Canadian Western Bank hit by tough margins

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Stubborn net interest margins keep stifling Canadian Western Bank's stellar loan growth.

Though the bank reported solid second-quarter earnings Thursday morning, investors were left wondering what could have been. Total loan growth jumped 12 per cent from the year prior, but the bank also saw a 16 basis point reduction in its net interest margin – the difference between the rates at which it borrows and lends money.

The drop is particularly frustrating for CWB because the bank isn't as exposed to retail clients who are feared to be curbing their borrowing as home sales slow and credit card debt soars, and is instead traditionally a commercial lender.

In other words, CWB isn't as exposed to the slowdown. However, the bank is now making a good chunk less on each loan and that's got investors a bit spooked because no one knows how the next few quarters will shake out.

Net income in the second quarter was down 5 per cent from the first – though CWB said that had more to do with higher expenses and a shorter quarter – and the bank admits that the margin environment isn't going to get better anytime soon.

"We expect net interest margin will continue to be constrained and achieving meaningful improvement in this measure over the near-term will be difficult," CWB said in a statement.

To offset this, "management remains focused on mitigating margin pressures through an emphasis on achieving higher relative growth in better yielding loan portfolios, improving the deposit mix to lower the overall cost of funds, increasing the level of contributions from other income and prudently managing liquidity levels."

The problem is that CWB and other small banks can only do so much on these fronts – whereas the big banks can start leaning on capital markets or international operations to make it through the storm.

Laurentian Bank faces the same problem. Its profit was up from the same period a year ago, but the boost actually stemmed from its acquisition of AGF Trust and core operations came in worse than the second quarter of 2012. The longer this uncertainty drags on, the less confidence investors will have. Coming out of the crisis CWB was the hot stock and everyone piled in. But now it's off more than 10 per cent from this year's peak and down again Thursday morning.

To be clear: right now the situation isn't dire. Analyst Andre-Philippe Hardy at RBC Dominion Securities noted that CWB's industry-leading loan growth more than offset the margin pressure. But the headwinds are certainly something to track.

(Tim Kiladze is a Globe and Mail Reporter.)

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