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Sustained rally expected to boost Big Six banks’ bottom lines

Exterior of the Royal Bank Plaza towers at the corner of Bay St. and Wellington St. West in Toronto on April 17 2014. Investors will get a first look at earnings results when Royal Bank of Canada reports earnings on Friday.

Fred Lum/The Globe and Mail

Even the skeptics are giving up. Canada's biggest banks are on a roll, and very little in the current landscape seems capable of slowing them down.

For close to two years there were warnings of weaker earnings, most of which stemmed from the assumption that domestic lending was bound to nosedive. But the banks kept proving their critics wrong, and after so many strong quarters the naysayers are now staying mum.

It helps that other units have picked up any slack created by a softer, yet resilient, loan market – particularly wealth management. U.S. equity markets went on a tear in 2013 and now Canadian stocks are on fire, helping the banks earn higher fees on their assets under management.

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Investors will get their first look at the extent to which the sustained Canadian rally boosts bottom lines when Royal Bank of Canada becomes the first lender to report earnings on Friday.

The bank's results, as well as those of its Big Six rivals, are also widely expected to show a big uptick in capital markets revenues – yet another sector that looks poised to offset any weak lending volumes.

National Bank Financial analyst Peter Routledge forecasts that capital markets income for the Big Six banks climbed 12 per cent in aggregate in the quarter ended July 31, boosted by heavy equity underwriting and a solid stream of debt financings.

This capital markets resurgence has surprised some, suddenly making it seem like bank stocks have extra room to run as investors start to reprice market values.

"We would not be surprised if market multiples for the banks rose moderately in the near term to reflect a greater comfort level with capital markets earnings streams," Mr. Routledge wrote in a note to clients.

Such a thought can seem shocking. Bank stocks have been on a tear, and it is easy to believe they can't climb much higher. However, CIBC World Markets analyst Rob Sedran crunched a slew of numbers to compare current valuations to historical trends, as well as to other sectors, and found that there is likely room left to run.

Based on history, "it would appear that while the Canadian banks have seen a run-up in share prices and valuations, these levels are far from out of the ordinary. We think investors should focus on operating conditions, which remain benign to favourable, and less on absolute valuations (though even those are not that problematic at this point)," he wrote in a note to clients.

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Still, the banks don't have an easy go, particularly when comparing earnings to the previous quarter, when loan losses plummeted to create large non-cash profits.

The drop was so significant that RBC chief financial officer Janice Fukakusa said the bank's managers were taking extra time to go through the books to make sure they weren't missing anything. "We're] thinking it's too good to last," she said in an interview.

The Big Six banks also have to prove they can keep growing. Even though their bottom lines have been healthy, investors don't want them to get complacent.

Core profits across the banks grew by an average of just 0.2 per cent quarter over quarter the last time they reported, and five of the Big Six lenders averaged core profit growth of just 1.5 per cent in the first half fiscal 2014, relative to the final six months of the previous fiscal year. Toronto-Dominion Bank was the exception.

When the major banks report:

Friday, Aug. 22

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Royal Bank of Canada

Tuesday, Aug. 26

Bank of Montreal

Bank of Nova Scotia

Wednesday, Aug. 27

National Bank of Canada

Thursday, Aug. 28


Toronto-Dominion Bank

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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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