Have Canadian Banks Reached Their Earning Peak for the Current Cycle?

Canada’s largest lenders have been under investor scrutiny for the past many years. Their prime concern has been the quality of their credit after a decade, which saw an unprecedented boom in personal loans led by home mortgages.

Two of the five top banks in Canada reported their latest quarterly earnings today, showing some signs that their profitability may have peaked for the current cycle as they get ready to absorb higher losses on loans, following interest rate hikes by the central banks in North America.

Toronto-Dominion Bank (TSX: TD)(NYSE: TD), the nation’s largest lender, reported fiscal first-quarter net income that rose 2.4% from a year earlier to $2.41 billion, or $1.27 a share. Adjusted per-share earnings totaled $1.57, missing the $1.71 consensus estimate by analysts.

The smallest among the five, Canadian Imperial Bank of Commerce (TSX: CM)(NYSE: CM), also reported its first-quarter earnings today, showing net profit fell 11% to $1.18 billion, or $2.60 a share. Adjusted per-share earnings rose to $3.01, missing the $3.09 average estimate by analysts.

The lower-than-expected profit by these two lenders was coincided by more provisions for bad loans that banks set aside to cover defaults. Such provisions for TD rose 23%, and for CIBC that amount more than doubled.

Despite earnings slowing down, TD raised its dividend by 7% to $0.74 a share, while CIBC hiked its payout by $0.04 to $1.40 a share.

Cooling real estate markets

Though lenders in their post-earning commentary tried to downplay this surge in provisions, blaming seasonal factors, many analysts relate these hikes to Canada’s slowing real estate market to which Canadian lenders are highly exposed. Home sales in the nation’s two largest cities — Toronto and Vancouver — have been falling for the past two years after the government implemented tighter mortgage regulations, raising fears that they will ultimately hit bank earnings.

Despite these concerns, I don’t think investors should panic and hit the sell button on Canadian banking stocks. My optimism on Canadian top banks comes from the quality of their balance sheets, their diversified revenue base, and still a strong North American economy.

Though you never know when the economic cycle is about to turn, these lenders are well positioned to weather any economic downturns. With their payouts growing each year, investors have the incentive to remain invested, as these lenders usually recover strong from any pullback strongly.

Bottom line

Canadian banks may have seen the peak of their earnings in the current economic cycle, but any pullback in their share prices should be a buying opportunity for long-term investors whose investing aim is to earn growing income.