Bloomberg News

World’s Soundest Banks See Lower Profit: Corporate Canada

August 22, 2012

Canada's Finance Minister Jim Flaherty

In June, Finance Minister Jim Flaherty cut the maximum amortization period for mortgages to 25 years from 30, and reduced the most homeowners can borrow against the value of their homes to 80 percent from 85 percent -- moves aimed at avoiding a collapse similar to one in the U.S. housing market. Photographer: Nelson Ching/Bloomberg

Canada’s banks, the most stable in the world, will probably post the lowest profit growth in two quarters as consumer lending eases and spending subsides ahead of a potential housing slowdown.

Profit before one-time items among Canada’s six main banks, led by Bank of Nova Scotia, rose an average of 6 percent in the period ended July 31, Mario Mendonca, an analyst at Canaccord Genuity in Toronto, said in a note dated Aug. 13. That’s down from 9 percent in the previous quarter, Mendonca said.

“The current macro environment is less than fertile ground for bank profit growth,” Robert Sedran, an analyst at CIBC (CM) World Markets in Toronto, wrote in an Aug. 13 note, citing concerns about the housing market and signs of “fatigue” among Canadian consumers.

Scotiabank and Bank of Montreal, respectively Canada’s third- and fourth-largest banks by assets, are the first banks to report third-quarter results on Aug. 28.

The country’s banks, ranked the world’s soundest by the World Economic Forum, will probably report consumer lending eased, while investment bank fees are expected to be higher than a year ago, Mendonca said. A slowdown in housing is expected to put profit growth in the “mid-single digit” range next year, he said.

Bloomberg Markets magazine in June ranked Canadian Imperial Bank of Commerce, Toronto-Dominion (TD) Bank, National Bank of Canada (NA) and Royal Bank of Canada (RY) as the world’s third, fourth, fifth and sixth strongest banks, respectively.

Credit Cards

Canadian consumers are borrowing less on credit, driven by a slowdown in credit card use, Sedran said in his note. Concern about consumer indebtedness led to efforts by the Canadian government this year to cool Toronto’s overheated condominium market.

In June, Finance Minister Jim Flaherty cut the maximum amortization period for mortgages to 25 years from 30, and reduced the most homeowners can borrow against the value of their homes to 80 percent from 85 percent -- moves aimed at avoiding a collapse similar to one in the U.S. housing market.

“Fears of an outright housing crash will continue to weigh on investors, given the experience in the United States and across the world where stretched markets did indeed crash,” Sedran wrote.

Canadian household debt levels could “constrain” earnings growth for the six main lenders in the second half of 2012, according to Fitch Ratings.

Net interest margin -- the difference between what a bank charges for loans and pays in deposits -- may decline to 2.13 percent for the six main banks in the third quarter from 2.25 percent two years ago, according to Credit Suisse analyst Gabriel Dechaine.

‘Steady As She Goes’

“We’re not expecting any blockbuster earnings; more like steady as she goes,” said Anil Tahiliani, head of North American equities at Calgary-based McLean & Partners Wealth Management, which owns shares of Canadian banks. “There’s no real strong catalyst to take them considerably higher.”

The 10-member S&P/TSX Banks Index (BKX) climbed 4.6 percent this year through yesterday, compared with a 1.4 percent rise for the benchmark S&P/TSX Composite Index (STBANKX) and a 21 percent rise in the 24-member U.S. KBW Banks Index. The Canadian bank index fell 0.7 percent at 4 p.m. in Toronto as the country’s six biggest banks declined.

Banks are likely to keep trading at lower average levels than in the past, said Sumit Malhotra, an analyst at Macquarie Capital Markets in Toronto.

“There are two big-picture issues -- ongoing concern over the European sovereign debt crisis and the magnitude of slowdown in the domestic housing market -- that are weighing on both the valuation accorded to the sector as well as aggregate investor sentiment towards the stocks,” Malhotra said in a note to clients yesterday.

Slow Expenses

Curtailing expense growth will become “especially important” as mortgage growth slows and net interest margins narrow, Mendonca said. The banks will probably begin announcing cost-cutting plans to counter future declines in domestic lending as a result of a cooling housing market, analysts said.

“It’s going to become an increasing portion of the dialogues coming out of these banks as we move forward,” said Tom Lewandowski, an analyst at Edward Jones & Co. in St. Louis. “I think you’ll start to hear a bit about that this quarter and it will get incrementally louder as we get into 2013.”

Spokesmen at Toronto-Dominion, Scotiabank, Royal Bank and CIBC declined to comment when contacted by Bloomberg News regarding their third-quarter results.

Toronto-Dominion, the country’s second-biggest lender, has said it will find ways to slow the pace of expense growth for the second straight year.

‘Staff Reductions’

“We have to look at our core expense base and find ways to create competitive advantage and sustainable reductions,” Chief Financial Officer Colleen Johnston said last month in an interview at Bloomberg headquarters in New York.

Lenders may also look at “modest” staff reductions and postponing technology expenses as a way to cut costs, Lewandowski said.

“If you kind of use the U.S. playbook for Canada, they’ll find themselves in a slower-growth environment,” Lewandowski said.

Scotiabank will post profit before one-time items of C$1.20 a share, up from C$1.10 a year ago, according to Mendonca. Bank of Montreal will post profit of C$1.40 a share, compared to a year-earlier C$1.32.

“In many ways, we’re getting back to what banks should be like,” said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages about $4 billion in assets, including bank shares. “They’re not supposed to be volatile.”

Dividends

Canadian Western Bank (CWB), the eighth-largest bank, is scheduled to release third-quarter results on Aug. 29 after markets close.

Royal Bank of Canada, Toronto-Dominion, CIBC and National Bank of Canada are scheduled to report earnings Aug. 30, while Laurentian Bank of Canada will report on Aug. 31.

Toronto-Dominion and CIBC are also expected to announce increases to their quarterly dividends, according to Bloomberg Dividend Projections. Other analysts at Desjardins Securities and TD Securities said Royal Bank of Canada and Bank of Montreal may also increase their payout. Bank of Montreal (BMO) hasn’t boosted its dividend since the third quarter of 2007.

To contact the reporters on this story: Sean B. Pasternak in Toronto at spasternak@bloomberg.net; Katia Dmitrieva in Toronto at edmitrieva1@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net


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