Canada's major banks are expected to post lower profits this week, and analysts increasingly believe their numbers will continue to weaken in coming quarters.
Combined, the banks are forecast to post third-quarter earnings that are down roughly 10 per cent from a year ago, as the U.S. subprime mortgage crisis continues to plague financial markets and infect the economy.
While investment banking divisions and U.S. operations continue to suffer, investors are watching for signs that the bread-and-butter Canadian branch networks are developing bruises from the soft economy.
Roughly two-thirds of the sector's profits come from domestic banking, and “several economic indicators suggest that growth rates in lending activity for the Canadian banks will moderate, while real estate prices may decline during a period of rising unemployment,” CIBC World Markets analyst Darko Mihelic wrote in a note to clients.
“With a weakening economy, we believe domestic [personal and commercial] earnings are at risk of significant decline” in the coming quarters, he wrote.
A year ago, the banks were reporting their best results ever, having been at the peak of their game in the three months ended July, 2007. In the time since, the subprime crisis has pummelled the world's financial institutions, causing more than $300-billion (U.S.) in writedowns.
Three months ago, Canadian bank chief executives were cautiously optimistic that the rescue of Bear Stearns marked the tail end of the crisis. But tough credit conditions and weakness in the U.S. housing market have not let up, while new signs of economic pitfalls on both sides of the border have emerged.
Analysts forecast pre-tax writedowns of as much as $900-million for Royal Bank of Canada, and potentially more than $2-billion for Canadian Imperial Bank of Commerce this quarter, although estimates vary significantly. Toronto-Dominion Bank will take a $96-million charge because of mispriced assets.
Canada's banks have already taken more than $10-billion in charges related to the liquidity crunch, notes Merrill Lynch analyst Sumit Malhotra.
But they are relatively unscathed compared to peers in the U.S. and Europe, and have been trading at lofty relative values as a result. Some analysts are skeptical they can maintain the premiums.
While the outlook for this quarter isn't too bad, Dundee Capital Markets analyst John Aiken believes “the banks face significant longer term pressure on valuations stemming from U.S. economic deterioration.”
Credit Suisse analyst James Bantis said in a note to clients that “it's unlikely that the present valuation level for the Canadian banks is sustainable.”
One of his concerns is that the banks might make risky takeovers in the struggling U.S. consumer banking market. U.S. exposure is expected to drag down results.
BMO Capital Markets banking analyst Ian de Verteuil waded through recent regulatory statements for the U.S. subsidiaries of the Canadian banks, and found evidence of weak loan books.
“It certainly looks as if the results from the U.S. subsidiaries of Canadian banks, particularly [Bank of Montreal's U.S. bank] Harris, are deteriorating,” he wrote in a note to clients.
Another one of Mr. Bantis's concerns is that the slowing Canadian economy will cause more loans to sour.
There is now evidence Canadian consumers are being squeezed in terms of their capacity to take on more debt, Mr. Mihelic noted.
Canadian banks might not be able to pump out as many loans in the future, and that could last for several years, he suggested.
Potential softness in the banks' core Canadian divisions is even more worrisome now because of the weakness in the U.S. operations and investment banks.
“With rising risk in U.S. platforms and market sensitive businesses struggling, the importance of domestic retail earnings has increased,” National Bank Financial analyst Robert Sedran wrote in a note to clients.
Analysts have been ratcheting down their expectations for future bank performance, and boosting their estimates of losses from bad loans.
While Royal Bank of Canada, TD, and National Bank could each raise their dividends this quarter, few analysts are expecting them to do so, as the banks try to preserve capital.
© The Globe and Mail
