* Narrow profit gain seen for sector
* Loan losses to decline, markets revenue to fall
* Bank of Montreal first to report on Tuesday
By Cameron French
TORONTO, Aug 23 (Reuters) - Canadian banks are expected to start reporting solid if unspectacular quarterly results this week as shrinking credit losses and modest loan growth make up for the impact of flagging capital market revenue.
There may be exceptions, but the results are not expected to overly impress investors. The rock-solid strength of the banks’ domestic retail franchises, however, ensures progression from last year’s uncertainty.
“My expectation is for capital markets (revenue) to be fairly weak in the quarter, and I think we got an indication (from) the reporting out of some of the U.S. banks,” said Edwards Jones analyst Craig Fehr.
U.S. banks, whose second quarter overlaps with the Canadian banks’ May-July financial third quarter, took a hit from lower capital market revenue as economic and market uncertainty ate into trading revenues and advisory fees.
Fehr expects year-over-year results for the Canadian banks to be “flat to slightly up”.
Bank of Montreal BMO.TO will be the first to report, releasing its results on Tuesday.
Canada’s No. 4 lender is expected to show a profit of C$1.21 a share, up from a year-before profit of C$1.05 a share, according to Thomson Reuters I/B/E/S.
Analysts also expect modest gains from Bank of Nova Scotia BNS.TO and Canadian Imperial Bank of Commerce CM.TO.
Royal Bank of Canada RY.TO and Toronto-Dominion Bank TD.TO, Canada’s two largest banks, are expected to report a slight decline in quarterly profit, while smaller National Bank of Canada NA.TO should see a sharper drop due to its relatively high weight of capital markets-related revenue.
Robert Sedran, an analyst at CIBC World Markets, expects Canada’s big six banks to report a combined 2.1 percent year-over-year rise in profit, driven by a 27 percent drop in loan-loss provisions.
Those provisions, or money set aside to cover bad loans, have declined in the past year as the economy has improved.
The improving economy, however, has prompted the Bank of Canada to twice raise interest rates, which has the effect of quelling loan growth. But it also has allowed the banks to raise lending rates, which helps retail bank revenues.
“The strength has been the P&C (personal and commercial) banking, and it’ll be interesting to see, with what’s happening in the economy, whether that will continue or not,” said John Kinsey, a portfolio manager at Caldwell Securities in Toronto.
With credit quality and profits rebounding from the financial crisis, investors are looking forward to a resumption of dividend increases. Dividend hikes stalled in 2008 as the economy fell into recession and banks moved to shore up their financial footing.
While profit levels might justify dividend increases, hikes are not expected until after the Basel Committee of global banking supervisors -- which is putting together rules to avoid another bank crisis -- publishes new standards for bank capital levels later this year.
“As optimistic as we are, I think that the Street and investors are waiting to see what the Canadian banks growth plans are and we’re still in a holding pattern until we really get a little more definite answer on the Basel rulings,” said John Aiken, an analyst at Barclays Capital.
Analysts note the banks’ results have largely managed to exceed expectations in recent quarters, but say this could raise expectations to the point that it may take a very strong result to give their recently underperforming shares a lift.
The TSX financials sector, which is heavily weighted with banks, has fallen more than 10 percent since the beginning of May, outdistancing the 3.7 percent drop of the benchmark Toronto stock index in the same period.
“Should the banks simply meet consensus, this would likely weigh on valuations given that the market has become comfortable with them exceeding expectations over the past three quarters,” Aiken said.
$1=$1.05 Canadian Reporting by Cameron French; editing by Peter Galloway