08/30/2012 01:58 EDT | Updated 10/30/2012 05:12 EDT

Big banks dish out dividend gold rush as profits soar

It's been a surprisingly good week for shareholders of Canada's five biggest banks.

All reported higher third-quarter profits — up 45 per cent from the same quarter last year — as they collectively reported net income of $7.8 billion. The profits were so healthy that they all soared past estimates from analysts – number crunchers who do nothing but follow the sector.

A good week, too, because all five also boosted their quarterly dividends. In BMO’s case, it was the first dividend boost in five years. People who follow the banking industry were trying to remember the last time all five boosted dividends at the same time.

The surprise in all the bank earnings announcements this week comes from the unexpected juxtaposition of surging profits and boosted dividends at a time when the entire banking industry is supposed to be facing a “tough operating environment,” as TD’s chief executive Ed Clark put it.

Banks supposedly don’t like rock-bottom interest rates. Too hard to make money. They don’t like it when consumers start to scale back their demands for credit, which they appear to be. We’re starting to see signs of a cooling housing market, where Canada’s banks hold millions of mortgages. Margins in some cases have been shrinking. The growth in the economy can best be described as modest. They all have exposure to the U.S. market, where conditions remain challenging.

Confidence amid caution

Yet here we have banks boosting dividend payouts – an indication that the banks expect their businesses to remain relatively stable and just as profitable. After all, banks are loath to cut their dividends, even amid bad times. None of the big five banks has cut a dividend since the Second World War.

So where is all this confidence coming from? Let's look at where the profits came from.

In a couple of cases, the profit increases were in part due to one-off events. Scotiabank, for example, made more than $600 million from the sale of its corporate headquarters earlier this year. Royal Bank got a big tax refund.

But even after stripping out the one-time items, the banks are performing well. Their domestic retail operations are, by and large, money machines. Consumer lending is still growing, if not at the same pace as two years ago. Their mortgage business remains healthy, as has commercial banking. Several banks also reported stronger capital markets profits. Growth may be slowing overall. But, so far at least, it’s still growth.

They’ve also trimmed costs, squeezing more efficiency out of their operations. The banks are also making money from some of their recent foreign acquisitions.

In some cases, they’ve also boosted those much-hated fees and service charges. But there's no sign that surging profits will result in lower fees. That has one consumer lobby group looking for more accountability.

"We're concerned that these large profits are a result of dollars being taken taken out of Canadians' pockets, which doesn't deserve to be done," says Tyler Sommers of the Canadian Community Reinvestment Coalition.

"That's the reason we're calling on the federal government to implement annual audits to ensure Candians aren't being gouged, that service charges are fair," he told CBC News.

Going forward, the banks are trying to further grow their businesses by increasing market share and growing through acquisition — most recently showcased by Scotiabank's news Wednesday that it would buy ING Bank of Canada for $3.1 billion.

Analysts see 'headwinds'

But market analysts question whether this week's big profit figures are sustainable through what could be a bumpy environment ahead, saying Canada's banks face the prospect of slower growth in some of their core businesses.

Barclays banking analyst John Aiken predicted that Royal and CIBC, for instance, would face "headwinds" in their domestic retail operations.

A similar sentiment came from National Bank Financial analyst Peter Routledge.

"Earnings from Canada face a lot of headwinds," he told The Canadian Press. "I think people are starting to pull back on how much they borrow from banks, but nonetheless it certainly didn't start this quarter."

Brad Smith, an analyst at Stonecap Securities, warned that TD could be hit by rising costs.

"While revenues held well in domestic banking, they are continuing to be increasingly crowded by expense escalations," he wrote in a client note.

Danielle Park, a portfolio manager at Venable Park Investment Counsel, says it's only a matter of time before the financial turmoil in the U.S. and Europe spreads to an over-stretched Canadian economy — with dire consequences for Canadian bank shares.

"When you look at the domestic economy, how over-levered the Canadian retail market is ... to housing which is off-the-chart over-valued, I think that the Canadian banks are vulnerable to this incoming global recession," she told the CBC's Mike Hornbrook.

So there are clearly caveats amidst the bankers' bravado.

Market conditions may be "uncertain," as Royal's CEO Gord Nixon acknowledged Thursday. But judging by the tone of their earnings reports this week —and their dividend hikes — the big banks are all saying that they think they're well-positioned for long-term growth and will still be spewing profits.