January 5, 2012 / 12:22 PM / 6 years ago

Canada's banks may face difficult year

TORONTO (Reuters) - Global economic headwinds may finally have caught up with Canada’s banks, a haven of stability over the past few years in an otherwise turbulent global financial industry.

On Thursday, one of the country’s top financial industry analysts downgraded Canada’s financial sector and predicted that three top lenders will actually see their shares decline in 2012.

The grim outlook portends a shift for a bank sector that emerged from the 2008 financial crisis in much stronger shape than its counterparts in other markets around the world. Indeed, the country’s lenders have been named the world’s soundest by the World Economic Forum for four straight years.

While nobody’s calling for the kind of turmoil that’s hit lenders in the United States and Europe over the past three years, Barclays Capital analyst John Aiken sees an end to the double-digit profit growth that has made the sector a safe haven for investors spooked by rocky markets.

“The fact that we’re looking for modest share price declines in the Canadian banks doesn’t mean that we’re negative on the group as a whole, but what you’ve got to keep in mind is that their earnings are slowing after two years of pretty strong relative performance,” Aiken said in an interview.

While Canada’s banks managed to churn out strong profits during what was expected to be a challenging 2011, analysts expect reduced consumer debtloads and narrow interest margins to weigh on revenue growth in 2012.

Meanwhile, Europe’s debt crisis, while not seen as a direct threat for any of the Canadian lenders, puts pressure on stock valuations, Aiken said.

He lowered his rating on the Canadian financial sector - which is dominated by the banks, but also includes insurers and asset managers - to “neutral” from “positive.”

He also cut price targets for Canada six biggest banks, including sector heavyweights Royal Bank of Canada (RY.TO) and Toronto-Dominion Bank (TD.TO), as well as for the three biggest insurers, which are led by Manulife Financial (MFC.TO).

Aiken expects bank profits to grow by about 2 percent this year, but sees valuations increasingly strained.

He expects shares of three banks - Royal, Bank of Nova Scotia (BNS.TO), and National Bank of Canada (NA.TO) - will fall slightly during the year from their price on Thursday.

REALITY CATCHING UP

Aiken is hardly alone in seeing tough times ahead.

“I would say that reality is catching up with them a little bit,” Craig Fehr, a St. Louis-based analyst at Edward Jones, said of the banks.

“If we look at 2012, I think it’s going to be much more of an average year for them, not necessarily a dire year, and not a banner year, but really something where it’s going to be far more about the business model, ” said Fehr.

That means controlling costs, reducing exposure to low-margin businesses, and trying to manage the expectations of shareholders who have watched the country’s banks rebound strongly over the past two years from the 2008-09 financial crisis.

Looking forward, the external environment remains very uncertain,” Gerry McCaughey, chief executive of Canadian Imperial Bank of Commerce, told investors in December. His comments were echoed by CEOs of Canada’s other big banks.

The six top lenders reduced payrolls slightly during the fourth quarter of 2011 by about 500 jobs from the end of the third quarter, the first such reduction in at least two years for most of the lenders.

INSURER TARGETS CUT

For the insurers, whose shares fell hard in 2011 due to the impact of weak stock markets and low bond yields, Aiken warned that growth and profitability remain challenged by difficulties inherent in legacy U.S. insurance policies.

He cut his price targets on Manulife and Sun Life (SLF.TO) by 25 percent and 17 percent, respectively.

For the banks, the target price cuts range from 3.8 percent to 8 percent.

While the Canadian banks may still outperform international peers if the macroeconomic environment becomes more dire, good news for the global economy might actually drive capital away from the banks, he said.

“The way we’re characterizing it ... is for the Canada banks to outperform again like they did in 2011. It’s going to have to be another down environment, because you’re not going to get multiple expansion, and at this point we’re seeing more risks to earnings than upside catalysts,” said Aiken.

Additional reporting by Euan Rocha; Editing by Frank McGurty

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