Canada Banks’ ‘Phony’ Profitable Quarter Belies Future Trouble

After a smooth third quarter, there’s danger ahead for Canadian banks.

All of the country’s six largest lenders reported third-quarter profit this week that beat analysts’ estimates, helped by higher earnings in Canadian personal and commercial banking. Still, analysts including National Bank Financial’s Peter Routledge say trouble is lurking as cost cuts and low loan-loss provisions compensated for slowing revenue growth.

“It’s a phony quarter,” Routledge said in a telephone interview. “It shows really well, but there’s other things happening under the surface that are really risky.”

Royal Bank of Canada, which beat estimates by a cent, reported declining revenues in the period ended July 31. Bank of Nova Scotia joined Toronto-Dominion Bank, Bank of Montreal and National Bank of Canada in raising provisions for bad loans.

Shares of Canada’s banks were down Friday in Toronto trading, led by National Bank’s 2.8 percent drop as of 2 p.m. The eight-company Standard & Poor’s/TSX Commercial Banks Index fell 0.4 percent and has declined 8.4 percent this year.

Still, profit from Canadian personal and commercial banking rose across the group in the quarter, ranging from Royal Bank’s 4.5 percent increase to Scotiabank’s 10 percent jump.

Slowing Economy

“I think anything above five percent is pretty good,” said John Kinsey, fund manager with Caldwell Securities Ltd. in Toronto, whose firm manages about C$1 billion ($758 million), including bank shares. “We’re talking not a very robust economy here in Canada and if they can keep turning out five percent, or six percent even, I’d be happy with that.”

Growth in domestic banking earnings has dwindled compared to several years ago, as overindebted Canadians pare borrowing and the country’s economy struggles with slumping oil prices. Mortgages have increased an average of 5.2 percent year-over-year since the start of 2013, less than half the growth rate from 2008 and the slowest pace in 14 years, according to Bank of Canada data.

“Canadian consumer credit performance is as strong as it’s ever been,” Scotiabank Chief Financial Officer Sean McGuckin said Friday in an interview. “We’re at all time lows for delinquencies or past due accounts. We believe we can still create growth even in a more moderated economy like Canada.”

Banks have continued to add deposits and loans, while trimming costs and increasing revenue from fee-based businesses including mutual funds and credit cards. Bank of Montreal and Canadian Imperial Bank of Commerce also benefited by setting aside less money for bad loans.

“The banks are adjusting their operating cost structure to deal with revenue headwinds; that’s part of the explanation for the resiliency,” Routledge said. “Credit losses are at historically low levels and that might persist for one more quarter, but at some point it’s going to rise.”

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