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analysis

CIBC reported a shrinking net interest margin, falling seven basis points quarter-over-quarter.Fred Lum/The Globe and Mail

Nine months into a supercharged cycle of interest rate hikes, Canada’s largest banks are starting to benefit from higher loan margins. Canadian Imperial Bank of Commerce CM-T, however, is not, and confusion over why the lender is such an outlier is hitting its share price.

For years, Canada’s banks have stressed that rising interest rates would not be disastrous for their bottom lines. Although their blistering loan growth would likely slow, executives said the lenders could make more money off each individual loan. As rates rise, loan margins – or the amount made per loan – tend to increase.

That scenario is now playing out for heavyweights such as Royal Bank of Canada RY-T and Toronto-Dominion Bank TD-N. The lenders reported net interest margins – a measure of the difference between what it costs a bank to borrow money and the rate at which it lends that money out – that expanded by six basis points and five basis points, respectively, in the most recent quarter. (A basis point is one-hundredth of a percentage point.)

While these gains may seem minuscule, they are multiplied by hundreds of millions of dollars’ worth of assets – an almost invisible undercurrent with a massive impact.

CIBC, meanwhile, reported a shrinking net interest margin, falling seven basis points quarter-over-quarter. This margin is now also two basis points lower than it was one year ago, when interest rates were still near zero.

CIBC isn’t the only bank in this boat; Bank of Nova Scotia’s BNS-T margin is also shrinking. But Scotiabank was already struggling to win over investors after a string of uninspiring profits and a change in the corner office that was unexpected. CIBC, meanwhile, mostly caught people off guard – and the last thing investors want in turbulent markets are surprises.

It didn’t help either that CIBC chief executive officer Victor Dodig and chief financial officer Hratch Panossian struggled to explain what exactly is going on.

CIBC’s shrinking margins are “quite perplexing,” Barclays analyst John Aiken wrote in an e-mail. Although management offered some commentary on why the bank is trailing its peers, “we do not believe the discussion on the call adequately explained the [difference].”

CIBC’s shares are down 9 per cent since the earnings were announced. The bank declined to comment for this story.

The bulk of CIBC’s loan-margin woes come from its Canadian personal and commercial banking arm – and some are the by-products of decisions made five years ago. Around 2017, CIBC aggressively pursued growth in its mortgage business, so much so that its mortgage book grew at double the rate of the industry average.

The decision originally got the bank in hot water because home prices fell in Toronto and Vancouver in 2018, and investors fretted about mortgage defaults. The issue today is mortgage renewals. Most mortgages come due every five years, which means CIBC has a good chunk of them up for renewal now and early next year. While mortgage rates have jumped dramatically, growth in the mortgage business has slowed considerably. That’s made the banks much more competitive when it comes to pricing these loans above the cost to fund them.

Slowing mortgage prepayments are also a factor. When interest rates were falling, borrowers often found it beneficial to break their mortgage, even though it required paying a hefty fee, because they could take out a new loan at a much lower rate. Prepayment fees are considered interest income, which helps to boost the net interest margin.

While this dynamic is hitting all the banks, CIBC’s balance sheet is heavily weighted to Canadian residential mortgages, relative to most peers, so it feels the impact more acutely.

The rest of CIBC’s margin woes can be traced to a litany of variables. For one, the bank has a smaller proportion of personal banking deposits than RBC and TD. Chequing accounts are extremely beneficial to banks in rising rate environments, because they pay the account holders paltry interest rates, while the banks earn more and more on each loan funded by these deposits. This difference, or spread, boosts profits.

Although CIBC has been trying to expand its deposit base, and is seeing some success, its loan growth was the slowest of the Big Six banks last quarter. In other words, it is having a tougher time actually lending that money out, for various reasons, and the return it is getting for parking this money at the Bank of Canada is much lower than it would receive on a loan.

CIBC’s executives have stressed this isn’t a permanent trend. And unlike Scotiabank, which said its balance sheet is structured such that loan margins likely won’t expand until rates fall, CIBC does see improvements next year. “You will see a better trajectory in the back half [of 2023] than the first half,” Mr. Panossian said on the bank’s quarterly conference call.

But that means there will be a few more quarters of pain, and in these markets investors are on edge and ready to jump at the first sign of trouble. A good chunk of CIBC’s have already done just that.