And
it’s all Mark Carney’s fault. The Bank of Canada governor’s obsession with aggressively
low interest rate policies and his get-tough message on climbing household debt
are really putting a crimp in the historically predictable and reliable sources
of income the big banks have enjoyed at home.
The
two engines that have fuelled strong earnings momentum during the global
economic turmoil— growth in consumer credit and residential mortgages — are
stalling.
All
six of the majors — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova
Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank
— are said to be feeling the squeeze.
To
pick up the imminent slack, they’re being forced to look outside the country to
boost their balance sheets in 2013. Except the problem is that it isn’t a whole
lot rosier out there either, which is why the mighty financial institutions
will likely see their credit ratings lowered a notch next week by Moody’s
Investors Service Inc.
Basically,
the rating agency is concerned about the banks’ exposure to record high levels
of consumer debt and elevated house prices, which has made them more vulnerable
to the downside risks than they have been of late.
The
big red flag is that current Canadian household debt resembles rates in the
United States before the housing market tanked in 2008. According to Statistics
Canada, the ratio of household debt-to-income in this country reached 163.4% in
the second quarter of 2012, up from 161.8% in the first three months of last
year.
The trend continued in the third quarter of 2012, showing Canadian
households owed $1.65 on average for every after-tax dollar they earn.
Compare
that to the U.S., where household debt-to-income at the height of the housing
bubble in 2007 was 170%.
This
is causing considerable angst because a shock to the Canadian economy will inevitably
reverberate on bank balance sheets.
Already,
bank retail margins are under pressure. Consumer lending is falling; 5.1% in
November, 2012, from 5.8% during the same month in 2011.
At
the same time, a series of initiatives to tighten mortgage requirements has had
a cooling effect as the resale of homes in Canada fell 17% in December from
2011. The end of the boom in residential mortgages has a double whammy effect
on banks because that revenue stream helped cushion the blow of slimmer margins
on loans and shrinking revenues courtesy of persistently low interest rates.
Stalling
income growth at home means the banks have to find other ways to shore up their
balance sheets. Obviously, that means focusing on their operations outside
Canada. Except for Scotia, which has carved a unique presence in Latin America
and risky developing markets where the margins are wide, the focus for the rest
will likely be in the U.S. For RBC, that means trying to capitalize on the
exodus of European players in capital markets and wealth management. TD and BMO
will continue to scratch out a presence in the lucrative and hugely competitive
U.S. regional banking sector.
Nonetheless,
the challenge on the home front will be keeping expenses at, or below,
diminishing revenues. In order to maintain a competitive position in Canada,
the banks have to make major investments to their retail banking
infrastructures, while at the same time, making sure expenses don’t get ahead
of income growth.
The
bottom line: expect bank earnings to be stunted this year, with predictions of
industry revenue growth in personal and commercial banking to be a paltry 1%.
That translates into estimated earnings per-share growth to be in the 5% range
this year — hardly the end of the world, but still below 10% from 2012.
Even
so, the trends may be going in the wrong direction, but much of the
balance-sheet consequences will be played out at the margins. It may be harder
to make the kinds of heady returns bank shareholders have enjoyed in recent
years, but in Canada banking will always be a profitable proposition. So chin
up, no matter what Moody’s says.
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