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Canada's banks are finally getting some respect.
Derided for years as meek and mild while banks around the world expanded wildly, suddenly the reputation of Canada's big lenders as prudent and sometimes downright boring has become an asset instead of a liability.
U.S. President Barack Obama has heaped praise on the management of this country's financial system. Ireland is considering overhauling its system to look more like Canada's. Financial papers around the world are running headlines such as “Canada banks prove envy of the world.”
Whether measured by market value, balance sheet strength or profitability, Canada's banks are rising to the top. Since the credit crunch began in the summer of 2007, the Big Five banks have booked a total of $18.9-billion in profits.
In roughly the same period, the five biggest U.S. banks have lost more than $37-billion (U.S.). One, Wachovia Corp., was forced to sell out to avoid failing. Another, Citigroup Inc., long the world's largest bank, may have to be nationalized and this week became a penny stock. The picture is similar in Britain.
The U.S. has spent most of the $700-billion the government earmarked for bank bailouts, and there are estimates that the final tally could be more in the trillions of dollars. The head of the Bank of England said last month that it's “impossible” to know how much money it will take to fix his country's banks.
Canada, by contrast, has not had to inject capital directly into banks, other than starting a program to buy from banks $125-billion (Canadian) of insured mortgages – any losses from which the government was already on the hook for anyway.
The reason comes down to a fundamental conservatism. From lending practices to bets on trading to financial reserves and takeovers, the Big Five banks have long tended to be more careful than their global peers. And when they did want to get aggressive, government and regulators held them in check.
“The Canadian banks were under a significant amount of pressure from both the analysts and the marketplace in general to be more aggressive in expanding into international markets, particularly the United States, and I think to some degree resisted partially because of a more conservative approach,” says RBC chief executive officer Gordon Nixon.
Still, the industry has had stumbles, most notably Canadian Imperial Bank of Commerce's misadventure in derivatives, which led to a $2.1-billion loss for 2008.
And shareholders in Canadian banks have been battered. As a group, the banks' shares are down almost 50 per cent since Aug. 1, 2007, with most of the decline in the past six months as the economy worsened.
The concern weighing on these bank shares, for starters, is that profit growth in general is a thing of the past until the economy picks up. Most analysts say the banks' profits will shrink in coming quarters as more loans go sour and margins on lending tighten up. There's also nagging doubts that dividend payments are unsustainable and that something bad is still lurking on balance sheets.
More writedowns are likely in store for banks such as Toronto-Dominion Bank and Royal Bank of Canada, both of which made big acquisitions in recent years that now look overpriced.
Still, bank bosses such as Rick Waugh, CEO of Bank of Nova Scotia, say the banks are insulated from lingering problems because they have profits rolling in from many sources.
“We have made mistakes,” he says, “but we made sure that we were well diversified.”
That's a result of a conservatism not just among executives. That same approach extends to consumers, helping the banks sail along on the strength of their domestic lending businesses.
“You've got a more balanced cultural approach towards consumption and savings than we do in this country,” says Charles Dallara, head of the Washington-based Institute of International Finance, and a former managing director at JPMorgan Chase & Co.
Much of that stems from the pain of the last recession. While the downturn of the early 1990s was short and sharp in the U.S., it was drawn out in Canada, leading to more of a social evolution, says CIBC chief executive officer Gerry McCaughey.
Former central bank governor David Dodge agrees. Canadian bank executives keenly remember that period, “and there was therefore perhaps a degree of prudence, a lack of aggressiveness, in comparison with major banks around the world,” he said.
And he gives top marks to the Office of the Superintendent of Financial Institutions, Canada's banking regulator, for being more conservative than those in the U.S. or Britain. “I think that, from a regulatory point of view, you can say that the Canadian banks were more appropriately regulated.”
The final key is the structure of the mortgage market.
While U.S. banks sold a large proportion of their mortgages, Canadian banks held the bulk of theirs on their balance sheets, giving them an incentive to make sure they were good loans. Riskier ones are backed by government insurance. And the law here makes it tough for consumers to walk away from a mortgage because banks can go after other assets.
Still, the banks are wary of getting cocky when a careful approach has worked well.
“It's a good thing for us to recognize the things we do very well, but maybe do it in what is appropriately a Canadian way – with modesty,” said Bank of Montreal CEO Bill Downe.
Royal Bank of Canada
First quarter profit: $1.05-billion, down from $1.25-billion.
What's working: The bank's securities arm makes big bucks, and its huge retail bank in Canada generates steady earnings. RBC benefits from strong loan growth and expense control, notes UBS analyst Peter Rozenberg.
What's worrying: A foray into the U.S. leaves it exposed to the sagging American economy. Investors never like to see too much of a bank's earnings come from capital markets, because it's a volatile business. And while the securities division is doing well, it's also booking big writedowns. “RBC's Achilles heel, in Moody's view, is its U.S. operation,” the rating agency says.
What the CEO says: “As a Canadian bank with global operations, RBC does have a competitive advantage relative to many of our global peers. The fundamentals of our domestic economy, while stressed, appear stronger than in Europe and the United States, having benefited from a public policy agenda that for many years valued prudent fiscal management.”
Total assets: $713-billion
Tier 1 capital ratio (Jan. 31): 10.6 per cent
Provision for credit losses: $747-million, up from $293-million
First-quarter profit: $712-million, down from $970-million.
What's working: Retail arm TD Canada Trust is a dominant force across the country. “The bank's sizable capital cushion, combined with the recurring earnings from its Canadian franchise, leave it well positioned to manage through a period of economic headwinds,” says Moody's Investors Service.
What's worrying: TD expanded in the U.S. just as things were getting really bad. Now, the bank has the biggest U.S. retail banking presence of any Canadian bank – half of all the bank's branches are in the U.S. Plus, TD owns a big U.S. wealth management operation that may suffer as markets plunge. The consensus among analysts is that the bank's securities and trading side isn't big enough to make up for declining performance in other areas of the bank.
What the CEO says: “We are living in unprecedented times. So what we consider solid performance in the current environment is certainly not what we would be happy with in the long term. … We are going to take some bruises if the situation gets worse, but we're still going to be able to deliver solid earnings.”
Total assets: $585-billion
Tier 1 capital ratio (Jan. 31): 10.1 per cent
Provision for credit losses: $537-million, up from $255-million
Bank of Nova Scotia
First-quarter profit: $842-million, up from $835-million.
What's working: The bank's international business – the largest of the Canadian banks – posted a record quarter, and Scotiabank's reputation for risk management remains intact. The bank's securities and trading arm, Scotia Capital, had a near-record quarter.
What's worrying: Investors are leery of exposure to car loans and the auto industry. They are also keeping an eye on the bank's corporate loan book, the biggest of any Canadian bank.The bank's large international division, with a big presence in Latin America, was much more profitable than anticipated in the latest quarter, but the macro environment in Latin America has deteriorated in recent months, notes RBC Dominion Securities analyst André-Philippe Hardy.
What the CEO says: “The banking sector in Canada is still in good shape. Some say the best in the world. As a group, we are all very well capitalized by global standards. And Scotiabank clearly demonstrated this by the fact that we were able to raise more capital this quarter, all of it from the market, from private sources.”
Total assets : $510-billion
Tier 1 capital ratio at Jan. 31: 9.5 per cent
Provision for credit losses: $281-million, up from $111-million
Canadian Imperial Bank of Commerce
First-quarter profit: $147-million, up from a loss of $1.46-billion.
What's working: Most of the big problems relating to exposure to subprime-linked investments are behind the bank, and its balance sheet is rock solid after raising another $1.6-billion of capital this week. Analysts and investors like the fact that its Canadian-focused business means bad U.S. loans aren't a big issue.
What's worrying: The bank is getting out of or cutting back in so many business lines to avoid problems that it's unclear where growth will come from. Investors worry that the bank is becoming so risk-averse that it won't be able to compete.
Its core consumer lending segment saw earnings decline 14 per cent in the latest quarter, due in large part to rising provisions for bad credit card, manufacturing and real estate loans, notes Blackmont Capital analyst Brad Smith.
What the CEO says: “Market conditions worldwide for banks remain difficult. Yet arguably one of the better places to be right now is in Canada. At CIBC, the majority of our revenue is derived from retail markets, where we enjoy strong market positions in a broad range of products and services.”
Total assets: $354-billion
Tier 1 capital ratio at Jan. 31: 9.8 per cent (it's now a whopping 11.5 per cent)
Provision for credit losses: $284-million, up from $172-million
Bank of Montreal
First-quarter profit: $225-million, down from $255-million.
What's working: The bank's trading operations are buoying profit, and its retail operations are rebounding after lagging for years. A switch toward more profitable products, such as lines of credit, is helping the core operations churn out strong earnings.
What's worrying: Investors are concerned that trading profits can disappear fast, and the bank has a U.S. loan portfolio by virtue of its presence in the U.S. Midwest. There's also a nagging worry that the bank will cut its dividend that won't go away no matter how many times CEO Bill Downe says the payout is safe.
Credit Suisse analyst James Bantis is watching for rising credit losses in the $42-billion (U.S.) U.S. loan portfolio. He sees a large drop-off in the quality of the U.S. portfolio, which accounts for 27 per cent of BMO's loan book, compared to the Canadian portfolio.
What the CEO says: “Financial institutions everywhere continue to face headwinds in credit markets and the capital markets environment. BMO is well positioned to meet these challenges, having accessed markets to bolster our capital position and having further strengthened our strong liquidity in the period, albeit at a higher cost.”
Tier 1 capital ratio at Jan. 31: 10.21 per cent
Total assets: $443-billion
Provisions for credit losses: $428-million, up from $230-million