February 20, 2011 / 3:34 PM / in 7 years

BAY STREET-Canada banks profit to grow, lending to slow

* Modest profit gains expected, sluggish growth ahead

* TD seen raising dividend

* Shares could rise on results, but choppiness seen

By Cameron French

TORONTO, Feb 20 (Reuters) - Canada’s banks can look back over the past quarter with the satisfaction of knowing they probably had to set aside less to cover sour loans.

Looking ahead may prove a bit more uncomfortable for the Big Six, making the outlook for their stocks decidedly cloudy.

Sluggish lending growth and weaker trading revenue in the just-completed fiscal first quarter could highlight more modest earnings expansion in the months ahead.

The salubrious effect of moderating loan loss provisions, which helped pull the banks through the financial crisis, may have run its course, analysts say. The question is, is lending growth now strong enough to take up the slack?

“I think that the first quarter for the banks will really set the tone for the year in terms of some of the other drivers that we can see for profits outside of declining provisions,” said Craig Fehr, an analyst at Edward Jones in St. Louis.

The country’s top six banks as a group should report year-over-year growth of just under 5 percent, a decent result all in all. But that doesn’t tell the whole story.

Royal Bank of Canada (RY.TO) and Toronto-Dominion Bank (TD.TO), the top two lenders, may not have fared as well, due to their reliance on trading revenue and extensive U.S. operations.

They now have to rely on their traditional driver of revenue growth - personal and commercial lending.

The outlook here is mixed. While commercial lending has been growing, personal lending growth may have ground to a halt, or nearly so, due to higher interest rates and more cautious borrowing habits.

At the same time, trading revenue will likely suffer comparison with a strong first quarter a year ago.

“Despite providing ongoing evidence that the recovery is progressing, this quarter’s results should continue to point to a sluggish lending environment and a more challenging capital markets business,” CIBC analysts Robert Sedran said in a note.

Bank of Nova Scotia (BNS.TO) and Bank of Montreal (BMO.TO), Canada’s No. 3 and 4 banks, are expected to show double-digit profit growth.

Canadian Imperial Bank of Commerce (CM.TO) and National Bank of Canada (NA.TO) will kick off bank earnings when they report on Thursday. The pair should show single-digit growth, according to Thomson Reuters I/B/E/S.

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TD, Canada’s No. 2 bank, could stand out from the pack if it does as expected and raises its dividend this quarter.

National Bank became the first Canadian bank to resume dividend increases after the financial crisis when it lifted its payout last quarter, but TD would be the first in the top five to do so.

“It’s a signal from the bank management that they are confident that this is sustainable growth,” said Gavin Graham, president of Graham Investment Strategy in Toronto.

TD Chief Executive Ed Clark has said the bank would provide guidance on its dividend plans this quarter, which most have taken to mean he’ll raise the payout.

Edward Jones’s Fehr, however, said the bank’s $6.3 billion acquisition of auto lender Chrysler Financial -- launched in December -- may prompt it to stand pat for a quarter.

Doing so would likely put some pressure on TD’s stock.

Barclays Capital analyst John Aiken says the stocks -- which have outperformed the market so far this year -- could get a further boost from the results, as he sees capital markets revenue beating current expectations.

However, the euphoria could dry up quickly as the expected slowdown in lending growth becomes increasingly evident.

“I believe the share prices are going to be pretty choppy coming out of the quarter,” he said.

To be sure, others see more sustained gains from the shares, as investors become more comfortable with equities in general.

Graham notes the banks, which typically outperform the broader Canadian market, lagged it last year. Even with sluggish revenue growth prospects, that puts them in a position to make up ground on their valuation, he said.

“If you assume that we’re going to see reasonable earnings growth, equity markets keep on being strong and bad debt provisions keep coming down, then this might end up being a decent year for the banks, maybe something in the 15-25 percent total return,” he said.

$1=$0.98 Canadian Reporting by Cameron French; Editing by Frank McGurty

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