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Canadian banks enjoy strong earnings boosted by sizzling stock markets

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TORONTO - Red hot stock markets have helped generate big profits at Canadian banks this year, with nearly all of the country's largest lenders reporting record third-quarter results this week.

Canada's largest bank, Royal Bank (TSX:RY), kicked off the slew of bank earnings on Aug. 22, as it reported profits that grew by four per cent to $2.38 billion in its latest quarter, mainly due to a surge from its capital markets division.

Royal said profits from its capital markets climbed by 66 per cent year over year, earning $641 million on higher trading fees, more business from advising on takeovers and arranging stock sales.

In fact, this arm did so well that new president and CEO Dave McKay warned that the bank might even start reining in the division if profits continue to surpass Royal's internal target of making up more than 25 per cent of earnings. Capital markets contributed nearly 27 per cent of Royal's earnings in the most recent quarter.

It was a similar story at the other banks, which also mostly credited strong markets as the reason for their stellar earnings.

CIBC (TSX:CM) said its profits were up by five per cent this past quarter due to a strong performance from its wealth management division, which was propped up by higher commissions and the sales of mutual funds. The division earned a net income of $121 million, up $19 million, or 19 per cent, from the third quarter a year ago.

National Bank (TSX:NA) saw its profits from wealth management climb 31 per cent year over year, and its financial markets segment jump 21 per cent. The Montreal-based lender's trading was up 25 per cent while advisory fees jumped by 36 per cent in the quarter compared with a year ago.

TD Bank (TSX:TD) reported that its capital markets unit also generated more revenue in the third quarter due to advisory, underwriting, trading and faciliation services. It saw its revenue in its wholesale banking division, which includes capital markets, climb by $116 million or 21 per cent to $680 million the quarter.

"The increase in revenue included higher trading-related revenue, equity and debt underwriting volumes, and M&A fees that benefited from improved client activity and robust capital markets in the quarter," the bank said.

It has been a positive year for stock markets, with the Toronto Stock Exchange up about 14 per cent year to date. In the U.S., the Dow Jones is up about three per cent, the Nasdaq has gained more than nine per cent and the S&P 500 is ahead by more than eight per cent.

This has translated to more profits at capital markets divisions at banks, which benefit from underwriting and advisory fees that increase with investments.

Dan Werner, an equity analyst with Morningstar Inc., said the markets have created a perfect storm for underwriting fees because low rates have helped debt underwriting and high stock prices have helped with equities underwriting.

Wealth management operations have also seen their profits climb in good market conditions because the value of assets under management has gone up. The more assets there are, the more the banks will earn on a percentage of those asset values.

In general, the banks have done a good job at diversification, particularly emphasizing their personal and commercial unit, which will help shield them from the future volatility of the stock markets, Werner added.

"They will still generate a significant amount of profits," he said in an interview from Chicago.

"Is it going to be the record profits we've seen this quarter? Likely not, but are they still going to earn high return on equity, a double digit return on equity? I think that's likely in the near term because for most of the banks, Canadian personal and commercial banking segment is their bread and butter, a significant part of their net income and revenue. That segment is still going to do pretty well in the near term in terms of generating spread and generating profit."

Managing director and portfolio manager Patrick Blais of Manulife Asset Management said that although the majority of the banks met or exceeded analyst expectations on earnings, they were still perceived as "lesser quality" than the market had hoped.

"The reality is that the capital markets division is typically seen as more volatile and earnings derived from that division are less sustainable," he said. "The market is more comfortable with the personal and commercial division where earnings are sustainable, more resilient and recurring than capital markets. "

Blais said the banks recognize that volatility and have tried to set targets on how much of their results they want these divisions to account for.

"That just speaks to the concerned nature of the banks," he said.

Follow @LindaNguyenTO on Twitter.

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