Bank-owned dealers expecting to post soft quarterly financials

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After a couple of strong quarters, Canada's big banks are expected to post declines in capital markets revenue in the fiscal third quarter.

Blame that on waning volatility over the past few months, which is expected to weigh on trading revenue, and a seasonal slowdown which often crops up this time of year.

"We are forecasting a softer quarter for capital markets. Our earnings estimates imply a 6 per cent year-over-year decline," wrote Darko Mihelic, analyst with RBC Dominion Securities Inc., in a recent note to clients previewing the upcoming quarterly financials for the big banks.

Royal Bank of Canada kicks off earnings season on Aug. 23 when it reports results for the three months that ended on July 31. The other members of the big-five cohort report over the week or so afterward.

The expected slowdown comes after a period of outperformance for Canadian bank-owned dealers.

"Strong capital markets results have been a feature of recent quarters, most notably in [the first quarter], which benefited from volatility surrounding the U.S. election," wrote Robert Sedran, analyst with CIBC World Markets Inc., in a note.

"Recently reported results at U.S. banks showed a slowdown in activity, primarily in fixed income, currency and commodity trading (FICC) owing to low levels of volatility in most asset classes," Mr. Sedran added.

Goldman Sachs Group Inc., for example, saw its revenue from FICC fall 40 per cent year-over-year for the quarter that ended on June 30.

Heightened market volatility is a key catalyst that impels investors to trade. But when it's low, as it was during the fiscal third quarter, investors generally feel comfortable holding on to their positions, thus generating less revenue for brokerages. The average level of the CBOE Market Volatility index, the so-called "fear index" which measures stock-market volatility, was down by roughly 25 per cent during the period.

Gabriel Dechaine, an analyst with National Bank Financial, predicts that Royal Bank of Canada, which has the largest trading operation and largest global footprint of any of the Canadian banks, will see its trading revenue fall by nearly 15 per cent year-over-year.

One mitigating factor for Canadian banks (as opposed to their U.S. counterparts), is that their results include July, a month which saw some increased volatility. And domestically, trading in currencies and government bonds was frisky ahead of the Bank of Canada hiking interest rates for the first time in seven years in July.

On the underwriting and advisory front, weakness is also expected for the big banks with mergers-and-acquisitions deal volume down in the quarter. Mr. Sedran predicts that Bank of Nova Scotia will see revenue in that segment drop by 26 per cent year-over-year and National Bank should post an 18-per-cent decline. One bright spot is expected to be revenue from underwriting debt financings which were up 8 per cent compared with the same quarter last year.

Also working against the Canadian banks this quarter, as it typically does this time every year, is seasonality.

"Our retrospective look at capital markets revenues over the past seven years suggests that Q3 is a generally weaker quarter," wrote Barclays analyst John Aiken, in a note. "Analysis indicates the banks have experienced quarterly declines in five out of the past seven Q3 periods."