Canada Bank Earnings May Be ‘as Good as it Gets’

For Canadian banks, ranked the world’s soundest, it may not get any better than this.

Domestic banking profit growth will slow in the second half of the year as household debt rises and concerns about a crisis in Europe curb demand for loans, even as some of the lenders report better-than-expected second-quarter earnings.

“It’s pretty much as good as it gets when it comes to the Canadian banking segment,” said Tom Lewandowski, a bank analyst at Edward Jones & Co. in St. Louis. “I don’t think that’s going to continue where consumer debt levels are.”

Canadians may slow their borrowing with household debt at record highs and as the Bank of Canada signals it may raise interest rates to curb inflation. Domestic consumer banking is the largest single profit segment at most of Canada’s six main banks.

Royal Bank of Canada fell 2 percent to C$50.35 at the close in Toronto, leading the decline of Canada’s six-biggest banks. The country’s largest lender by assets had its biggest drop in almost seven months yesterday after reporting profit that missed analysts’ estimates by a penny. Toronto-Dominion Bank slipped 1 percent to C$78.22, a day after the No. 2 bank posted earnings that topped estimates. Bank of Montreal fell 1.1 percent to C$54.50.

Toronto-Dominion Chief Financial Officer Colleen Johnston said slowing loan growth, margin pressure and “regulatory headwinds” may mean the bank will reach the “lower end” of its 7 percent to 10 percent profit growth forecast this year. The bank reported that second-quarter profit climbed 21 percent to C$1.69 billion ($1.64 billion), or C$1.78 a share.

‘Work Hard’

“Our current view is that we’re going to continue to work hard to get in the 7 to 10 percent range,” Johnston said in a telephone interview. “We expect to be at the lower end of the 7 to 10 percent on a full-year basis.”

A residential real estate boom in the world’s 10th-largest economy has prompted Bank of Canada Governor Mark Carney to warn that high levels of household debt are the biggest domestic risk to Canada’s economy. The central bank may increase its key lending rate in the first quarter next year, according to a survey of analysts’ forecasts, after keeping it unchanged at 1 percent since September 2010.

“The Canadian market is pretty saturated with the six big banks and with interest rates so low their margins are getting squeezed,” said John Kinsey, who helps manage about C$1 billion at Caldwell Securities Ltd. in Toronto, including bank shares. “It’s kind of ’What do we do, where do we go?’”

Margins Narrow

Domestic banking net interest margin at Royal Bank narrowed to 2.72 percent in the second quarter, from 2.79 percent a year earlier. Toronto-Dominion’s overall net interest margin narrowed to 2.25 percent from 2.3 percent. Net interest margin is the difference between what a bank charges for loans and pays in deposits.

“We believe household demand for credit will slow materially over the coming years,” National Bank Financial analyst Peter Routledge said yesterday in a note to clients. He said that a 15-year expansion of Canadian household leverage “would come to an end in the near term.”

Royal Bank reported yesterday that profit from continuing operations, excluding a loss tied to its RBC Dexia Investor Services purchase, increased 4.9 percent to C$1.77 billion, or C$1.15 a share. Domestic consumer banking will provide the Toronto-based bank with more than 50 percent of its profit over the next year, Routledge said.

“The most significant long-term risk facing (Royal Bank), in our view, is its reliance on the Canadian banking segment,” Routledge said in the note.

‘Taking Away Share’

Royal Bank Chief Financial Officer Janice Fukakusa said the lender will expand at home by increasing market share and cutting expenses.

“Our strategy is growing at a premium to the market growth by taking away share,” Fukakusa said yesterday in a telephone interview. “In addition to that, ensuring that we operate at a very tight cost base.”

Bank of Montreal, which reported a 27 percent increase in profit on May 23, said increased competition for deposits is hurting bank margins.

“The real issue with deposits is the low interest rate environment and that’s just putting continued pressure on our spreads, as we earn less on those deposits,” said Frank Techar, head of Canadian consumer lending at Bank of Montreal, the country’s fourth-biggest bank. “And we expect that to continue for at least two or three more quarters.”

Canadian banks will have other “levers” to expand profit over the coming years, including operations in the U.S. and asset-management businesses, said Edward Jones’s Lewandowski.

“Looking at this more broadly, I think there are still some good underlying positive trends,” the analyst said.

Bank of Nova Scotia, Canada’s third-largest bank, is scheduled to release second-quarter results on May 29. Canadian Imperial Bank of Commerce and National Bank of Canada, respectively the No. 5 and 6 banks, report results May 31.

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