The big six Canadian banks had stronger than expected earnings to start the year, but face challenges ahead, Fitch Ratings says in a new report.

The rating agency reports that the Big Six enjoyed a strong start to the year, with first quarter earnings “driven primarily by volume growth in retail and commercial banking and modest provisioning expenses as asset quality continued to be sound.” Earnings from wealth management activities were constrained by low interest rates and choppy market valuations, it adds.

Reported earnings were up sequentially for all the banks, it notes; although they were down year over year at Royal Bank and TD Bank. “The year-over-year decline in RBC’s earnings mainly reflected the high and unsustainable level of earnings of a year earlier, particularly in capital markets activities. TD’s earnings were dampened by one-time litigation charges,” it says.

Conversely, Bank of Montreal reported the strongest year-over-year earnings growth of the Big Six, Fitch says, largely due to the integration of the acquired Marshall & Ilsley Corporation and reduced loan loss provisions.

The better than expected earnings are neutral to the banks’ ratings, Fitch notes, adding that the current ratings and rating outlooks factor in solid results, and an expected moderation in earnings growth.

Looking ahead, Fitch says that domestic retail loan growth is showing preliminary signs of slowing, and margin pressure is likely to continue for an extended period of time. Managing lending spreads will be a priority and a challenge for the Big Six in future quarters, it suggests.

Moreover, it warns that household indebtedness and the housing market continue to be the main downside risks to the ratings of the Big Six. “With interest rates likely on hold for still some time, the near-term threat to the Canadian banks would be any labour market shock that significantly reduces consumers’ ability to pay,” it says, although it notes that the unemployment level has remained relatively stable, and is expected to remain so in the near to intermediate term.

Amid the prospect of weaker loan growth low margins and ongoing market volatility, Fitch says that the Big Six are all focused on managing costs. “Positive operating leverage has emerged as a key management target,” it says.