Canadian banks enjoyed the continuation of a very favorable credit environment in the first quarter, and a strong performance from the domestic retail banking market, according to a new report from Standard & Poor’s Ratings Services.

Retail banking continues to be the backbone of the operating performance of the Canadian banks, S&P notes, despite the ongoing effects of margin compression and intense competition. “However, the overall strong financial performance continues in part to be fuelled by credit loss reversals, which are slowing and high trading and other market-sensitive revenues, which given their volatility, are not likely to be sustainable,” it cautions.

S&P says that the release of credit reserves and reversal of loan loss provisions, and recoveries particularly in large corporate lending, which boosted the bottom line of many banks in the past several quarters, are not likely to be repeated in 2005, at least not to the same degree. “Asset quality is unlikely to get any better, which means provision expenses will turn upward in 2005,” said Standard & Poor’s credit analyst Lidia Parfeniuk.

“Having said that, credit quality is expected to remain relatively benign, and along with the lower risk profile of some Canadian banks, particularly TD Bank and CIBC, this will support more stable earnings performance in future.”

Canadian banks continue to face formidable challenges in establishing a U.S. presence, S&P notes, because the regional banks they are competing against are themselves being squeezed within their own market. “The credit card and mortgage sectors have become concentrated in the hands of the large, complex banks and specialty lenders. Also, revenue and cost synergies are not as compelling as they would be for a U.S. incumbent, and valuations remain high,” it adds. “Furthermore, the overall lack of knowledge of the U.S. retail banking market has been an impediment to a successful U.S. strategy for some Canadian banks.”