Canadian banks are on the hunt for new ways to raise profits as a sluggish environment looms in the coming year, with persistent low interest rates expected to take their toll.
For now, the banks have continued to churn out growing profits. Toronto-Dominion Bank, Canadian Imperial Bank of Commerce, and National Bank of Canada all reported strong increases in earnings Thursday.
But to maintain that steady rate of growth, the banks have had to depend increasingly on other factors, such as cost-cutting. As bank bosses warn of a stagnant year ahead, particularly as mortgage growth in Canada starts to slow, they are also seeking acquisitions beyond Canada and in businesses like wealth management to bolster their balance sheets.
TD became the latest to expand its wealth management business Thursday, paying $668-million (U.S.) to take over U.S. asset manager Epoch Holding Corp. That deal is one of more than a half-dozen wealth management acquisitions Canadian banks have made in roughly a year, designed to inject growth into their operations.
"We have taken an important step forward with our growth strategy," TD chief executive officer Ed Clark said. "This deal will strengthen TD's wealth management business in Canada and can be a pillar of our developing U.S. wealth strategy."
At the same time, Mr. Clark said the bank will continue to focus on keeping costs in check, as low interest rates make earnings growth harder to come by. "That is a must in today's economic environment," Mr. Clark told analysts on a conference call.
The concerns about slowing growth belie the profits three of Canada's biggest banks reported Thursday. TD, Canada's second-largest bank, unveiled a $1.6-billion profit for the fourth quarter, up slightly from last year. CIBC, the country's fifth-largest lender, made $852-million, up 13 per cent. And National Bank, the sixth-biggest, reported a 20-per-cent increase in profit to $351-million.
However, analysts note that the profit increases at the banks have started to become what's known in the markets as "lower-quality" earnings. That is, profit that is derived from cost-cutting or lower taxes in the quarter rather than reliable revenue growth from their various lending operations. So while several banks have reported record quarters, there is concern about whether that is sustainable in the year ahead.
The biggest challenge the financial sector faces is persistent low interest rates, which are eating into the margins between what they make on loans and what gets paid out on deposits.
The Bank of Canada acknowledged Thursday that its steady diet of rock-bottom interest rates – and similar policies by other central banks – is making it difficult for the financial sector to boost earnings. However, the central bank said the low rate problem is much more of an issue for life insurers and pension funds than banks. The problem facing life insurers is that they are continually reinvesting cash at lower interest rates than when they first sold various long-term policies to consumers.
However, the Bank of Canada said it is concerned that low rates are making some companies vulnerable to losses, while pushing others to take risks in the pursuit of higher returns. "The direct effects become larger the longer the low-interest-rate environment persists," the central bank warned in its twice-yearly snapshot of risks to the Canadian financial system.
That has forced insurers to do more hedging, scrap some products and re-price others. But the bank worries it may also spur some insurers and pension funds to take on "excessive risk ... in search for yield."
Governor Mark Carney and other top bank officials have previously warned about the problem facing life insurers around the world. But it's the first time the Bank of Canada has explicitly highlighted the challenge facing Canadian insurers. For the banks, the low-interest-rate problem means working harder to squeeze profits out of every quarter, rather than chase riskier growth strategies.
Gerry McCaughey, the CEO of CIBC, said his bank has spent the past few years stripping risk out of CIBC's operations, "to deliver consistent and sustainable earnings. We believe this is the right strategy for this environment, and we believe it is a strategy that will be proven to do well in years to come."
Mr. McCaughey said the sector will face slower profit growth in 2013, echoing comments made by other bank CEOs, who warned that the pace likely won't stay as strong. "Looking forward, it appears the current headwinds that are negatively impacting industry profitability, such as lower interest rates and a slowdown in consumer credit growth, will continue to be with us in 2013," Mr. McCaughey said.