Canadian banks scramble to diversify amid low rates

Posted on 02-27-2014 04:02
Summary: Uncertainty over interest rates is buying Canada’s banks even more breathing room this earnings season.

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Uncertainty over interest rates is buying Canada’s banks even more breathing room this earnings season.

For nearly two years, the big question mark for Canadian lenders has been over their prospects for loan growth. Every quarter, investors and analysts raise concerns that the good times are coming to an end. This time, the worries aren’t as widespread. Deflation concerns have persuaded the Bank of Canada to stand pat on rate hikes, helping to send bond yields lower.

During the banks’ first fiscal quarter, which ran from November to January, the five-year benchmark government of Canada bond fell 23 basis points to 1.55 per cent. The impact on lending was clear: Mortgage rates fell in January and February, helping extend the lending boom.

While expectations for the first quarter are not overly optimistic, with estimates of low single-digit mortgage growth, investors do not have to worry about a sudden reversal. “Loan growth in Canada, while slowing, remains healthy,” Royal Bank of Canada analyst Darko Mihelic wrote in a note to clients.

The longer rates remain low, the more time the banks have to diversify their operations. Already a number of Big Six lenders are strengthening their bottom lines with money from their wealth-management and capital-markets units. Wealth management has been particularly hot, with many banks aggressively pursuing growth in this area over the past few years, both in Canada and abroad.

Investors can expect strong results from these units yet again this quarter, aided by encouraging equity markets and better bond valuations, which are persuading investors to deploy more of their savings.

Still, there isn’t reason to be overly excited.

“We enter the year with a more optimistic stance than we had last year at this time, when net interest margins were declining, profit growth was slowing, capital markets-related revenues were still being affected by market volatility and risks in the operating environment were generally elevated,” CIBC World Markets analyst Rob Sedran wrote in a note to clients. He summed up his views on the environment as: “Still not great, but better.”

That sentiment can be seen in bank stocks as well. After a strong run in the second half of 2013, Canadian bank shares took a breather in January and February, with many falling 1 or 2 per cent. Bank of Nova Scotia is the notable outlier, falling 4.7 per cent in 2014, largely on fears emanating from emerging markets.

Although the outlook is rather stable for now, there are warning signs on the horizon. Early in February the U.S. Federal Reserve Board released its latest survey of senior loan officers, which found that two-thirds of big U.S. banks – those with more than $20-billion (U.S.) in assets – are seeing narrowing spreads on their large and mid-market commercial and industrial loan portfolios. In simple terms, the banks are making less per loan.

Updates like this are making investors pause, because the Big Six banks with sizeable U.S. lending operations – RBC, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal – have all been counting on solid profits from their commercial loans. Last quarter, BMO stressed that its U.S. team had another strong year, with its core commercial and industrial loan portfolio jumping 19 per cent in fiscal 2013. Yet, while the volumes are growing, profits per loan are shrinking.

Because the banks are expecting road bumps, many are now cutting back on their expenses. “In anticipation of a slower revenue growth environment in Canadian retail banking, we are expecting the banks to be diligent with costs to support positive operating leverage,” Mr. Mihelic noted.

TIM KILADZE

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