TORONTO (Reuters) - Canada’s stalwart and sturdy banks are set to report another string of strong profits in the second quarter -- and that just may be the problem.
With credit losses easing, Canada’s biggest lenders are expected to impress again as they unveil results. But as global uncertainty takes a bite out of stock markets, even Canadian banks may find it hard to live up to the hype.
“Expectations have just gotten very, very high for the banks and that’s probably the biggest headwind to stocks in the near term,” Edward Jones analyst Craig Fehr said, forecasting a third straight quarter of strong bank earnings.
Canada’s Big Six banks have mostly exceeded expectations in recent quarters. They have boasted strong returns and a steady stream of small acquisitions, even as international rivals struggle to regroup from the global financial crisis.
Signs are good for profit growth in the quarter that ended April 30. Loan losses are ebbing as the economy improves, and segments like wealth management and even trading are stronger or still solid.
But headwinds include the stronger Canadian dollar, which erodes the value of earnings from growing U.S. operations.
The outlook for profits, and investor sentiment, could also take a hit if Europe’s debt crisis worsens and pulls down global growth.
Bank of Montreal reports results on Wednesday, while Canadian Imperial Bank of Commerce, Royal Bank of Canada, Toronto-Dominion Bank and National Bank of Canada report on Thursday. Bank of Nova Scotia caps the earnings season June 1.
For some, the steady-as-she-goes performance relative to global peers is just the reason to invest in the banks’ shares, even though some have just come off all-time highs and dividend increases are thought to be several quarters away.
“Investors should absolutely be investing in Canadian banks,” said Barclays Capital bank analyst John Aiken. “With significantly less exposure to Europe and the additional weakness in the U.S. economy ... you’ve got very strong downside support.”
Relief from more than a year of huge credit losses will also allow the banks’ fundamental strengths -- from money-making domestic operations to still-solid trading revenues -- to shine, Fehr said.
“For many quarters now, the Canadian banks have been performing well, but that’s been masked a bit by stubbornly high provisions,” Fehr said, referring to the amount of money set aside to cover loans that went bad during the recession.
“As provisions tail off, that will unmask some of the core earnings,” Fehr said.
Forecasts for growth in core cash earnings per share in the second quarter range from 6 percent to 17 percent from a year earlier, analyst reports show.
“We think that positive year-over-year drivers in domestic retail divisions -- stronger wealth management earnings, robust growth in consumer-related loans and mortgages, higher net interest income margins and lower loan losses -- will more than offset the translation impact of a stronger Canadian dollar and flat wholesale earnings,” RBC Capital Markets analyst Andre-Philippe Hardy wrote in a research note.
But while profit growth seems certain, analysts disagree whether the stocks are a good buy right now, given that prices have already had a strong run-up. Still, a recent willingness to make acquisitions despite regulatory uncertainty has foreshadowed long-term growth prospects.
“Now is an exciting time for Canadian banks. We have already started to see some cross-border acquisitions, namely FDIC-assisted deals. We expect this activity to continue and possibly veer away from FDIC-assisted deals,” Desjardins Securities analyst Michael Goldberg said in a note to clients.
By buying assets of failing U.S. lenders from the Federal Deposit Insurance Corp (FDIC), banks can make relatively risk-free deals, typically negotiating a loss-sharing agreement that limits the risk of taking on an unfamiliar loan book.
A strong capital position has put the banks in the drivers’ seat for growth. And while acquisitions may not boost earnings immediately, the banks’ ability to grab market share in wholesale banking during the crisis is one reason profit growth has held up so well.
Aiken said that while trading and markets revenue had been expected to fall off sharply after a few outsized quarters, most now expect a more tempered decline, even as battered global competitors return to claim a share of activity.
“All else being equal, the Canadian banks have bigger trading operations than they had two years ago,” Aiken said.
Fehr urges a conservative approach.
“My advice to investors is to remain cautious, be selective with these banks and expect near-term volatility because results aren’t going to continue to be stellar quarter over quarter,” he said.
Reporting by Andrea Hopkins; editing by Janet Guttsman and Jeffrey Hodgson