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Bank growth slows as consumers pinch their pennies

Canadian households turn off borrowing taps, pay down debt

From Monday's Globe and Mail

19:00 EDT Sunday, May 20, 2012

For more than a decade, consumer loans have fuelled Canadian bank earnings, pushing profits upward as home buyers took out mortgages and consumers extended their lines of credit. But as the banking sector prepares to report second-quarter earnings this week, a different picture is emerging.

Canadian households are beginning to sputter. While none of the Big Six banks are expected to see their second-quarter earnings fall dramatically because of this trend, the strong growth they have long been able to muster for investors will now be a lot harder to achieve, say analysts.

“The Big Six Canadian banks will suffer from the impending completion of a near 15-year expansion in Canadian household leverage,” National Bank Financial analyst Peter Routledge said in a research note previewing second-quarter earnings.

Sumit Malhotra, an analyst at Macquarie Equities Research, raised the same concerns. With global pressures weighing on the financial sector, from instability in Europe to a sluggish economic rebound in the United States, Mr. Malhotra argues the most pressing challenge for Canadian banks is actually in their own backyard.

“Perhaps the biggest headwind [for bank stocks] is found close to home,” Mr. Malhotra said in a research note. “The key question … is whether the banks can outperform when their largest source of revenue – consumer loan growth – is showing clear signs of slowing.”

Bank of Montreal kicks off second-quarter earnings for the Big Six on Wednesday, followed by Royal Bank of Canada and Toronto-Dominion Bank on Thursday. Bank of Nova Scotia, Canadian Imperial Bank of Commerce and National Bank of Canada report the following week.

While much attention is being paid to the housing sector and the potential for home prices to drop, National Bank’s Mr. Routledge suggests high consumer debt is the more glaring issue.

“The risk to the Canadian economy lies not in the prices of residential housing but in the level of household debt relative to income,” Mr. Routledge said. “Households in this segment have little room in monthly income to withstand [shocks], such as loss of employment, higher mortgage interest rates, or other unanticipated and continuing expenses.”

With Canadian consumers heading to the sidelines to pay down debt, or at least slow their borrowing, the challenge for the banks is find another area of profit growth. Commercial loans – which have slumped for the past several years – could return to life, which would provide some upside for earnings. But analysts are mostly looking to the international operations of the Canadian lenders to drive stock prices.

“We prefer banks with viable growth platforms outside Canada,” Mr. Routledge said.

The strategies that have seen Canadian banks build out their operations globally will now be looked upon for bigger contributions. The expansions of TD and BMO into the U.S. retail banking sector, RBC’s push into global wealth management, and Scotiabank’s foray into South American and Asian markets will all be looked upon to replace some of the earnings growth that is slowing at home.

This could leave CIBC and National Bank, which are primarily focused on the domestic market, struggling to find new growth. “[CIBC] and to a lesser extent National are the most exposed to a slowdown in consumer loan growth,” Canaccord Genuity analyst Mario Mendonca said in a note to his clients.

Despite the gloominess though, Mr. Mendonca is optimistic commercial lending will pick up in Canada. While consumer loan growth has slowed to 2.2 per cent over the last three months, according to data from Canada’s bank regulator, commercial loan volumes have grown 6 per cent in that time. “Residential mortgage growth appears to have slowed noticeably, and commercial loan growth remains very strong and may be accelerating,” Mr. Mendonca said.

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