Friday, August 18, 2006

Bank Profits Seen Up; Domestic Margins Key

Reuters, Lynne Olver, 18 August 2006

Thanks to a still-sunny economic picture, the big six Canadian banks are seen reporting per-share earnings growth of 10 percent to 12 percent when their parade of third-quarter results starts next week.

Growth in loans and near-perfect credit quality should result in solid reports for the latest May-July period, analysts said, although cooling real estate markets may slow the banks' retail loan growth in upcoming quarters.

Compared with previous quarters, wholesale banking earnings may reflect weaker trading and equity-underwriting activity than in the first half. Choppy equity markets in the spring also discouraged mutual fund investors, which may weigh on wealth management profits.

But, overall, bank stocks have been rising in recent weeks "on expectations for decent earnings," as well as the perception that North American interest rate hikes are probably over, said John Kinsey, a portfolio manager with Caldwell Securities in Toronto.

Most of the big banks have been buying back shares or raising dividends, and in a volatile stock market, "they're regarded as a safe haven to put some money," Kinsey said on Friday.

Return on equity for the industry is seen around 18 percent to 20 percent in the third quarter, and two banks -- Royal Bank of Canada and Toronto-Dominion Bank-- could boost their dividends.

Observers said performance of the domestic retail divisions will be key, as most banks have seen steady declines in net interest margins, a key measure of lending profits.

"We've seen quarter after quarter of spread compression," said Ohad Lederer, an analyst with Veritas Investment Research. He will be watching to see if that trend continued, or if it stabilized.

Darko Mihelic, a bank analyst with CIBC World Markets, agreed that interest margins will grab a lot of attention.

"There may be some valid arguments that, potentially, margins stabilize going forward, but I haven't seen enough evidence to suggest that margins stabilized during the quarter," Mihelic said.

If net interest margins were still squeezed, each bank must show where it will make up for the slowdown in retail earnings, he said. In general, strong wholesale earnings growth and solid profits from international units should more than offset slower retail earnings growth, in his view.

International profits are rising as a percentage of bank earnings, and could become even more important if domestic growth slows, Mihelic noted. "Maybe the international growth prospects would legitimize and spur more acquisition activity outside of the country," he said.

Earlier this month, Royal Bank made its first retail acquisition in the United States in several years, snapping up Flag Financial Corp.'s Flag Bank in Georgia for more than C$500 million ($445 million).

Meanwhile, Canadian banks continue to enjoy "pristine" credit quality, said Mario Mendonca, a financial services analyst at Genuity Capital. Although three key factors -- the Canadian dollar, interest rates and energy prices -- all moved higher in the third quarter, he does not expect to see signs of deterioration in loan portfolios.

"In our view, the underlying economic strength underpinning both consumers and business is sufficient to cope with these additional cost burdens," Mendonca wrote in a report.

Robert Wessel, a bank analyst at National Bank Financial, expects the inevitable decline in credit quality will show up very gradually, becoming noticeable in the first half of 2007.

Bank of Montreal, Toronto-Dominion and Royal report quarterly results the week of Aug. 21.

Analysts expect per-share earnings, before items, of C$1.20 for BMO, C$1.16 for TD and 85 Canadian cents for Royal, according to Reuters Estimates.

Bank of Nova Scotia , National Bank of Canada and Canadian Imperial Bank of Commerce will follow in the week of Aug. 28.

The mean analyst estimates are 87 Canadian cents a share for Scotiabank, C$1.24 for National, and C$1.60 for CIBC, according to Reuters Estimates.