The International Trade Agreement in emergency cases expects an increase in provisions for bad loans and rising debt servicing costs as two challenges.

Nigel de Souza, financial services analyst at Veritas Investment Research, pointed to sharp recent sell-offs among the largest Canadian banks and warned that there are more downside risks in this sector.

The company expects credit loss provisions, or the amount of capital allocated to bad loans, during 2024 to be higher than pre-pandemic levels, assuming central banks do not take a cautious approach to raising interest rates.

"We expect debt servicing costs to rise to a record high in 2023 and expect (credit loss provisions) to accelerate and possibly peak in 2024 with inflationary pressures, rapidly rising rates, and provisions for loans under IFRS 9 likely to drive recognition of (credit loss provisions)," de Souza said in an October 4 note to clients.

De Souza added that in the medium term, Veritas expects a significant low single-digit decline in adjusted earnings among the Big Six banks. While de Souza upgraded Nova Scotia Bank to "buy," the company lowered the target price to $72 from $80.

The change largely stems from weak growth in the bank's Latin American operations and rising credit losses heading into a recession environment. De Souza pointed out that the unexpected leadership transition, with Brian Porter retiring in January, raises some uncertainty, but the current stock price would give investors "an attractive risk-reward skew."

Toronto Dominion Bank was maintained as a "buy" and stands as Veritas's top pick among the Big Six, despite expecting a low single-digit earnings decline. The company's new valuation target was raised to $88 per share from $96.

TD is expected to come out of the recession relatively unscathed as TD’s $13.4 billion acquisition of the regional Tennessee bank First Horizon Corp. is expected to close early next year, boosting some earnings. The target price for Royal Bank of Canada was adjusted from $129 per share to $124 as Veritas expects a moderate decline for the bank on its way to recession.

However, de Souza expects RBC to remain stable with only a low single-digit earnings decline. Canadian National Bank received a downgrade to "reduce" and the revised target price dropped to $88 per share from $89.

De Souza noted that the company preferred Canadian National for its low ceiling on loan loss provisions during a recession, describing the bank as a "low-risk, low-reward play."

Veritas downgraded Bank of Montreal to "sell," lowering its target price to USD 113 per share from USD 134, as the bank is seen as more exposed to credit risks facing recession with a heavily weighted loan portfolio toward commercial loans.

Canadian Imperial Bank of Commerce also received a downgrade to "sell," with its target price dropping to $55 per share from $72.

De Souza pointed out that he sees a significant downside to CIBC heading into a recession, as high credit loss provisions will impact earnings. After enjoying huge profits and record stocks of excess capital during the pandemic, banks have been on shakier ground this year as rising interest rates have hindered borrowing demand and concerns about a possible recession. Over the year, all bank stocks have declined:

Scotiabank declined by 27 percent to $66.26. TD shares fell 12 percent to $87.17; RBC shares dropped about seven percent to $127.37. National bank shares fell 10 percent to $89.37; BMO is down just under 12 percent to $123.78; and CIBC shares plunged 18 percent to $61.07.

Edited by: Yusra Bamtarf