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27 May

Banks face lending squeeze

General

Posted by: Mike Hattim

John Greenwood, Financial Post

Economic uncertainty and rising concern about consumer debt levels are shaking up the cozy world of Canadian banking, forcing players to compete ever more fiercely on rates just to preserve market share.

Canadian Imperial Bank of Commerce and TorontoDominion Bank, which reported lower-than-expected second-quarter results Thursday, both acknowledged that intense competition in their core business has resulted in lower net interest margins -the difference between what it costs them to borrow funds and what they charge customers.

Speaking on an analyst conference call, Tim Hockey, head of TD’s Canadian banking operation, said he expects the market “to continue to be quite competitive” and that will “keep up the pressure on margins.”

TD posted second-quarter profit of $1.3-billion, or $1.46 a share, up 13% on the back of higher loan volumes and lower credit provisions. The main driver was the domestic retail operation which posted income of $847-million, up 11% from the same period last year on higher loan volumes.

Meanwhile, the U.S. business had a profit of US$315million, about flat with the previous quarter but 31% higher than the same period in 2010.

The main reason for the stronger results was a drop in provisions for bad loans as Canada’s second-largest bank set aside $343-million of provisions for credit losses in the three months ended April 30, compared to $414-million in the previous quarter and $365-million in the same period last year.

CIBC’s results reflected a similar theme as the country’s fifth-largest bank reported a profit of $678-million, or $1.60 a share, up 3% on falling credit loss provisions.

The retail lending business had net income of $553-million, up $66-million as the bank benefited from higher loan volumes.

CIBC set aside $194-million in provisions for bad loans in the second quarter, compared to $316-million last year.

Since the end of the financial crisis in 2009 the banks have been steadily lowering credit provisions to the point that they are now close to the level they were at before the turmoil began. Analysts said the problem is that players are left with less room to lower provisions in the future, taking away what has been an important earnings driver.

At the same time banks are competing harder than ever for business and that’s forcing them to accept lower rates on loans and other products in order to hold onto their place in the market.

TD’s net interest margin in the second quarter was 2.78%, down 14 basis points from last year. By comparison, the net interest margin at CIBC Retail Markets fell to 2.79%, the lowest since the second quarter of 2009.

In the aftermath of the crisis the economy recovered and consumers started spending again, and the impact on real estate -and bank’s mortgage portfolios -was dramatic. But in the face of growing uncertainty about the economy and the realization on the part of consumers that they need to pay down debt consumers are borrowing less and at the same time businesses have yet to take up the slack. That’s putting pressure on lenders, forcing them to cut prices to hold onto marketshare.

At first, conventional wisdom was that the price competition would be transitory and that the industry would return to more normal conditions but players have come to “the realization that this is going to be a more competitive market for banks than it has been historically,” said Brad Smith, an analyst at Stonecap Securities.

Shares in CIBC fell $3.30, to $81.15. TD slipped $1.27, closing at $84.02.

Analysts said pressure on lenders is set get even tighter as consumers respond to tougher mortgage rules by buying fewer homes and cranking back on credit card debt.

Bank of Montreal kicked off earnings season on Wednesday, posting income of $800million, ahead of analysts estimates. National Bank of Canada, which came out Thursday, also exceeded expectations.

The pressure on lenders is exacerbated by declining activity in capital markets. A key driver in the aftermath of the crisis, the banks’ capital markets operations have run into trouble in recent quarters amid a slump in trading opportunities and renewed sovereign debt concerns.

Next to report results is Royal Bank of Canada -the country’s largest bank and most valuable corporation -which comes out Friday.