Banks remain profitable but outlook lacks optimism

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Canada's Big Banks have emerged unscathed from the collapse in oil prices and won plaudits for raising their dividends during the quarterly reporting season, but they have not inspired much optimism for the rest of the year.

Bank chief executives called the operating environment challenging, with low interest rates and a slowing domestic economy holding back growth.

But some observers believe difficult conditions will persist through the remainder of 2015.

"I'm not surprised at what's happening, and I think subsequent quarters will get worse," said Terry Shaunessy, a portfolio manager at Shaunessy Investment Counsel and a former bank analyst at Merrill Lynch.

The banks entered earnings season with low expectations, driven by uncertainty over how they would navigate through the current economic environment.

They soothed rattled nerves with earnings that, in some cases, showed modest growth.

Depressed oil prices haven't affected their energy-related loan portfolios and lower short-term and longer-term interest rates haven't put a significant dent into their interest income.

Bank of Nova Scotia's first-quarter results fit into the trend. On Tuesday, the bank concluded the reporting season for the Big Six banks with net earnings that rose to $1.73-billion, up just 1 per cent from last year.

On a per-share basis, earnings rose 2 per cent to $1.35, or $1.36 a share after taking some extraordinary items into account, slightly missing analysts' expectations.

The bank boosted its quarterly dividend to 68 cents a share, up 2 cents.

"Over all, it was a small miss and performance at the operating segment level was at best okay this quarter," said Robert Sedran, an analyst at CIBC World Markets, in a note.

Scotiabank, like its peers, sees better days ahead. Sean McGuckin, the bank's chief financial officer, believes that loan growth in Latin America will rise by double-digits and margin headwinds will ease following a number of central bank rate cuts.

"We're excited about the second half of the year for international banking," Mr. McGuckin said, adding that the bank's Canadian operations, as well, should benefit from improving commercial lending and growth in its credit card portfolio.

Other banks argued that low energy prices and a weaker Canadian dollar would help drive the manufacturing sector, boosting economic performance in central Canada.

However, the stock market hasn't embraced this level of cautious optimism. Although the S&P/TSX commercial bank index has recovered from 12-month lows in February, it fell 1.2 per cent on Tuesday and remains more than 8 per cent below its highs in September.

The skepticism appears to be flowing from the belief that the banks' first quarter results are not sending an all-clear signal on some of the thornier issues still outstanding.

In particular, low oil prices continue to threaten the Canadian economy, which slowed to 2.4 per cent growth in the fourth quarter at an annualized pace and is expected to slow even further over the next year.

Fitch Ratings noted that provisions for credit losses related to the banks' exposure to oil were close to zero in the first quarter.

However, "the more significant risk of lower oil prices is from the second-order impacts of potentially higher unemployment rates or losses on lending commitments for businesses and projects supporting the oil industry," the credit rating agency said in a note.

The Canadian real estate market also looks uncertain, given the economic outlook and the high level of indebtedness among Canadians, which could affect the banks' loan volumes.

"The degree of severity in the property market will depend upon how frightened the banks, as a group, get," Mr. Shaunessy said. "If they start to get worried about asset values and they start to rein in credit, they'll make the situation much worse."

In conference calls with analysts, all the banks noted that their stress tests are incorporating gloomy downside scenarios of ongoing cheap oil prices, significantly higher unemployment rates and double-digit house price corrections.

The results of those tests, they said, show that the banks would remain profitable if the economy gets significantly worse. But they won't be thriving, either.