The Canadian banking industry’s core earnings are strong and should be able to absorb rising credit costs in the near term, but earnings growth will be relatively modest over the next year, says DBRS Ltd.

The rating agency says that core earnings, defined as revenue less operating expenses but before loan loss provisions and taxes, are the first line of defence against loan loss provisions. “During this period of the credit cycle, considerable attention is paid to core earnings and the extent to which these levels are able to absorb increasing credit costs,” it notes.

The industry’s core earnings have been able to weather many previous negative events since the early 1990s, DBRS says, and it currently expects that “the Canadian banking industry’s aggregate credit costs will remain manageable relative to earnings. “

At the same time, DBRS anticipates that the growth of core earnings “will be relatively modest over the next year in light of a weak domestic economy impacting retail businesses and consumer borrowing, as well as lower levels of interest rates.” Additionally, it says that the growth in corporate lending is likely to moderate as funding opportunities in the capital markets increase for many corporations.

“With the uncertainty and volatility in the capital markets abating from the highs of the early part of fiscal 2009, it will be challenging to replicate the levels of trading revenue. Structured credit losses may persist as de-leveraging of financial institutions and hedge funds continues,” it adds.

Loan loss provisions have been steadily rising over the past two years, and DBRS expects this to continue in all segments of the loan portfolio over the next year. DBRS continues to expect further increases from the U.S. loan portfolios and more pronounced losses from the domestic portfolio due to the effects of a weak Canadian economy. Even if the economy stabilizes, DBRS expects loan loss provisions to rise in the near term.

IE