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28 Feb

Expectations muted ahead of banks’ first-quarter results

General

Posted by: Steven Brouwer

TORONTO – Expectations are muted as Canadian banks get set to report first quarter earnings starting Tuesday, with results likely to come under pressure on a number of fronts, from slowing consumer loan growth and choppy capital markets to stricter regulations.

But the main concern is the banks’ exposure to ballooning consumer debt and the drumbeat of warnings from Bank of Canada Governor Mark Carney on down about the dangers of over leverage and the risk that has created for the whole economy.

Given the still-steady housing market, it’s probably not a problem in the first quarter or possibly even the current year, but nevertheless investors will be closely scrutinizing results when they come out this week for signs of where things are headed.

The good news is that lenders have mostly laid off the risk by ensuring their mortgage portfolios — the biggest single asset on bank balance sheets — through the Canada Mortgage and Housing Corp.

But they are not entirely protected. There remains significant potential for collateral damage in terms of falling credit card and other borrowing that could result from a housing correction.

Consumer borrowing has been a key source of strength for the sector for the past decade, so any decline — especially when other earnings drivers such as capital markets are showing signs of weakness — would be bad news for the sectors.

Another theme likely to get plenty of attention is expense reduction. In the face of shrinking revenue, players’ natural response is to cut overhead, and they’ve been doing that for the past several months, with Bank of Montreal revealing last week it laid off 60 employees from its capital markets business.

BMO kicks off the season on Tuesday, followed by Royal Bank of Canada and Toronto-Dominion Bank on Thursday. National Bank of Canada comes out Friday, with Bank of Nova Scotia on March 6 and Canadian Imperial Bank of Commerce wrapping things up on March 8.

UBS analyst Peter Rozenberg is calling for a 0.5% drop in earnings for the group compared to the first quarter of 2011 because of moderating loan growth and lower profit margins.

John Aiken, an analyst at Barclays Capital, expressed a similarly bearish view, pointing to “slowing consumer spending” which he said will likely have “a significant impact on the banks’ ability to grow revenues.”

As players increasingly focus on retail banking for profit growth, they’ve been forced to compete harder than ever for customers, resulting in falling net interest margins (NIM), the difference between lenders’ cost of funding and the interest they charge customers.

Mr. Aiken warns this phenomenon of declining NIMs is a major concern.

In the first quarter of last year the banks had an average NIM on their domestic retail operations of about 3.5%, but that is expected to come in at just over 2.5%, a drop of nearly a full percentage point, he said.

“Given a prospect of continuing low interest rates and the now full-bore effort to de-leverage both banks and their retail customers that have provided the bulk of recent revenue and earnings growth, revenue advances will in our view be a key leading indicator of future shareholder value potential,” said Stonecap Securities Inc. analyst Brad Smith.

While there doesn’t seem much to look forward to here, it’s also true that we’ve been here before.

Or at least, the picture we see today looks a lot like the one we were presented with going into the first quarter of last year, with analysts warning of tumbling capital markets profits and a possible housing correction.

But instead it was actually a pretty good year, with at least two players — RBC and TD — putting out record adjusted earnings as Canadian households continued to borrow even while they socked savings into bank mutual funds.

Indeed, Moody’s Investor Services predicted on Friday that household spending will remain “a key support to Canadian growth” in 2012 with sales remaining “on an upward trend.”

“A sudden, unexpected drop in house prices could prompt a drop in consumer leverage and in consumers’ ability to spend,” Moody’s said, adding that it does not believe such a correction is in the cards for 2012.

“Our baseline forecast does not assume a sharp correction in house prices,” the rating agency said.

Financial Post