Wednesday, February 22, 2006

BMO, Scotiabank Expected to Lead in Q1 Profit Growth

Canadian Press, Tara Perkins, 22 February 2006

Toronto (CP) - The Bank of Montreal and Scotiabank are expected to take the gold and silver for first-quarter earnings growth in Canada's banking industry.

The Big Six banks will take turns releasing financial results for the November-to-January period over the next two weeks, with TD Bank first out the gate on Thursday. Analysts are forecasting a strong showing for the quarter and are cautioning investors not to be spooked by higher provisions for loan losses.

The consensus estimate of analysts surveyed by Thomson Financial expects the Bank of Montreal to report a 10 per cent rise in first-quarter profit, followed by the Bank of Nova Scotia at seven per cent, Royal at six per cent, TD at five per cent and CIBC at two per cent.

National Bank trails with an expected earnings drop of two per cent.

Canada's banking industry took a slight tumble in 2005, when half of the Big Six took charges for their liabilities in lawsuits related to the Enron scandal in the United States.

But it also proved that it can land on its feet, picked up in part by good mortgage lending and wealth-management sales. The outlook is good for those sectors again.

"It should be a good quarter for wealth management and trading activity at the Canadian banks," said Sumit Malhotra, an analyst with Genuity.

Factors that are expected to boost capital market-related revenue and wealth-management income include volatile foreign exchange and commodity markets, high stock-trading volumes, continued mutual-fund market share gains, tightening activity by central banks and the federal government's decision to leave income trusts untaxed.

"The economy has remained pretty solid, the consumer has remained solid, so you would expect retail banking to post good results in general," said Tom Kersting, a financial services analyst with brokerage Edward Jones.

"Overall, we would expect a clean bill of health for the quarterly earnings checkup."

Malhotra said 2006 is expected to bring a return to stable net interest margins - the difference between what the banks receive on loans and what they pay on deposits - a trend that showed signs of beginning in the second half of 2005.

Scotiabank is expected to lead the way on that front, Malhotra said.

The most important valuation issue facing bank-stock investors, though, is rising loan losses, said National Bank Financial analyst Robert Wessel.

Excellent earnings growth of the past two years was driven primarily by falling loan losses, Wessel said in a note to clients.

He expects provisions for loan losses to begin to rise in the second half of 2006, and notes "there are already signs that the credit cycle is beginning to turn."

Many investors will be watching the provisions closely.

"Because credit has been so good for so long, it's almost as if investors are just waiting for the other shoe to drop," said Malhotra. "They are very sensitive to even the perception that the environment for lenders is weakening."

Credit losses will be higher in the first quarter, on a year-over-year basis, Malhotra said. But "it's not so much that we think there are bad trends in credit, as much as there is just less in the way of reversals and recoveries," he said.

"Those huge pools of gross impaired loans that were around after the writedowns of 2002 are getting smaller, so there's less recoveries for the banks to get from bad loans."

Kersting agrees that larger provisions for loan losses in the first quarter will not be a signal of bad credit quality.

"It's really a return to a more normalized level," he said.

Malhotra expects Royal, BMO and TD to announce an increase in their quarterly dividends, along with their earnings.

Looking further into the next two years, Wessel expects the "excellent" dividend growth of the past two years to slow, as earnings headwinds arise.

At the same time, he expects the banks to deploy more capital as their common equity continues to grow.

"The acquisition cycle has begun," he said.