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Canada’s Big Six facing headwinds ahead of first-quarter reports

Canada’s Big Six facing headwinds ahead of first-quarter reports

Posted by Juan Gavasa on February 23, 2015

As Canada’s Big Banks roll out first-quarter results this week, they will face a skeptical audience that is concerned about the impact of low interest rates, weak oil prices and a slowing domestic economy.

The good news: Expectations are down, giving banks an opportunity for clearing a low bar.

“Most years, having faith in the banks’ capacity to pull the levers necessary to generate good earnings growth is precisely the right approach,” said Mario Mendonca, an analyst at TD Securities, in a recent note. “This year [2015] does not feel like one of those years.”

The stock market is reflecting this sentiment. Bank stocks have lagged Canada’s benchmark index in a big way since the start of the year, marking their worst relative underperformance since the financial crisis in 2008.

After hitting a record high in September, the S&P/TSX commercial bank index fell as much as 15 per cent by the end of January.

The banks have recovered some lost ground in February, but are still trailing the benchmark S&P/TSX composite index by nearly 8 percentage points – offering a rare setback for names that gush cash and reward shareholders with hefty dividends.

What explains the setback? The short answer is that earnings growth is expected to slow.

Robert Sedran, an analyst at CIBC World Markets, estimates that earnings in the first quarter – usually a strong one for the banks – will rise just 3 per cent from the first quarter of last year. That’s down from 5.5-per-cent earnings growth in the fourth quarter, year-over-year.

Other analysts are making similar forecasts, based on the idea that the banks are facing a number of headwinds right now.

Crude oil prices, which have tumbled more than 50 per cent since the summer, get part of the blame. Although the banks’ direct exposure to the Canadian energy sector is small from a loan perspective, the downturn is weighing on investment banking activities as struggling energy firms shy away from initial public offerings and acquisitions.

Sumit Malhotra, an analyst at Bank of Nova Scotia, estimates that domestic underwriting fees for the Big Six banks fell about 40 per cent in the first quarter.

“This clearly has a negative impact on earnings power in the wholesale segment” – or services provided to large, institutional clients – “an important point to consider given that wholesale was the strongest business line for the sector in 2014,” Mr. Malhotra said in a note.

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