Canada banks face storm clouds after good quarter

Thu Sep 1, 2011 3:49pm EDT

* Canada bank profits surprisingly strong in Q3

* Loan growth seen drying up

By Cameron French

TORONTO, Sept 1 (Reuters) - Gloomier times are ahead for Canada's resilient banks, which stayed strong through the financial crisis and beyond and which largely beat analysts' expectations with their third-quarter results.

The banks impressed investors with strong loan growth and wealth management revenue in their most recent results [ID:nN1E78013D]. But analysts expect narrow lending margins and increased caution by already overstretched borrowers to weigh on earnings growth in the months ahead.

"The next four quarters will not be as powerful as the last four quarters for the sector," said CIBC World Markets analyst Robert Sedran.

Canada's banking sector is dominated by a half dozen big banks which are both protected from foreign takeovers and prevented from merging with each other. They generate billions in profits from their domestic branch-bank businesses and required no bailouts during the 2008-09 crisis.

Analysts had expected weaker loan growth to start to bite in the third quarter, which ended on July 31. But it rarely pays to bet against Canada's banks, and the lenders surprised with strong performances in their Canadian and U.S. retail operations.

Toronto-Dominion Bank (TD.TO) -- which owns vast branch networks in both Canada and the United States -- capped off reporting period for the big banks with a better than expected profit on Thursday. [ID:nN1E77U1CO]

It earned C$1.72 a share profit, compared with analysts' estimates of a C$1.62 a share profit, and net profit rose 23 percent to C$1.45 billion ($1.48 billion).

BORROWING TO DRY UP

But Canada's No. 2 lender said earnings growth should moderate in coming quarters due to slower loan volume growth and margin pressure. "Obviously there's a lot of uncertainly given what's going on in the world," said Chief Financial Officer Colleen Johnston.

Europe's banks are in the grip of a debt crisis, while U.S. banks are selling assets to build up capital.

Even Canada, which has ridden a strong housing sector to a relatively even-keel economic performance over the past two years, experienced an unexpected economic contraction in the second quarter, data this week showed.

Through it all, Canadians have kept borrowing, enticed by rock bottom interest rates that have proven a double-edged sword for the banks.

Profits from strong loan growth is partially offset by the low rates charged. With central banks in Canada and the United States both seen holding rates low fore the foreseeable future, margins are expected to continue to narrow.

And with Canadians carrying record debt, observers say mortgage and credit card lending growth will likely stall and business lending may not make up the shortfall.

"Most banks are talking lower levels of loan growth as we go through the rest of the year," said Juliette John, a portfolio manager at Bissett Investment Management in Calgary.

The results this quarter have helped drive Canadian financial stocks up by more than 7 percent since reporting began, against a 5.8 percent rise for the broader market.

Along with TD, Bank of Montreal (BMO.TO), Bank of Nova Scotia (BNS.TO), Canadian Imperial Bank of Commerce (CM.TO) and National Bank of Canada (NA.TO) all topped analysts' estimates.

Royal Bank of Canada (RY.TO), the country's biggest lender, was the only one to miss estimates, as market volatility hit its proportionally large capital markets division.

That's the weaker trend that many observers had expected to take hold in the current earnings period.

"I hadn't expected too much (profit) this quarter, so I may have been one quarter too early," said John Kinsey, a portfolio manager at Caldwell Securities in Toronto. ($1=$0.98 Canadian) (Reporting by Cameron French; editing by Janet Guttsman)

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