Canada’s big banks to end strong financial year with a ‘whimper’

TORONTO — Canada’s biggest banks are expected to close out a strong financial year that was helped by interest rate hikes and favourable credit conditions with a “whimper” of a quarter.

The Bank of Nova Scotia is the first of its peers to report its earnings for the three months ended Oct. 31 on Tuesday, and the quarter is expected to provide a solid but quiet end to a year of strong growth and earnings “well above” estimates from 12 months ago, CIBC Capital Markets analyst Robert Sedran said.

“Ending the year with a whimper may be an overstatement given the still strong (year-over-year) growth we forecast, but we do see fewer positive catalysts this time than we have seen in earlier quarters,” he said in a recent note to clients.

Royal Bank of Canada reports its quarterly results on Wednesday, followed by the Canadian Imperial Bank of Commerce and Toronto-Dominion Bank on Thursday. The Bank of Montreal and the National Bank of Canada will deliver their results the following week on Dec. 4 and Dec. 5, respectively.

Analysts are expecting the country’s largest financial institutions to collectively deliver earnings per share growth as high as 12 per cent in the financial fourth quarter, year-over-year.

That would mark a steady close to a financial year whose initial outlook was clouded by concerns surrounding domestic mortgage demand amid new stricter lending rules and the negotiations of the North American Free Trade Agreement.

Canada’s housing market appears to now have adjusted to the regulations for uninsured mortgages that were implemented on Jan. 1. And in September, the United States and Canada were able to reach an agreement in principle called the U.S.-Mexico-Canada agreement.

Meanwhile, multiple Bank of Canada rate hikes this year have helped expand the banks’ net interest margins — the difference between the money they earn on the loans they make and what they pay out to savers.

“After five BoC rate hikes over the past year, we anticipate margin expansion will continue to play out” in the latest quarter, said John Aiken, an analyst with Barclays in Toronto in a recent note to clients.

“And, with Canada’s economy staying positive, we anticipate lending volumes will edge higher to close out the year.”

Canadian loan growth remains strong, with solid commercial lending offsetting slowing personal lending, said Scott Chan, an analyst with Canaccord Genuity in a note to clients. However, U.S. capital markets saw a light quarter and the equity market selloff in October will have ripple effects for the banks’ asset management businesses, he added.

Still, credit conditions remain favourable and the banks with U.S. exposure will likely benefit from lower taxes, said Sohrab Movahedi, an analyst with BMO Capital Markets.

“Earnings fundamentals of the group remain generally intact for the foreseeable future with a benign credit environment, focus on efficiency improvements, and central bank rate increases helping offset moderating economic growth outlook in Canada,” he said.

Despite the favourable conditions, Canadian bank stocks have been languishing and market sentiment has been tepid amid a weaker stock market overall.

On a forward price-to-earnings ratio basis — meaning a current stock’s price relative to its predicted earnings per share — the Canadian banks are trading at 9.6 times, below the 20-year average of 11.1 times, Aiken said.

“While bank valuations have been caught in the broader market downdraft, we believe that investors are concerned that the domestic operating environment remains challenged, underscored by a slower loan growth and an economic cycle likely in the late innings,” he said.

However, the banks’ fairly diversified businesses to weather a slowdown, steady mid-single digit earnings growth and solid dividend yield ”offers compelling counterpoints to fend off the bears,” he added.

Perhaps more important than the actual earnings churned out this quarter are the signals from bank executives about what they expect in the year ahead, analysts say.

One theme that will be closely watched is mortgage market trends, after the revised underwriting guidelines drove home loan growth down to its lowest level in decades, said Gabriel Dechaine, an analyst the National Bank of Canada.

Mortgage originations in the first half of the latest financial year were inflated by home loans that were locked in before the revised rules for uninsured home loans took effect on Jan. 1. Any guidance on the likelihood of zero or possibly negative mortgage growth in the coming year is something to watch for, Dechaine said.

Also key will be commentary on signs that Canadian homebuyers are turning to lenders who are not subject to the new underwriting guidelines, which involve implementing a stress test to gauge whether borrowers would be able to service their mortgage if interest rates go up.

A recent Teranet report that showed that nine per cent of mortgage originations in the Greater Toronto Area during the second quarter went to “private lenders”, up from six per cent the prior year, Dechaine noted.

“We are curious to hear what banks think of clear signs that shadow banking in Canada is getting bigger.”

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