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Slow growth the new normal for Canada's banks

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Investors must adjust to a new slow-growth reality for Canadian banks, according to many analysts.

Canadian banks are expected to report a slowdown in third-quarter profit growth next week, as they contend with leveraged consumers attempting to repair their balance sheets amid an uncertain global economy, the analysts say.

Though profits are likely to slow, the analysts predict a number of banks will likely reward investors with dividend hikes.

Earnings growth is expected to fall to 6 percent in the third quarter for the country's six largest banks, down from 9-percent second-quarter growth, according to Canaccord Genuity's Mario Mendonca.

"We expect domestic retail earnings growth to remain in mid-single digit territory for the remainder of 2012 and into 2013," he said in a note to clients. "Our estimates reflect low single digit revenue growth associated with weaker loan growth and lower margins, offset by lower expense growth and lower provisions for credit losses."

The biggest headwind facing the banks is figuring out how to boost profits when consumers are looking for ways to cut back on spending. Year-over-year growth in consumer credit fell to 2.8 percent in June, down sharply from the post-financial crisis high of 10.1 percent in April of 2010, according to data from the Bank of Canada.

"With Canadian consumers starting to show signs of fatigue, concerns over the housing market growing, and net interest margins continuing to be squeezed by record low interest rates that are unlikely to rise any time soon, the current macro environment is less than fertile ground for bank profit growth," says CIBC analyst Robert Sedran. "As such, we continue to model modest earnings growth assumptions for the large Canadian banks both for the remainder of this year and into 2013."

Many analysts say that the banks will start taking an axe to their costs in order to boost their bottom lines.

"As the top line continues to slow the spotlight on expense control only gets brighter," Sedran says. "We saw the same dynamic in United States this past quarter, and look for this issue to remain a key focus."

Canaccord's Mendonca agrees, adding that "improving efficiencies" will be one of the key methods of delivering mid-single digit earnings growth.

The money that banks make on the spread between what they pay to borrow money and the price they charge to loan it out – known as net interest margin (NIM) – is also expected to remain under pressure.

This week, ratings agency Fitch Ratings warned about a coming slowdown for the country's largest banks.

"Fitch expects high leverage levels in the Canadian household sector, driven by mortgage credit expansion and a frothy housing market, in addition to margin pressure and reduced capital markets-related earnings, to put greater pressure on the financial results of the Big Six over coming quarters," the agency said.

"We expect retail loan growth to decelerate in the second half of 2012 as the housing market cools and new regulations aimed at curbing residential lending take effect. Given the sheer size of the consumer loan book on Canadian banks' balance sheets, continued earnings improvement in commercial lending may not offset the slowdown on the retail side."

Investors though may benefit from dividend hikes, analysts say.

Both Sedran and Mendocca predict TD and CIBC are likely to raise their quarterly payouts. Desjardins Capital Market's Michael Goldberg says RBC and CIBC are most likely to hike their dividends, while the odds of a BMO dividend hike are about 50 percent.

Scotiabank and Bank of Montreal kick off bank earnings season on August 28.

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