Gloria Nieto/The Globe and Mail
Don't hold your breath waiting for an immediate earnings spike from Canadian banks as interest rates rise.
As the U.S. economy picks up speed and the Federal Reserve pares back its massive bond buying program, there's more and more speculation that the country's biggest banks will see their earnings soar because longer-term rates will ultimately rise.
The sad reality, though, is that this profit spike won't be in the near future.
No doubt, the banks will benefit from higher rates in the long run. Playing the yield curve is the very crux of how they make money. They borrow for short terms at low yields, and then lend these funds out for longer periods at higher rates. Voilà, immediate margins.
However, banks can't immediately reprice all of the products they have tied to interest rates, something Bank of Nova Scotia recently explained at its Canadian banking investor day.
Speaking to an audience full of the country's biggest institutional bank investors and analysts, Laurent Mareschal, Scotiabank's chief financial officer for Canadian banking, said shareholders would have to wait as long as 48 months to realize the full benefit of higher rates.
"As far as sensitivity to interest rates, generally speaking, if you had a 100-basis-point lift in rates today, it would take about three to four years for that to flow its way through our books," he said, adding that it would eventually lead to a 10-basis point rise in the bank's overall net interest margin, or the difference between the rates at which it borrows and lends money.
Scotiabank execs elaborated on this point when asked about it by analysts. Chief executive officer Brian Porter explained that the bank takes savings and chequing deposits and invests them through the bank's treasury operations. When doing so, Scotiabank invests different portions of the deposits over various time frames – some get invested for three months, some for three years.
Because a good chunk of the money is invested for periods longer than one year, the bank is locked into pre-established rates of return, and those rates can't be repriced until the preset term ends.
The same applies to assets such as mortgages. If I sign up for a standard Scotiabank mortgage today, but rates start to rise next year, Scotiabank won't benefit from that rise until my rate is repriced when I renew my mortgage in five years.
Scotiabank isn't the only lender affected by the delay in realizing big gains from higher rates. Each of the Big Six banks is in the same boat, and last year a number of them spoke up to tame investor expectations when bond yields spiked last summer.
At the time, Royal Bank of Canada chief financial officer Janice Fukakusa stressed the timing mismatch between a bank's liabilities and its assets. "What happens generally is that your liabilities – your deposits – reprice faster than assets," she said.
National Bank of Canada CEO Louis Vachon told his own investors that it often takes four to six quarters for the bank to even start benefiting from a rate hike.
While all of this sounds rather unfortunate for shareholders in a rising-rate environment, keep in mind that lenders didn't immediately suffer when central banks slashed rates during the crisis. As the financial system crumbled, it took years for fat margins on old assets to be repriced.
Editor's note: A previous version of this article referred to Janice Fukakusa as chief executive officer of Royal Bank of Canada. Ms. Fukakusa is the bank's chief administrative officer and chief financial officer.
Tim Kiladze