TORONTO - Canada's five biggest banks earned a combined $4.8 billion in third-quarter profit — nine per cent more than last year — as they cashed in on strong growth in mortgages, consumer and corporate loans and other retail operations.

While the results were higher than the $4.4 billion in profits booked in the same 2009 period, the banks took a major hit from weakness in their capital markets divisions as economic uncertainty affected returns on stock markets.

Overall, the third-quarter results were mixed with three of the five banks missing analyst expectations for the period.

The economic recovery in the last year and continued growth in the housing market helped boost the banks' main lending businesses to ordinary consumers, homeowners and companies. As well, the healthier economy reduced the number of bad loans.

TD Bank chief executive Ed Clark said Thursday the bank saw the best credit quality and lowest credit losses in seven quarters across all of its businesses, adding he expects to see further declines in losses next year.

"The continued strength of the housing market drove strong volumes in real estate lending and business deposits also became a very good source of growth," he said on a conference call with analysts to discuss the bank's strong third-quarter earnings.

However, it was hard to ignore some of the potential dangers that still threaten Canada's banking industry, which has often been championed as one of the best in the world after surviving the financial crisis with little significant damage.

One key weakness was on full display, in each of the Big Five banks' capital markets results. Overall, earnings for the divisions were nearly halved to $1.05 billion, as trading revenues declined from lofty heights last year when the economy was first showing signs of a recovery.

"Wholesale earnings continue to normalize, as we have been indicating," Clark said.

"Last year, we were seeing unsustainable market activity and positive valuation adjustments, given a broad rebound following the financial crisis. Today, we're generally seeing softer capital market activity and earnings declined 45 per cent versus last year."

Troubles in Europe and the continued weakness of the U.S. economy eroded global economic optimism and with that stock markets have taken a hit. That has led to lower corporate financings and weaker profits on stock and bond trading.

The capital markets decline has put a major pressure on overall results when compared to the second quarter of this year, when big banks' profits were a beefier $5.09 billion.

As the economic recovery becomes more tepid, it may be even more difficult for banks to find a source of revenue in the fourth quarter as demand for new credit slows, and stock markets continue to bounce around, says Craig Fehr, a banking analyst at the Edward Jones brokerage in St. Louis, Mo.

"I would expect loan growth to be relatively modest in the very near term and for banks to really look for other ways to squeeze out profits until the economic engine begins to fire more on all cylinders."

TD Bank (TSX:TD) was the last of the Canadian banks to report its third-quarter results, saying that its profits grew 29 per cent to $1.18 billion, narrowly missing analyst expectations.

The results released Thursday were equivalent to $1.29 per diluted share for the quarter, and compare to a net income of $912 million in the same period a year ago.

On an adjusted basis that excludes certain items, earnings were $1.43 a share, falling a penny short of analyst expectations according to Thomson Reuters.

Revenue rose to $4.74 billion from $4.66 billion a year earlier.

Provisions for credit losses dropped to $339 million versus $557 million in the comparable period of last year, as more of the bank's corporate and retail clients paid their loans back on time. TD said it expects credit losses on personal loans will remain stable for the rest of this year.

In its wholesale banking division, TD's profits dropped about 45 per cent to $179 million on weaker trading results as economic uncertainty affected stock markets, leading to lower corporate financings and weaker profits on stock and bond trading.

The bank expects a loss in its corporate segment to continue into the fourth quarter. However, it says it could announce changes in the first quarter of 2011 aimed at address the size of its corporate segment loss.

Those changes could including re-examining its reporting principles or allocating more costs out to its businesses.

TD's North American retail banking operations were the high point of its results with the Canadian division's profits increasing 24 per cent to a record $841 million.

U.S. retail operations reported a profit up 30 per cent to US$271 million, as the bank continued to grow its operations in New England and parts of Florida. However, the bank is cautious about the outlook for its U.S. portfolio as the economic recovery stateside appears far more uncertain than in Canada.

The bank expects to see continued credit performance improvement in 2011 across its portfolios, assuming there is no double dip recession.

However, the bank warned that a slowdown could be afoot in the domestic retail division which handles mortgage lending, credit cards, consumer loans and other financial services aimed at ordinary Canadians.

A weakening Canadian housing market and a competitive environment continue to put pressure on margins, but Canadian credit performance is expected to remain strong, TD said.

TD now operates about 1,300 branches in the United States and bills itself as the bank with the widest presence across North America, having roughly 1,000 branches in Canada.

Fehr says Canadian bank earnings will continue to move modestly higher in the near term because they are solidly anchored by their core retail business.

TD Bank is best poised to ride out the uncertainty due to its focus on the retail banking sector, a more consistent source of earnings, Fehr says. However, in the medium to long-term, when a more positive market environment emerges, banks that are capital markets-focused, like Royal Bank (TSX: RBC) will benefit most.