Another voice turns cautious on Canadian banks

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The credit rating agencies have taken a lot of heat for their inability to spot the U.S. housing crash that precipitated the 2008 financial crisis. It's a mistake they evidently don't want to repeat.

Credit rating agencies are becoming increasingly vocal about Canada's housing market – and that's driving a cautious assessment of the country's Big Banks, even as investors and analysts remain upbeat about the sector.

As the banks roll out their fiscal first-quarter results this week and next (Bank of Montreal kicked things off on Tuesday), Fitch Ratings is pointing to slowing loan growth, compressed profit margins, rising competition and increasing loan-loss provisions.

"Retail loan growth, a meaningful driver of revenue and earnings growth, is likely to decline when and if consumers start to deleverage and the housing market shifts to a lower gear," Fitch said in a report.

"Additionally, a sharp reversal in house values could significantly affect consumer demand for credit and further constrain earnings."

Okay, any thesis that contains the words if , likely and could doesn't sound like a reason to panic.

However, the Fitch report follows a similar view from Standard & Poor's, in which it argued that a weak Canadian economy and high consumer indebtedness will act as powerful headwinds on the banking sector.

The combined caution from the two ratings agencies contrasts with signs of outright ebullience elsewhere. Consider that Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia and National Bank of Canada have been flirting with record high share prices in recent trading sessions.

That's baffling given that consumer debt is a record-high 165 per cent of disposable income, house prices are sliding, the labour market has stalled and economic growth has slowed to a crawl.

As well, the percentage of "buy" recommendations among analysts is near the high end of the past five years. They are more enthusiastic about bank stocks today than they were at the depths of the bear market in 2009, when share prices were about half of today's levels.

True enough, Canadian banks emerged from the financial crisis with a reputation as the world's soundest banks, and they have been using their new-found swagger to expand abroad.

But credit rating agencies see potential snags here, too. According to Fitch, Royal Bank's unsuccessful foray into U.S. retail and commercial lending suggests that the American market is riskier.

"Furthermore, after several years of restructuring, U.S. banks have strengthened their financial and risk profile, which enhances their ability to compete against Canadian banks," Fitch said in its report.

That raises an idea: If sky-high Canadian bank stocks are making you nervous, there are plenty of beaten-up alternatives elsewhere.