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Drop in consumer lending puts banks in ‘offset’ mode

As Canada’s biggest banks prepare to roll out a parade of first-quarter earnings this week, new data suggest a telltale drop in consumer lending is starting to rear its head – brought on by tighter mortgage-lending rules and high household debt, which is crimping borrowing.

Fernando Morales/The Globe and Mail

Canada's major banks have warned for more than a year that consumer lending was poised for a significant slowdown, making it harder for earnings and stock prices to rise meteorically, as they seemingly always do.

It appears that moment is now here.

As Canada's biggest banks prepare to roll out a parade of first-quarter earnings this week, new data suggest a telltale drop in consumer lending is starting to rear its head – brought on by tighter mortgage-lending rules and high household debt, which is crimping borrowing.

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Regulatory filings show that consumer loan growth for the country's largest banks slowed to 0.6 per cent in November and December, which is considerably lower than previous quarters. And though January data haven't been compiled yet, the trend is clear – Canadians are borrowing less, which is a challenge for banks trying to increase their profits.

It is also a trend investors will be watching closely, to see if the impressive run that Canadian bank stocks have been on lately will be able to continue – the key will be the ability of the Big Six to boost performance elsewhere.

"Lending to the Canadian consumer has been the safest and most consistent revenue stream for the banks over an extended period of time, and it is now very reasonable to expect that this growth engine is going to be much less robust for a foreseeable future," Sumit Malhotra, an analyst with Macquarie Capital Markets, said in a research note to clients.

"Does this mean they can no longer grow? No, we do not think this is the case."

Instead, Mr. Malhotra points out the biggest job for Canadian banks will be to boost income from their other businesses, such as capital markets, corporate lending and wealth management, to offset the expected slowdown in consumer lending.

For investors looking closely at bank stocks, the word 'offset' is now "the most important word in Canadian banking," Mr. Malhotra said.

The emergence of this tradeoff was evident in the second half of 2012. Despite worries about a slowdown in consumer borrowing, the banks posted record profits – largely because they were offsetting the drop in other ways. Cost-cutting and increased business from other operations, along with lower losses from bad loans, have helped push earnings higher, even though the growth outlook has become tempered.

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The impact of these offsets can be seen in the resiliency of bank stocks and dividends to date, which have churned higher in spite of the questions over consumer lending. Even as the banks brace for a potentially slower 2013 in their core Canadian banking operations, the TSX bank index closed at an all-time high on Feb 20.

Fears of slowing growth "seem to be at odds" with what's happening on the TSX, Mr. Malhotra admits. But in reality, investors will need to pay closer attention to which banks are most effective at finding growth in other businesses, and which are effective at keeping costs from rising.

On Tuesday, Bank of Montreal kicks off the first-quarter earnings season. Thursday will see a logjam with Royal Bank of Canada, Toronto-Dominion Bank, Canadian Imperial Bank of Commerce and National Bank of Canada all reporting. Bank of Nova Scotia rounds out the Big Six the following Tuesday.

Though hefty profit numbers usually steal the show during quarterly earnings season, there are often nuances in the numbers that indicate broader trends at work.

Rob Sedran, an analyst at CIBC World Markets, said much of the focus in this week's earnings will be on margins – the difference between what banks make on loans and what they pay out in deposit interest. In a low-interest-rate environment, keeping margins from collapsing is the key concern for banks and investors.

"Margins remain under pressure from a combination of competition and low rates while asset growth continues to slow in the face of elevated consumer debt and an economy that is showing some signs of weakness," Mr. Sedran said in a research note previewing the quarter.

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Barclays Capital analyst John Aiken said bank stocks have been helped by dividend hikes over the past year. He expects further increases this quarter, most likely from TD, RBC, and possibly Scotiabank. But he questions whether the capital markets will provide enough of an offset to compensate for sluggish consumer lending. Keeping expenses from rising in the sector "is even more critical with slowing revenues," he said.

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About the Author
Senior Writer

Grant Robertson is an award-winning journalist who has been recognized for investigative journalism, sports writing and business reporting. More

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