Consumer debt could be drag on banks

John Greenwood, Financial Post

Last year Canadian banks emerged as global heroes after they made it through the financial crisis almost unscathed.

But if the financial meltdown was the defining challenge for 2009, analysts worry that ballooning debt levels may end up being the comparable trial for 2010 as consumers struggle to meet their obligations amid an uncertain economy and rising interest rates.

We'll find out what the big banks think as Canadian Imperial Bank of Commerce and National Bank of Canada kick off the bank earnings season on Thursday.

According to a recent report by Moody's Canada, Canadian household debt climbed to a record 145% of income, from around 95% 20 years ago, and could exceed U.S. levels in the next three years.

Meanwhile, a task force on financial literacy sponsored by the federal government found that more than a third of Canadians are struggling to keep track of their finances and make responsible decisions.

Analysts are watching closely because most of that debt, including nearly $446-billion of mortgages and $336-billion of credit cards and other loans, is held by the banks.

The good news for investors is that the riskiest mortgage debt is insured through the Canada Mortgage and Housing Corp.

Mario Mendonca, an analyst at Genuity Capital Markets, said he's not "overly concerned" by the high level of consumer debt, pointing out that Canadians tend to be conservative with their finances and try to meet their obligations even if they get into trouble.

With most economists predicting healthier economic growth in 2010 and 2011, unemployment should not prove a major headwind meaning that the banks' consumer loans are safe despite the high level of indebtedness, according to Mr. Mendonca.

He's calling for a provisions for credit losses to start to decline noticeably in the second half of the year as revenue from underwriting and advisory services pick up amid a strengthening economy.

"We view the next few quarters as a transition period," he said in a research note last week,

Barclays Capital analyst John Aiken is also optimistic on the debt front, pointing out in a recent note that "all signs point to improving credit quality and lower provisions."

Given recent positive signs in credit markets in Canada and the United States, Mr. Aiken said "it is quite possible" that the domestic banks will set aside less than they did last quarter to cover delinquencies.

Mr. Aiken's main area of concern is revenues from trading operations. A source of eye-popping profits last year as banks took advantage of wider spreads and the dislocation in credit markets, trading revenue at all the banks is expected to shrink in 2010 as financial markets continue to normalize.

"We believe that a significant decline in trading revenues could be the story of the quarter and reset earnings levels for 2010," he said in a note to clients.

Still, much depends on the economy which remains fragile as Ottawa looks for ways to withdraw supports put in place in the wake of the financial crisis.

"There is a fair degree of uncertainty," said Lindsay Gordon, chief executive of HSBC Bank Canada, who pointed out that while the Canadian economy appears in good shape relative to other countries, the world is increasingly connected and it was less than a year ago that storm gripping financial markets created almost "a sense of Armageddon."

"All governments including the Canadian government are in a challenging situation," he said in an interview.

Though a small player in this country HSBC has significant exposure to residential mortgages in Vancouver and other urban markets.

"There is no question that over the last year there has been an increase in delinquencies in residential mortgages at all the banks," he said, adding that the increase at HSBC has been slight.


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