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No matter how gloomy the economic outlook, investors are accustomed to seeing Canadian banks churn out higher profits, quarter after quarter, year after year.
This time could be different.
Four out of the Big Five banks – all of them except Canadian Imperial Bank of Commerce – missed earnings projections in the latest quarter. While the misses were mostly narrow, and revenues and profits are still climbing, there are signs of strain as the factors driving the spectacular performance of Canada's dominant financial oligopoly begin to fade.
As my colleague Boyd Erman has pointed out, the dominant theme for the big banks this quarter was a sharp decline in revenue growth from Canadian consumer and business banking, to 3 per cent from 3.7 per cent a quarter earlier.
There's nothing to suggest an imminent pick-up. Banks are facing a rapidly cooling market for both consumer and business loans.
Consumer debt stands at 165 per cent of disposable income, more than 20 percentage points higher than it did in the United States at the pre-crisis peak. Already bloated with borrowing, Canadian households are unlikely to keep on piling up debt at the same pace as they have in recent years.
The housing market, which fuelled a seemingly insatiable appetite for mortgages in recent years, has cooled, and lenders now have to fight for a piece of the dwindling pool of prospective borrowers. Bank of Montreal's recent clash of wills with Finance Minister Jim Flaherty on bargain-basement mortgage rates smacked of – dare we say it? – desperation.
In the corporate world, demand for credit has also subsided as the expansion of mining capacity and the oil sands grinds to a halt.
Faced with a slowdown in their core lending operations, the major banks have turned to other businesses to meet profit targets. Profits from capital-markets trading dominated results for much of 2012, while wealth management – mutual funds, brokerages and other asset-management operations – was a key contributor to almost every bank's bottom line this quarter.
The problem is that commission revenue from operations like investment banking, bond trading and mutual-fund management is far less dependable than the profits from lending. A hot market for corporate debt can provide a big boost to earnings, then quickly fade. Investment banking revenue is even more volatile.
Banks' increasing reliance on wealth management is perhaps the biggest change in profit dynamics in the industry. Asset management is famously lucrative in periods of stable and rising markets, but can be a severe drag on earnings when markets head south. Assets under management – the basis for calculating fees – fall along with the market and client redemptions reduce profits further.
As the relative importance of basic lending declines, and riskier businesses have to pick up the slack, banks face increasing uncertainty. Their growth and their profits are likely to be far more volatile – "lumpy," in industry jargon – than they have been in the past.
Are Canadian investors prepared for lumpy returns from bank stocks? Much depends on how long you plan to hold these investments.
Looking a decade ahead, the Big Five banks will remain highly profitable entities. They are shielded from the full brunt of foreign competition by regulation and their extensive branch networks, and no one is going to challenge their dominant position in the Canadian economy.
In addition, the current dividend yield of the S&P/TSX bank index stands at 4.2 per cent, well above the overall benchmark's 3.0 per cent, which gives long-term investors an excellent reason to stick around.
But conditions are changing and the midterm may be less pleasant than the past decade has led investors to expect. Those unprepared to ride out some turbulence ahead may want to consider reducing their positions.
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Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB .