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Report On Business After a record run of profits, Canada’s Big Six banks brace for shift

The Big Six banks report their fourth-quarter earnings this week, starting with Bank of Montreal on Tuesday.

Michelle Siu/THE CANADIAN PRESS

Canadian banks' record run of profits is finally showing signs of cooling as the number of high growth businesses dwindles, prompting the country's largest lenders to prepare for a much more challenging year ahead.

The Big Six banks report their fourth-quarter earnings this week, starting with Bank of Montreal on Tuesday.

Expectations for profits are encouraging, driven by capital markets activity that should cap off a phenomenal year.

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But the focus has already shifted to what lies in the near future, where revenue growth will be tougher to generate, making cost cutting a major concern.

After a wild string of profits sent bank shares soaring over the fiscal year that ended in October, "we expect the outlook from management in regards to 2015 will focus more on 'defence (expenses, capital) than 'offence' (revenue growth)," Scotia Capital analyst Sumit Malhotra wrote in a recent note to clients.

Already there are signs that the banks are clamping down. In early November, Bank of Nova Scotia announced plans to slash 1,500 jobs in Canada and abroad after incurring $451-million in one-time charges.

A few weeks later, Royal Bank of Canada announced plans to refocus its wealth management arm by parting ways with its Caribbean business and launching a strategic review of its RBC Suisse operation.

To many, the changes can seem egregious because the banks have reported enormous profits. Over the first nine months of the fiscal year, the collective Big Six bank profit totalled $25-billion.

But the lenders have been warning about a challenging market for some time, and in many cases, were simply surprised by a sudden jump in capital markets earnings and wealth management fees over the past few quarters. More than anything, Canadian banks are susceptible to interest rates, which keep falling, hurting lending margins.

Since the financial crisis ended, banks have benefited from low rates because they prompted a lending boom, particularly for residential mortgages. But many Canadians are now chock full of debt and can't afford to take on any more.

"Our biggest issue continues to be the moderating pace of domestic lending led by personal lending," Macquarie Capital Markets Canada analyst Jason Bilodeau wrote in a note to clients.

"Market expectations have been coming down throughout the year and management commentary is incrementally more cautious in our view. However, we still see the risks as tilted to the downside as housing activity slows and households continue to delever – potentially for an extended period."

The banks do have ways to counteract this slowdown. Commercial lending, for one, has stayed hot, and banks' business models are diversified, so they bring in revenues everywhere from credit card transaction fees to capital markets.

However, for all the hope about profits from commercial lending, the banks have hurt their margins here because they all piled in and cut loan prices to win over clients.

The recent nosedive in oil prices also has investors on edge (hurting wealth management), and has the power to cause commodity deals to dry up for the time being.

Scotia Capital's Mr. Malhotra now expects only a 4-per-cent jump in share profit across the sector in 2015 – roughly half the growth the banks have exhibited in recent years. If the prediction proves correct, it will affect how quickly the banks can raise their dividends.

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However, there is a chance that the fears of an imminent slowdown are overblown.

Over the past few years, everyone from analysts to bank executives has been wrong about the timing of a cooling off.

Toronto-Dominion Bank, for one, had been the most vocal about a potential earnings slowdown over the last fiscal year, but ultimately upgraded its predictions halfway through the year because the short-term outlook looked so appealing.

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