Although Canadian banks reported results in the first quarter that were ahead of expectations as a result of stronger trading revenues, they will likely be challenged to sustain that performance in the year ahead.

In a new research report, UBS Securities Canada Inc., says that the banks beat expectations last quarter. However, it notes that the global banking outlook remains uncertain “due to ongoing sovereign and macro concerns”; and, the other key risks are record high consumer leverage and lower growth prospects, which UBS says “could put more pressure on margins and expenses, especially for smaller banks.”

Additionally, as loan loss provisions are cyclically low, and recent trading revenues have been more ‘normal’, it says “this could make bank stocks more susceptible to a downgrade, should economic conditions worsen more than currently expected.”

UBS reports that it recently downgraded the Canadian banking sector from overweight to neutral, on a global basis, “reflecting more limited growth and valuation upside, and better valuation and leverage elsewhere,” it says.

Given the risks and projected growth trends, UBS says its focus for the banks remains on international growth, non-interest income growth in areas such as wealth management and insurance, capital deployment strategies, return on equity, and controlling expenses. And, on that basis, it continues to favour Bank of Nova Scotia and Toronto-Dominion Bank.

UBS says it likes Scotia due to its higher international growth, improving expense control, high returns, accretion from recent acquisitions, continued capital deployment, and lower than average relative valuation. It also projects higher than average growth from TD due to growth in its U.S. business, and the ramp-up of Chrysler Financial.

“We note that BMO and CIBC are both trading at their lowest relative valuations in a year; however, growth is lower, and risk is currently higher due to execution of BMO’s U.S. acquisition of M&I, and CIBC’s new client focused strategy, particularly its exit from the broker channel,” it says. “While valuation could be attractive, we would like to see higher demonstrated growth and higher dividends.”