Banks bounce back

Canada’s biggest banks are expected to report a relatively strong finish to the financial year when they start reporting fourth-quarter earnings Tuesday, but their capital markets divisions could leave investors jittery about the future.

Canada’s biggest banks are expected to report a relatively strong finish to the financial year when they start reporting fourth-quarter earnings Tuesday, but their capital markets divisions could leave investors jittery about the future.

“It’s going to be a good quarter, for sure, for capital markets, but there may be room for disappointment if people have overestimated just how good it’s going to be,” said Brad Smith, an analyst at Blackmont Capital.

“If we get a disproportionate amount of earnings coming from trading profits, that’s going to be viewed as lower quality because it’s simply not sustainable.”

Bank of Montreal (TSX:BMO) is the first to report its earnings on Tuesday, while the other banks won’t follow suit for another week and a half.

Analysts will be closely monitoring the capital markets divisions, which have powered the last couple quarters and helped drive profits at Canada’s banks.

An estimate by Genuity Capital Markets puts overall trading revenue in the Canadian banks up 125 per cent so far this year over last, which is worth about $5.5 billion. That compares to an increase in provisions for credit losses of 100 per cent, or $3.6 billion.

At Royal Bank (TSX:RY), which reports on Dec. 4, capital markets contributed about 12 per cent of the total revenue in the third quarter, about $1.2 billion.

National Bank (TSX:NA) has also benefited from its capital markets divisions to the tune of about 20 per cent of its total revenue in the last quarter. It reports on Dec. 3.

Craig Fehr, a financial services analyst with Edward Jones in St. Louis, said banks need to demonstrate they know where to pick up the slack when trading revenues start to ease their growth.

“Many investors are asking if valuations are getting ahead of themselves,” said Fehr.

“You’ve got to be a bit more selective with which banks you buy now. As the market reconnects back to earnings growth, there’s going to be some banks that are going to outperform others.”

Fourth quarter earnings from CIBC (TSX:CM) and TD Bank (TSX:TD) are also due Dec. 3, while Scotiabank (TSX:BNS) follows on Dec. 8.

Mario Mendonca of Genuity Capital Markets expressed some caution for the next year.

“Looking beyond this quarter, however, we expect earnings comparisons to become less flattering early in 2010,” he said.

Mendonca expected that BMO will show earnings per share declines of 14 per cent in the quarter, weighed by weaker revenue growth and a higher share count.

He predicted that CIBC’s earnings per share will drop 18 per cent year-over-year on lower than average revenue growth and higher provisions for credit losses.

The biggest gainers will likely be the banks that have positioned themselves for further growth outside Canada’s borders, but haven’t strained their balance sheet.

Several analysts list Scotiabank as one of the banks likely to come out on top during the fourth quarter, while inspiring optimism for its longer term earning growth.

As for dividend growth, the banks will likely keep investors waiting even longer.

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