Canadian banks are feeling the squeeze of tighter competition on everything from mortgages and home equity lines of credit to interest rates on deposits.
The gap that banks maintain between interest they bring in on loans and interest they pay out on deposits has narrowed significantly in recent months as the banks try harder to steal business from each other.
The sandwich effect is being driven primarily by increased competition for mortgages and credit lines, as consumers scale back their borrowing. But the phenomenon is happening on many levels, from lenders offering up lower rates on commercial loans to an intensifying fight among the big banks to build up their deposit base.
The result has been a relatively sluggish second-quarter across the banking sector. Toronto-Dominion Bank and Canadian Imperial Bank of Commerce both said Thursday they are feeling the drag of shrinking net interest margins.
"There's no question, you can see if you look at the other banks as well as ourselves, there is some margin pressure coming on here," TD chief executive officer Ed Clark said on a conference call with analysts. He said Canadian banks are responding to slower growth in their loan portfolios by becoming more aggressive on pricing loans and deposits.
Similarly, CIBC said low interest rates are fuelling the competitive environment.
Typically, banks "borrow short and lend long." That means they borrow cheaply at the short end of the yield curve - typically through customer and business deposits - and then use it to make longer-term loans that pay them back higher rates of interest.
Yet because rates are so low across the entire yield curve, the banks aren't earning hefty spreads. In other words, the difference between the long-term and short-term rates isn't much.
"On the deposit side, in a lower-interest-rate environment, as rates continue to decline it just puts pressure on the spreads we are getting on business deposits, which also affects the overall spreads in the sector," David Williamson, head of CIBC's retail and business banking, said on a conference call Thursday.
CIBC reported a 3-per-cent increase in second-quarter profit, to $678-million on Thursday, but said its net interest margins fell to 1.94 per cent in the quarter, down from 2.08 per cent in the first quarter and 2.16 per cent a year ago. (The net interest margin is the difference between how much the bank has to pay to borrow money and the rate it charges to lend it out.)
TD, which saw second-quarter profit rise 12 per cent to $1.33-billion, saw a similar trend, though the drops were not as steep. Its net interest margins fell to 2.38 per cent in the second quarter, from 2.41 per cent in the first, and 2.39 per cent a year ago.
Multiplied across each loan in the portfolio of a bank, the impact of slightly lower average margins adds up. To make up for that lost revenue, the banks have been issuing more loans, and that fosters more competition for the limited number of businesses and individuals who want to borrow.
"The competitive forces right now in lending broadly and in mortgages [are]fairly strong," Mr. Williamson said, and that forces banks to offer lower and lower loan rates. For that reason, Mr. Williamson doesn't expect CIBC's loan margins to jump any time soon, but he wouldn't make any guarantees because "it's going to be somewhat dependent on the degree of the competitive pressure in the marketplace."
It's a trend seen across the sector, and one that is expected to continue today (Friday) when Royal Bank of Canada, RY-T the country's largest bank, reports its second quarter.
"The theme of the day, and the theme of the reporting season seems to be that the margins are more under pressure than probably the Street expected," said Tim Hockey, head of Canadian retail banking at TD. "And we're seeing that day to day in fighting over the growth opportunities in Canada."
Still, tighter margins aren't the only thing affecting Canadian banking profits. CIBC's retail operations were also affected by lower revenue at FirstCaribbean International Bank.
Similarly, earnings at TD's wholesale banking division fell 18 per cent to $180-million, owing to lower trading and underwriting revenue, compared with unusually high levels a year ago.
"Our results were at the lower end of our expectations," reflecting the global shocks and increased competition in fixed-income markets that characterized the quarter," Bob Dorrance, group head of wholesale banking, said in statement.
CIBC's second-quarter profit was equal to $1.60 a share, up marginally from $1.59 a share last year.
TD's profit was equal to $1.46 a share, an increase from $1.30 a year ago.
Grant Robertson
Tim Kiladze