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TORONTO (Reuters) - Investors are overlooking forecast-topping profits reported by Canadian banks this week and choosing instead to focus on the lenders' ability to grow in a weak economy that is feeling the heat of depressed oil prices.
The banks variously benefited from cost cutting and from lower tax rates, gains analysts said may not last. Canadian banks are also trying to counter slow domestic growth by expanding to new markets, potentially adding risk.
Investors are also worrying about lackluster loan growth, pressure on net interest margins and a challenging housing market.
"It's going to be harder to drive growth year after year. The big unknown is how they're going to continue to grow,” said Kevin Headland, director, capital markets and strategy, at Manulife Asset Management, which manages about US$294 billion and owns several Canadian bank stocks.
"If expectations remain elevated, they're eventually are going to have some missteps," he added.
Shares of the country’s five biggest banks slipped on Thursday, even as Toronto Dominion Bank (TD.TO) and Canadian Imperial Bank of Commerce (CM.TO) reported fiscal fourth-quarter earnings per share close to or better than expectations.
Profits at both TD, Canada’s biggest lender by assets, and CIBC were driven by their domestic retail and capital markets divisions. CIBC, the No. 5 bank, also raised its dividend.
On Wednesday, Royal Bank of Canada (RY.TO) topped C$10 billion (US$7.48 billion) in annual profit for the first time in Canadian history, following reports earlier in the week from Bank of Nova Scotia (BNS.TO) and Bank of Montreal (BMO.TO).
Canadian lenders delivered strong results even as an oil prices slump pushed the country into a modest recession in the first half.
The banks said they are closely monitoring energy sector clients. Some banks added more clients to their oil and gas watch lists in the fourth quarter but said they did not see any big damage to their bottom lines at any point soon.
“It's not something that's going to be pivotal for us in terms of making or breaking a certain quarter on earnings,” RBC Chief Financial Officer Janice Fukakusa said in an interview on Wednesday.
She added that while there will be further weakness if oil stays cheap, a pickup in merger and acquisition activity could offset some of that.
Scotiabank and CIBC have the biggest exposures to the energy sector, while TD has the smallest. TD and Scotiabank executives told Reuters this week that they have not relaxed terms for their energy clients.
Bad loans in the energy sector rose for all the banks from a year earlier, and as they mount there are concerns that they could result in more writedowns and losses.
While the banks' energy sector loans overall are small relative to their mortgage and consumer lending, some investors noted those business segments could also be hit if low oil prices persist.
“As long as oil remains under pressure, which it looks like it will be for most of 2016, then we're going to see limited upside for the banks,” said John Stephenson, president of Stephenson & Co Capital Management, which owns shares of TD and Scotiabank.
To be sure, some investors remain bullish on the sector, given that oil prices appear to have stabilized and the Canadian economy is still growing.
"I am positive on the banks. Their oil and gas exposure is not huge and their loan experience has not been that bad," said David Cockfield, a portfolio manager at Northland Wealth Management, which owns TD, Scotiabank and BMO shares.
"If oil is still at $40 six months from now, I would definitely become more concerned."
($1 = 1.3361 Canadian dollars)
With additional reporting by Matt Scuffham