Money in Canada's Banks

04/26/2010 12:01 am EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Canada's leading financials are reaping the benefits of prudent lending and a friendly government, writes Tom Slee in the Internet Wealth Builder.

This is shaping up as a banner year for Canadian banks. The recent federal budget was surprisingly kind to them. Prime Minister [Stephen] Harper, an unlikely ally, is vigorously defending them against demands for stricter regulations. And their first-quarter results were exceptional. Even the most optimistic analysts were surprised and for once the numbers were solid. All of the banks performed well, thanks to lower loan losses and impressive retail profits. Overall, the industry beat Street estimates by a startling 10% and at the same time increased its crucial Tier 1 capital ratio to 12.1%. No wonder banking executives are upbeat about their prospects!

The impressive earnings are good news for several reasons. For starters, this is the first broad-based proof that the Canadian recovery is well under way.

Equally encouraging was the fact that the Canadian banks have obviously steered clear of the US financial mess by building on their domestic operations. As recently as February, forecasters were suggesting that last year's gloomy results from major American financial institutions were bound to cloud Canadian credit and revenue growth.

The results were also important because our major banks are the Canadian commercial platform and account for more than 20% of the S&P/TSX Composite Index.  It's hard to imagine other sectors performing well in 2010 if the banks had turned in a dismal performance.

Moreover, the results have attracted attention south of the border. Analyst Craig Fehr at Edward Jones in St. Louis said "the first quarter (results) set the table for 2010...and allow the banks to focus on growth." Comments like that should attract buying from American investors unhappy with their own financial institutions.

Another plus is that the bankers themselves are more confident. Senior executives, such as Scotiabank (NYSE: BNS, Toronto: BNS) chief executive officer Rick Waugh, are speaking openly about acquisitions and new markets. Bank of Montreal (NYSE: BMO, Toronto: BMO) CEO Bill Downe said: "I think we've been out of the woods for six months." This is heady stuff coming from senior managers who a few months ago were still reluctant to call the bottom.

As to the first-quarter numbers themselves, total cash earnings were C$5.2 billion, up 68% from a year ago and 15% better than the previous quarter. At the same time, there was a significant improvement in asset quality. Loan-loss provisions of $2.1 billion were down 15% from the final quarter in 2009, as a result of strong risk management.

The consensus is that Canadian bank earnings are likely to grow [by] as much as 40% year over year in 2010, followed by a further 20% in 2011. We could see dividend increases late this year or even earlier if the second- and third-quarter results live up to expectations.

The federal budget on March 4th was especially good news for the banks. Nearly all of the experts were expecting [Finance Minister Jim] Flaherty to help reduce his large deficits with a new banking tax. After all, this sector is racking up relatively large profits, and Canada is under pressure to join other G20 countries in imposing a global levy on banks.

Instead, he followed through on a previous commitment to reduce the federal corporate tax rate to 15% by 2012. That should add about $1 billion, or 5%, to the banks' bottom lines two years from now. It's also going to give us a competitive international edge.

For the moment, therefore, the Canadian banks have a tailwind and are likely to outperform the market in 2010. TD Bank (NYSE: TD, Toronto: TD) in particular should continue to do well.

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