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Canada's banks expected to dig deeper for good news

Most analysts believe year-over-year bank earnings will jump – with the caveat that the bottom lines won’t be as strong as the spectacular first quarter.

Fred Lum/The Globe and Mail

The housing market is slowing. Consumer debt levels are sky high. But don't count Canada's banks out yet.

For the past few quarters, the banks faced the same headwinds, but every three months analysts and investors were pleasantly surprised with their results.

So this earnings season, which Toronto-Dominion Bank kicks off on Thursday, analysts are considering the possibility of another surprise, even though home sales slowed this spring after Ottawa tightened mortgage rules and capital markets underwriting and advisory activity has been soft.

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In fact, analysts are predicting year-over-year bank earnings will jump – with the caveat that the bottom lines won't be as strong as the spectacular first quarter, when Royal Bank of Canada posted a stunning $2.1-billion profit.

Working in favour of surprise is the fact that banks keep catching lucky breaks. Despite the tighter mortgage rules, yields on Canadian bonds dipped this spring. These yields are the benchmark from which mortgages rates are derived, and their drop prompted the likes of Bank of Montreal to offer, and later drop, its controversial 2.99-per-cent interest rate mortgage.

Canada's Big Six are also increasingly international. Both TD and Bank of Nova Scotia have substantial foreign retail banking operations, in the United States and Latin America, respectively, and RBC has a sizeable global capital markets business. These geographic mixes are expected to help their results because Canada has been a slower-growth country.

Still, analysts stress that the banks can only count on so many surprises. "We fear that that banks may be running out of items in their bag of tricks," Barclays Capital analyst John Aiken wrote in a research note for clients.

TD Securities analyst Jason Bilodeau echoes that sentiment: "It is not clear that the surprises of [the first quarter] can repeat. Wholesale results handily exceeded our expectations … but looked to be running at unsustainable levels in our view, particularly with recent weakness in the key mining and energy sectors." He noted the banks were boosted by paper profits on lower credit provisions that can easily fluctuate each quarter.

However, if the banks do surprise again, investors shouldn't count on solid gains in their stock prices. Despite respectable quarterly results in the recent past, investors appear to have priced in an expected slowdown, meaning they expect it to come, they just don't know when.

"While these are not boom times for the Canadian banking sector, the recent share performance of the sector as a whole is, in our view, more pessimistic than fundamentals would suggest," CIBC World Markets analyst Rob Sedran wrote in a research note. Investors should remember that credit-card loss rates are stable and economic output is "uninspiring" but still on par with estimates, he added.

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Banks worried about their stock prices have the option to boost dividends, but this quarter the only key candidate for a hike is National Bank of Canada , according to analyst John Reucassel at BMO Nesbitt Burns. In large part that is because many other banks, including RBC and TD, raised their dividends last quarter.

Should no surprises materialize, investors will look to cost cutting as a way to boost profit. Though the banks have already focused on keeping them low, slower revenue growth will put an even bigger spotlight on the second half of the income statement.

"Expense management will remain critically important in delivering earnings growth, particularly in what we expect will continue to be the revenue challenged domestic personal and commercial banking segments," Mr. Bilodeau noted.

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About the Author
Reporter and Streetwise columnist

Tim Kiladze is a business reporter with The Globe and Mail. Before crossing over to journalism, he worked in equity capital markets at National Bank Financial and in fixed-income sales and trading at RBC Dominion Securities. Tim graduated from Columbia University's Graduate School of Journalism and also earned a Bachelor in Commerce in finance from McGill University. More

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