Canadian banks face a tough economic environment, but they do so on a much stronger foundation than many of their U.S. and European rivals, according to the latest research from Standard & Poor’s.

“Against the backdrop of recessionary conditions in the U.S., a weakening global economy, and a comparatively stronger- but-weakening Canadian economy, and with the expectation that these trends will persist through at least the second half of 2009, the Canadian banks enter 2009 in our view on a much stronger footing than their U.S. and European counterparts,” the credit rating agency says in a research note.

It says that the decline in the U.S. housing market and the resulting impact on structured products has strained a number of Canadian banks’ investment banking and U.S. retail operations, but that their domestic retail and commercial banking businesses remain strong, and represent “a solid underpinning of stable revenues and earnings growth in the long term.”

“There is no doubt that the Canadian banks are facing a more challenging business cycle with a slowing Canadian economy in concert with rising credit costs, costly funding, fewer loan originations, and sharply lower capital markets-related revenues to pressure profitability growth. Nevertheless, with what we view as substantially more robust balance sheets and capital positions and lower risk profiles, the banks’ foundation appears stronger than that of U.S. and European peers,” S&P says. At the same time, the firm says that the risk in the Canadian banks’ U.S. businesses is, “in our view increasing and the outlook for investment banking revenues is expected to remain shaky while wealth management is always at the mercy of the health of equity markets.”

“Although we expect retail earnings growth to slow due to moderating loan growth reflecting tight credit conditions and rising provisions, we expect the Canadian banks’ retail franchises, which we believe are solid, to remain the bulwark of their overall financial performance,” it adds.

Also, Canadian banks generally benefit from substantially stronger and more conservative balance sheets, it says, particularly compared to their U.S. counterparts. And, they boast relatively robust capital positions. “In our view, their ability to raise capital too is testimony to the weight that their conservative franchises carry, which reflects good business line diversification and strong consumer deposit platforms,” it says. “In general, we believe that the Canadian banks are well positioned to manage through a cyclical downturn. We expect provisions for loan losses to increase over the next year; however, we do not expect huge jumps as the Canadian banks’ credit quality remains generally good,” it concludes.

“Like elsewhere around the world, Canada’s banks are responding to extreme stresses and tightening credit conditions in the global capital markets, but based upon current information, we expect that the Canadian banks will retain their stable ratings outlooks in 2009, reflecting the domestic industry’s decent fundamental condition entering the new and challenging year,” S&P adds.

IE