Canadian banks’ overreliance on mortgages could slow margin recovery

Banks are likely to face further cost pressures from rising spending, due to soaring inflation and planned business investments

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TORONTO – Canadian banks could struggle to see an immediate increase in their net interest margins next year, even if interest rates rise due to their overreliance on mortgages, particularly if the growth in this most profitable business and credit card lending is hampered by supply bottlenecks and runaway inflation.


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With interest rates near record lows, the average net interest margin of lenders’ six major Canadian banking units fell 10 basis points to 2.34% from a year earlier, with executives attributing the declines largely to loan portfolios dominated by mortgages.

Despite their lower yields, mortgages now account for around 67% of domestic lending, down from 64.5% two years ago. The six major banks, which released their fourth quarter results last week, posted mortgage growth of 11% in Canada in the year-ago period, with the pace accelerating over the past week. each of the last quarters. Loans outside of home loans grew 5.9% in the last quarter, which, while improving, still lags the pace of growth before the onset of the coronavirus pandemic.


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With money markets expecting the Bank of Canada to raise interest rates five times next year, net interest margins are expected to increase at a pace similar to previous cycles.

But “an increase in interest rates would take a bit longer to trickle down to banks’ margins, given the mix” of loans, said Rob Colangelo, vice president and chief credit officer at Moody’s Investors Service.

Banks and investors lamented the pressure on NIMs from pandemic-related central bank rate cuts, which narrowed the gap between what they paid in deposits and the interest they earned on the loans. This has weighed on interest income, making banks more dependent on fee income to generate profits.


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Cost pressures

Banks are likely to face further cost pressures from higher spending, driven by soaring inflation and planned business investments.

“It’s a tall order and highlights the importance of revenue growth,” said Edward Jones analyst James Shanahan. “They need to drive loan growth and margin expansion or they will struggle to outpace their operating expense growth.”

Banks, including Royal Bank of Canada and Canadian Imperial Bank of Commerce, expect NIMs to stabilize over the next few quarters and rise in line with interest rates. CIBC is also hoping to get an additional boost from its acquisition of Canadian credit card portfolio Costco, which is expected to close early next year.


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The recent jump in variable-rate mortgages, the price of which rises when the central bank raises interest rates, could ease some of the weight of home loans in banks’ portfolios, Colangelo said.

But while variable-rate loans accounted for more than 54% of new mortgages in September, they only accounted for a quarter of all outstanding home loans, according to Bank of Canada data, so the benefits will be probably limited.

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If the central bank were to raise its key interest rate by 100 basis points next year, BMO executives said the bank’s net interest income would rise by $384 million in the fiscal year. 2022. They added that this figure could double if BMO maintains its current deposit levels, and predict that margins will stabilize and increase if rates trend higher.

Mike Clare, portfolio manager at Brompton Group, hopes for a recovery in margins as interest rates rise, but warned that additional complications from the pandemic could delay a recovery in business lending.

“The biggest uncertainty is about the new variant and what it may do for commercial activity,” he said, referring to the emergence of the Omicron COVID-19 variant. “We could potentially have an environment where growth is not as high as expected, but inflation remains high.”

© Thomson Reuters 2021



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