Banks and insurers could take a bit of a bruising in the coming quarters from the rapid ascension of the Canadian dollar.
"The recent surge in the [Canadian dollar]has been acute and will put some nearer-term earning pressure on the bank group," Scotia Capital Inc. analyst Kevin Choquette wrote in a note to clients yesterday.
The loonie has already risen 8 per cent since the end of the banks' second quarter, which was April 30, he noted.
If it remains at its current level, he estimates that Canadian banks' profits will take a 2.2-per-cent hit in the third quarter. The impact will vary bank by bank, with Bank of Nova Scotia feeling the most pain because of its large international operations.
Mr. Choquette trimmed his estimates for the banks yesterday, and downgraded Scotiabank to "sector perform" from "sector outperform."
His estimates assume that the banks are not hedging against the currency risk.
Toronto-Dominion Bank said yesterday that it does not actively hedge its exposure "because the potential impact to TD is so small."
TD's exposure to fluctuations in the exchange rate is estimated at about 1 cent of annual share earnings for each 1-cent change in the exchange rate, meaning that if the Canadian dollar appreciates from $1.15 to $1.14 per U.S. dollar, about 1 cent will be cut from share earnings, spokesman Nick Petter said in an e-mail.
Royal Bank of Canada said it does not hedge against its own exposure, while Bank of Montreal said it hedges its U.S. earnings one quarter forward.
On a conference call with analysts last month, Scotiabank chief financial officer Luc Vanneste said "obviously, a rise in the Canadian dollar for a bank that earns as much as we do, non-Canadian currency, is a head wind."
He added that "we hedge our foreign currency earnings to a degree ... but it's certainly not enough to offset the full effect."
At Genuity Capital Markets, analyst Mario Mendonca is not changing his bank earnings estimates, saying any reduction by a few pennies could be overshadowed by larger items such as trading revenue.
"Among the large-capitalization banks, we have found that only [Scotiabank's]earnings in the international segment can swing on significant changes in the value of the Canadian dollar," he wrote in a note to clients.
Mr. Mendonca did change his exchange rate model for insurers, to $1.06 (Canadian) for each U.S. dollar from $1.15.
"Over a full year, an 8-per-cent reduction in our currency input reduces our [Sun Life Financial]estimate by 2 to 3 per cent, approximately half the effect for Manulife," he wrote.
He estimates that about 30 to 35 per cent of Sun Life's earnings are denominated in U.S. dollars, compared with 60 to 65 per cent of Manulife's.
"We have found, however, that the Canadian insurers' earnings generally do not adjust [up or down]for the full effect implied by changes in currency," he wrote.