Why the banks can't win in a 'race to the bottom'

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A new price war on mortgages being waged by the country's biggest lenders comes at the worst possible time for Canadian banks, which are scrambling to keep their lending margins from shrinking further after months of erosion.

Although the banking sector is well on its way to a $7-billion first quarter – with five of the six-largest banks reporting a combined $6.07-billion in profit so far – those blockbuster numbers have largely overshadowed a slowdown in lending growth.

As the banks enter the most important time of the year for mortgage lending – the spring buying season – they are getting aggressive. Bank of Montreal fired the first salvo on the weekend, dropping its advertised rate on a five-year fixed mortgage to 2.99 per cent.

While other banks have yet to match that offer, lenders such as Toronto-Dominion Bank and Canadian Imperial Bank of Commerce are advertising similar rates for a four-year, fixed-rate mortgage.

The battle is reminiscent of the 2.9-per-cent price war on mortgages a year ago that helped some banks bring in marginally more business, but also appears to have damaged their net interest margins.

Net interest margins, or NIMs, are the difference between what a bank collects on loans, and what it pays out on deposits. When BMO slashed its rates last year, the upside wasn't as big as the pain it caused to the margins, analyst John Aiken at Barclays Capital Research said in a note Monday.

"Although BMO's market share was largely unchanged, we note that over the period BMO experienced a significant decline in its NIMs. While the bank claims it is not related to its pricing strategy, the lack of pressure on the other banks' NIMs is quite stark," Mr. Aiken said.

BMO's market share rose 0.31 per cent after starting the price war, which was only slightly above rivals such as TD (0.2 per cent) and National Bank of Canada (0.27 per cent). Royal Bank of Canada fell by 0.8 per cent. However, as a smaller bank, BMO's gain had a bigger impact on its balance sheet than the movements at some of its rivals.

Mr. Aiken expects a similar trend with this spring's roll-out of low rates. "There was very little change in market share for total domestic mortgage volumes," he said. "Similar to last year, we do not anticipate much market disruption … although it could once again put BMO's margins under pressure."

Even though BMO grabbed headlines with its five-year fixed rate of 2.99 on Saturday, industry observers say a price war has been happening for weeks, in advance of the announcement.

"It's just to get the phones ringing," said Robert McLister, a mortgage adviser and editor of the Canadian Mortgage Trends blog. "In the broker channel, you could go to any broker and get quoted 2.99 per cent or less for a full-feature mortgage. The BMO product is limited in various ways."

He added that most qualified borrowers have also been able to go to their bank and negotiate a rate of 2.99 per cent or lower, even though the posted rates in most cases were above 3 per cent. "I've had some pretty aggressive rates," Mr. McLister said.

The stakes are high as banks look to keep their mortgage growth from slowing. Bank of Nova Scotia is the last of the Big Six lenders to report first-quarter earnings Tuesday, and several of the other lenders have so far shown a slight slowdown in consumer lending.

"It's a very competitive market. All the banks need volume," Mr. McLister said. "In general it's a slowing mortgage market, and it's the spring season so they've got four months where they make almost half their year. And if they can't generate the volume now, it could have an impact on earnings."

The BMO rate comes with restrictions on breaking the mortgage and moving it to another bank. Those terms are also what kept BMO from making significant increases in its market share a year ago, analysts say.

Scotiabank said Monday it does not plan to match the posted rate offered by BMO. CIBC and TD have been offering 2.99 per cent on a four-year fixed rate since the end of January, but neither bank is matching the five-year posted rate for now. "The mortgage market is clearly very competitive and TD is comfortable operating in current market conditions by offering our customers both competitive rates and flexible mortgage options," TD spokeswoman Crystal Jongeward said.

Tamara Vrooman, CEO of Vancouver City Savings Credit Union (VanCity), one of the largest credit unions in the country, said customers have to be aware of the strings on mortgage offerings before they jump in. VanCity's advertised rate on a five-year fixed mortgage is 3.04 per cent.

"Consumers really have to be informed in terms of what the restrictions are on some of those mortgage products. It's not so much a flat-out race to the bottom as it potentially appears at the outset. So I always preach a little bit of caution when it comes to those mortgage rates," she said.