Big banks set to reveal quarterly profits as NAFTA fears and rate hikes loom

The big Canadian banks are set to reveal their quarterly earnings over the next week, and investors will take a close look to see whether anxiety over higher interest rates and an uncertain trade environment are hurting the economy's prospects.

After all, beneath their staid and boring surface, the five big banks are the churning engine of the Canadian economy, managing loans and investments for consumers, and loaning out money for businesses to expand.

They're also inexorably linked to the housing market, a topic that is sure to be closely parsed when Royal Bank is first out of the gate with its numbersWednesday morning.

The Bank of Canada has hiked its benchmark interest rate four times since last summer, a trend the big banks havepassed on to their customers.

More rate hikes are expected, and in theory, higher rates are good news for banks they get to charge customers higher interest rates for loaning them money.

But that's only true if tighter lending conditions don't make it harder for themto drum up new business.

Currently, the five biggest banks dominate the Canadian mortgage market, providing nearly two-thirds ofmortgages.

But even the banks know that dominance can't lastforever. New tighter mortgage standards announced late last year are likely to slow new mortgage business at the banks between five and 12 per cent this year, Bloombergbanking analyst Paul Gulberg says.

Rather than struggling to look for new business in already overfishedwaters, Gulberg says the banks are likely to concede groundto alternative lenders.

"Banks will likely maintain their credit-quality standards and let mortgage loans decline," he said.

Sticking with rock-solid, safe borrowers is likely to cut down on losses, but it will cost the banks in terms of growth.

And the new mortgage rules could present an even bigger problem for the banks next quarter, because when they were announced last fall, there was a rush of people who tried to buy under the old, more lenient rules.

And that glut is going to make annual comparisons look worse when fall comes around.

"As this phenomenon fades, we are expecting to see a sharp drop-off in origination volumes in the second half," said Gabriel Dechaine, an analyst with National Bank of Canada.

Trade uncertainty

But the housing market isn't the only dark cloud on the horizon. Uncertainty over trade relationships has loomed large for Canadian businesses this year, and investors will search the banks'results for any sign of an impact.

To be clear, there's little chance trade uncertainty is making a material dent in the banks' profits right now. Loan delinquencies remain low, and the banks are all forecasting slow and steady growth in their profits, barring something unexpected.

Something like, say, the death of NAFTA, which, if it happens, would throw their best-laidbusiness plans for a loop.

Strictly speaking, the banks don't loan a lot of money to the industries likely to be hardest hit by the end of NAFTA, such as cars and car parts, oil and gas, andmachinery and equipment. Gulbergcalculates those industries each make up, at most, three per cent of the big banks' loan books.

But at the very least, the end ofNAFTAwould hit the loonie hard, which would hurt the banks' profitability.And the end of a 30-year trade agreement would be a psychological shock to Canada's economy.

Beyond the psychological risks, it's not hard to imagine how tariffs on Canadian goods would lead to less demand for Canadian products which filters down to the banks that loaned those exporters money.

So while he's not expecting any nasty surprises on the trade front this time around,Toronto-Dominion Bank analyst MarioMendoncasays the longer trade uncertainties fester, the worse the impact is likely to be down the line.

"We believe that the uncertainty created by shifting geopolitical allegiances and, perhaps as importantly, Canada's trading relationships, raises the spectreof higher consumer credit losses in the next 12-24 months," he said.

If NAFTAdoes meet its demise, Gulberg calculates that Royal Bank and TD would likely fare the best, since they are more active in the U.S. and lessdependent on Canada's economy. Scotiabank, meanwhile, would be hit hardest because the bank has many dealings in Mexico.

While there may be dark clouds on the horizon, for now at least, analysts are almost unanimous in their view that the banks are all likely to post higher profits.

CIBC releases its resultsThursday, followed by the Bank of Nova Scotia and Bank of Montreal next Tuesday, and Toronto-Dominion Bank next Thursday.

On average,Mendoncaexpects earnings per share to increase at the big banksby nine per cent compared to what they were a year ago. And he's expecting a small dividend hike fromScotiabank, Royal andBMOthis quarter.