Canadian banks suffered from lower trading revenues during the fiscal third quarter, but that retail strength somewhat offset this weakness, says Standard & Poor’s in a report released Monday. The rating agency sees a slowing economic recovery as the biggest risk facing the sector.

While trading slumped during the quarter, the demand for mortgages in particular bolstered the quarterly performance of Canadian banks, S&P says, benefiting the banks’ Canadian retail lending operations. However, it notes that “the strong growth in secured real estate lending started to abate over the summer months with the advent of the Harmonized Sales Tax on new homes in Ontario and British Columbia, rising rates, and slowing economic recovery — a trend we see continuing, and so, we believe that growth in consumer retail lending revenues is likely to slow and commercial lending remains tepid.”

Revenues from capital markets operations were halved from last year’s high levels, the rating agency notes. Although S&P believes those inflated levels were unsustainable anyway. It says market revenues were hurt by slumping debt and equity markets, which were feeling the fallout from the European sovereign debt crisis. “Deal flow has been tepid, in our view, though the pipeline appears to be strengthening and so higher underwriting and mergers and acquisitions fees in future could help compensate for lower trading revenues,” it adds.

“Loan quality in Canada appears to continue to improve, as seen in the credit metrics of Canadian banks’ domestic consumer and business loan portfolios, which represent the bulk of their lending. We expect the positive trend to continue as the economy recovers, albeit at a slower pace than expected,” it says, adding, “Canadian banks’ U.S. loan portfolios are generally stabilizing and even improving, though loan losses remain high and the U.S. economic recovery is uneven and slowing, and so we remain cautious.”

“We note that a risk to asset quality recovery could be sharply higher interest rates, a scenario we do not envision at this time, but which could lead to higher losses for Canadian banks,” it adds.

“In our view, potential risks for Canadian banks continue to include what appears to be a slowing U.S. and global economic recovery and the broader implications to the recovering Canadian economy, as well as uncertainty regarding new financial regulations,” it concludes.

It views capital as a strength for the banks, and says that the Canadian banks are well positioned to further build capital, “thanks in part to what we view as manageable credit losses that we believe should help to promote strong retained earnings growth.”

IE