Faced with a slowdown in revenue in the year ahead, Canadian banks are racing to find other ways to keep the profit taps flowing – and their bottom lines from slipping.
Canadian Imperial Bank of Commerce has been among the most aggressive of the Big Six Canadian banks in trying to protect its profit margins from eroding, and on Thursday the bank showed why its defensive posture may be starting to pay off.
CIBC reported a 6-per-cent increase in profit Thursday, which was less than some of its larger rivals such as Bank of Nova Scotia and Toronto-Dominion Bank, who had already reported. Most unexpectedly, however, the bank’s profit margins actually got fatter in the second quarter, at a time when the sector as a whole is battling margin erosion.
To do that, CIBC trimmed costs and stopped chasing low-margin business such as discount loans. When a price war over mortgages broke out in the banking sector this spring, CIBC sat conspicuously on the sidelines, refusing to wade into the fray as its rival lenders attempted to undercut each other to sign up new borrowers.
That strategy of protecting its profit margins, along with a strict commitment to keeping costs from rising, helped lead CIBC to what could be the most surprising second-quarter of Canada’s Big Six Banks.
CIBC, Canada’s fifth-largest bank by assets, made $811-million, or $1.90 a share, in the quarter. That compared to profit of $767-million, or $1.80 a share, during the same period last year.
Indeed, the second quarter for CIBC may be an indicator of what the banking sector could look like in the year ahead, as Canada’s banks will be forced to continue producing healthy profits from declining or flat revenue. Many of them will be looking to take costs out of their operations in order to prop up their margins.
Excluding one-time items such as tax gains, the bank made $2 a share, beating analysts’ forecasts for the quarter. On average, analysts expected CIBC to report adjusted earnings of about $1.86 a share.
In a sign of just how sluggish the banking business has become amid record-low interest rates and a slowdown in consumer borrowing owing to high household debt, CIBC’s revenue rose just 2 per cent in the quarter, to $3.08-billion.
The revenue picture is similar to what investors saw from the rest of the sector this quarter. While Canada’s banks are still making considerable profits – all told the Big Six made a combined $7.1-billion in profits this quarter – the momentum is slowing, and the revenue line is where it’s showing up first.
The key strategy for banks now, say analysts, is keeping expenses from expanding, while also trying to shift their focus toward higher-margin businesses.
“We’re starting to see a shift in our balance sheet to higher-margin products consistent with our strategic objective of accelerating profitable revenue growth,” said Kevin Glass, CIBC’s chief financial officer. “The benefits of the change in focus have offset the impact that the low-interest-rate environment is having on margins.”
In keeping with this shift, CIBC said it is also pulling back from some business lending, such as commercial mortgages, where competition is heating up and margins are becoming less profitable. “Unless spreads get fatter, we’ll continue to pull back there,” said David Williamson, CIBC’s head of retail and business banking.
CIBC “appears focused on margin rather than market share for now,” said analyst Brad Smith at Stonecap Securities. “A lot of little things came together to produce another better-than-expected bottom-line result.”
One of the strategies CIBC has announced is to stop selling mortgages through brokers. CIBC has put its mortgage broker business FirstLine up for sale in hopes of increasing its profit margins by writing the loans through its branch network, rather than paying commissions to middlemen. Analysts admit it’s a risky move, since the bank will likely lose market share to more aggressive rivals.
But where the bank will see traction is on its net interest margins, which are the difference between what the bank pays out on deposits and what it makes on interest from loans.
Analyst John Aiken at Barclays Capital noted that CIBC’s domestic banking margins increased slightly by four basis points in the quarter, which is unusual for the sector. (A basis point is 1/100th of a percentage point.) Most banks have been seeing their margins shrink as competition for loans intensifies and low interest rates put a squeeze on their business. Though CIBC’s loan growth lagged some of its peers, keeping costs down helped prevent those margins from shrinking.
However, CIBC, which has focused much of its operations on domestic banking, remains more exposed to a slowdown in Canadian banking than its peers that have more international operations. CIBC’s core retail and business banking segment, which is made up of its lending and deposit business in Canada, reported a $556-million profit, up 12 per cent from $496-million last year.
While higher net interest income at CIBC helped “cushion the blow” of slowing revenue growth for the bank, Mr. Smith points out “there is still no sign of a sustained recovery in revenue momentum.”
Like many of its peers this quarter, CIBC is warning of a slowdown in the economy that will take its toll on banking profit growth in the year ahead.
“Canada’s economy faces a deceleration in global demand due to a likely recession in Europe, a slower pace of growth in emerging markets, and the challenges of competing in the U.S. market at a near-par exchange rate,” the bank said in its economic forecast accompanying the earnings. “Retail and business banking is expected to face slightly slower growth in demand for mortgages, while consumer credit demand could continue to see limited growth,” the bank said.