Canadian banks may have sailed through the financial crisis with barely a scratch, but it is now apparent that the recovery is proving tough going.
The problem is that in today’s low-growth economy banks are being forced to compete for business and that’s squeezing profit margins as never before, pushing down earnings and causing analysts to question whether the sector’s glory days are over.
Canadians have generally applauded as the Bank of Canada has successively knocked interest rates lower over the past few years as a way to boost the economy but the flip side of that phenomenon is the consequences that are now becoming apparent. Low borrowing costs caused consumers to over indulge and now they’re dealing with the aftermath of too much debt. They’re already borrowing less and some analysts predict they will start applying the brake even more dramatically over coming months. Meanwhile, loans to businesses are growing but not enough to pick up the slack.
For the first time in recent decades slumping demand for credit is threatening bank earnings growth and players are responding by cutting rates. As the recent string of bank results revealed, in particularly competitive areas such as mortgages, lenders have given up hope of turning a profit just to hang onto market share.
“Is the old banking oligopoly is breaking down?” asked one analyst. “It sure seems like it.”
So far five of the big banks have reported second quarter results — all but Bank of Nova Scotia. Bank of Montreal and National Bank of Canada both beat analyst expectations. Two of them National and RBC announced dividend hikes, a brave effort to earn the good graces of shareholders. But dig into the numbers and the picture that emerges isn’t pretty.
“The theme of the day, the theme of the reporting season seems to be that margins are more under pressure than probably the Street expected,” Tim Hockey, head of Toronto-Dominion Bank’s Canadian banking operation, said on a conference call. “We’re seeing that day to day and fighting over the growth opportunities.”
A key measure of health of a retail bank is net interest margin (NIM), the difference between what a bank pays for funding versus what it charges borrowers. The fatter the NIM, the healthier the institution. After a brief spike around the financial crisis in 2008 and 2009, NIMS came back to earth as the Bank of Canada slashed interest rates and began calling for banks to do more lending.
TD’s NIM was down four basis points compared to the first quarter. National fell seven. BMO was down seven basis points and Canadian Imperial Bank of Commerce slipped six.
Pinched margins for a couple of quarters isn’t the end of the world but the trouble is, NIMs at all the banks have been basically treading water for the past two years and the most recent declines don’t bode well for their bottom lines.
The big advantage of Canadian banks is a business model that allows them to crank out profits even when part of their operations aren’t doing so well. For instance, when times are lean in plain vanilla lending there have always been opportunities in capital markets or wealth management to drive growth. More recently, players have branched out into insurance.
But this time around that strategy isn’t working because the other businesses aren’t taking up the slack.
As a result of the sovereign debt crisis, most of the banks have been hit by a drop in trading revenue which has hurt investment banking results.
Meanwhile, they’re all bracing for the impact of tougher capital rules and a slew of stringent regulations in the United States.
Not everyone shares the view that the good times are over for the banks.
Laurence Booth, a professor at the Rotman School of Management, argues that the banks troubles are simply a result of a depressed economy.
“The fact is we are still in a recovery and we’re still waiting for the United States,” Mr. Booth said in an interview. “At the moment we’re getting the benefit of emerging economies demand for raw materials and that’s been holding the economy up for the last two years” but it’s not enough to drive the kind of broad growth needed to bring the economy back to full health.
According to Mr. Booth the U.S. will recover over time. “When that happens, you’ll start to see bank lending increase and even more important you’ll start to see interest rates increase.”
Peter Nerby, an analyst at Moody’s, isn’t taking sides. For now, he agrees, low interest rates are the main challenge for the banks.
“In a higher rate environment, banks can make much more money,” said Mr. Nerby. But he’s not calling for the good times to start rolling soon. Right now he’s worried record consumer debt levels and how lenders would be impacted by a rise in defaults.
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