Our love affair with debt keeps Canada’s banks on top

Bloomberg Canadian banks lived up to their reputation for cranking out profits even in brutal conditions today — and they have Canadians' appetite for debt to thank. But for how long?

TORONTO • Canada’s banks have a well-deserved reputation for cranking out profits even under brutal conditions, and given the positive results from the start of third-quarter earnings season the halo isn’t going away any time soon.

Bank of Montreal and Bank of Nova Scotia both came out ahead of analyst expectations and just to reinforce the warm, fuzzy feeling among investors, they boosted their dividends.

It’s almost as if the gloomy headlines of the past several quarters around mounting consumer debt in Canada and darkening storm clouds over Europe and China didn’t happen.

One reason the banks are having an easy time compared to many of their international peers is because of the resilience of the Canadian economy, which has managed to avoid much of the turmoil buffeting other regions.

At the end of the day these are not companies that should be growing at double digits, they should be in the mid single digits

Another reason is the domestic consumer’s appetite for debt, especially mortgages. Despite lacklustre borrowing by businesses and volatile capital markets revenue, the Canadian banks have managed to meet or exceed Street expectations over the past year, and that’s happened largely on the strength of consumer loan volumes, primarily home loans. Tuesday’s results bear that out.

BMO posted adjusted cash earnings, or profit excluding one-time items, of $1.49 a share, compared to the consensus estimate of about $1.38. The country’s fourth-biggest bank has been aggressively expanding its U.S. operation but its biggest earnings driver remains the domestic personal and commercial loan business, which contributed $453-million to the bottom line, up 2.4% from last year on the back of higher consumer volumes that were only partly offset by shrinking net interest margin.

Scotiabank had adjusted cash profit of $1.22 a share, beating the Street’s estimate of $1.19. (The results included a $614-million gain, or 53¢ a share, on the sale of the bank’s Toronto headquarters.)

Domestic banking, the biggest earnings driver, had a profit of $521-million, up 22% from last year on higher loan volumes, lower provisions for credit losses and a gain on the sale of a leasing business.

BMO raised its dividend on the common shares by 2¢ to 72¢, while Scotiabank boosted its payout a similar amount to 57¢.

But there are already signs the earnings strength from domestic operations can’t go on for ever. Loan volumes across the sector has slowed sharply from more than 9% in recent years as households start to respond to warnings by policy makers such as Bank of Canada Governor Mark Carney to pay down debt.

The trend is hitting all the big banks. To avoid potential trouble down the road, investors should find a way to replace those declining revenues, and analysts are scrutinizing bank results closely for signs that’s happening.

On that front the picture is mixed so far.

Barclays Capital analyst John Aiken said in a note to clients that while Bank of Nova Scotia came in above expectations, the markets will likely show more interest in the international division which operates in more than 40 countries including in Latin America and Asia. Unfortunately, earnings and loan growth there “were essentially flat,” according to Mr. Aiken.

For its part, Bank of Montreal managed to meet expectations for its U.S. operation — which significantly increased in size last year following the acquisition of Wisconsin-based Marshall & Ilsley — while growing profits in capital markets and wealth management.

One school of thought has it that the days of double-digit profit growth for Canadian banks are over now that the explosion in credit that has taken place over the past decade or so is coming to and end.

The big question is what happens to all the accumulated debt — including more than $1.1-trillion of residential mortgages — that has built up. Many analysts predict that given slow but stable economic growth and low interest rates for the foreseeable future, it will gradually get paid off, enabling the banks to maintain modest profitability at their domestic operations.

“We are expecting things to slow down but not reverse,” said Rob Sedran, an analyst at CIBC World Markets. “At the end of the day these are not companies that should be growing at double digits, they should be in the mid single digits. I don’t know that I want aggressive growth, because beyond a certain level you’re just adding risk. I think normalized growth is a healthy thing.”