canada's big banks are known as reliable dividend-paying machines, slowly and methodically nudging uptheir payments to shareholders every few quartersfor more than a century. Those big bank dividends are so rock-solid that TD and Scotiabanksomehowmanaged to hike theirs even in the middle of the financial crisis in 2009.

The banks love to hike their dividends because investors love thatextra income. But banks won't do it unless they are confident they'll be able to sustain the higher level in perpetuity a harsh lesson that Quebec-focusedbank Laurentian learned this week when it cut its payout, the first dividend slash by a Canadian lender that big in almost 30 years.

If dividend payouts are the best barometer of the financial health of Canada's big banks and, by extension, the economy then the fact that none of them saw the need to cut this time around isan encouraging sign.

Those quarterly payouts look as rock-solid as ever, but even the banks admit the future still looks uncertain.

The CEO of National Bank, a distant sixth in the five-horse race atop Canadian banking, phrased it in a, well, enterprising fashion.

"This is Star Trek finance,"Louis Vachon said ona conference call with analysts to discuss the bank's quarter, in which it booked one-third less profit and set aside five times more money for bad loans.

"We would describe the current environment as going where no one has gone before."

Canada's economy has managed to live long and prosper for decades on the backs of its biggest lenders, but Vachon makes it clear that those samebanks are still keeping their shields up for now.

"We're still watching for the Klingons [because] we're not out of this crisis yet."