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Betting on Canada's Best Banks

Companies / Banking Stocks Feb 15, 2012 - 06:38 AM GMT

By: Roger_Conrad


Best Financial Markets Analysis ArticleBetting on Canada's Best Banks

Will Europe resolve its sovereign debt crisis and return to growth in 2012? Or will, as so many fear, the Continent’s economic unity dissolve and its banking system and common currency collapse, dragging the rest of the world into another recession?

Is the US banking system at last stable and ready to lend? Or will the legacy of the great American housing collapse keep the US banks and therefore the economy stalled?

And what about Australian banks, which Fitch--perhaps the only credit rater left with real credibility--put on ratings watch negative in late January?

Will their reliance on European and American wholesale funding trip them up this time around, pushing the country into a recession it miraculously avoided in 2008-09?

This year’s global stock market rally has pushed these questions off the front pages for now. But the threat they pose continues to lurk below the surface. And so long as Greece is still dancing on the edge of default, US housing prices are lagging and credit raters are on the warpath to avoid looking foolish again, they’ll remain a constant danger to derail global growth and to send stocks reeling--just as they have so many times since the recovery began in March 2009.

Conspicuously missing from the ranks of vulnerable financial institutions, however, are Canadian banks. In the same report it put Aussie banks on watch, for example, Fitch actually affirmed the health of Canada’s institutions.

One reason: Sharply lower reliance on “wholesale funding” from major US and European banks than, for example, Australian banks have. Wholesale funding is essential to liquidity, and greater reliance on homegrown sources simply makes Canada that much more resistant to external credit shocks.

Several Canadian banks do have major investments overseas. For example Bank of Nova Scotia (TSX: BNS, NYSE: BNS)--commonly known as Scotiabank--last month closed the purchase of a 51 percent stake in Colombia’s Banco Colpatria for CAD1 billion in cash and shares. The bank now operates in 13 countries across Latin America. Toronto-Dominion Bank’s (TSX: TD, NYSE: TD) head of wealth management Mike Petersen last month called the US a “wealth opportunity,” as the company continues to expand its deposits and loans presence here.

Foreign investments do expose their owners to the ups and downs of foreign economies. But unlike reliance on wholesale funding, they pose little risk to the home operation. In fact Royal Bank of Canada (TSX: RY, NYSE: RY) has been able to withdraw from its poorly managed US banking investment even while boosting its quarterly dividend 8 percent last year. Moreover, the apparent revival of the US economy--and its salutary effect on Latin America--should make these investments a growing profit center in 2012.

As for the health of Canadian banks at home, the industry’s loans-to-deposits ratio has fallen for the past decade and currently sits somewhere around 0.75-to-1, meaning deposits are consistently rising as a percentage of total loans. That’s an exceptionally conservative trend and stands in stark contrast to Australian banks’ 1.5-to-1 ratio as well as an average for the largest global banks that’s consistently above 1-to-1.

Deposits-to-total funding are also far higher in Canada than elsewhere. Canada’s net external debt as a percentage of GDP is by far the lowest of any major developed country. Finally, the country’s housing market is still in the pink of health, with average housing prices up more than 20 percent since 2007, versus steep declines in many countries.

Worries that Canada’s housing market has run too far too fast have begun to percolate in the country’s financial press. In fact, the consensus forecast seems to be for a slowdown, with some predicting an outright crash should Europe’s troubles worsen and shut down the global economy.

Canadian households’ debt-to-income ratio, for example, has risen to 153 percent, as consumers and businesses have taken advantage of low interest rates to use leverage as never before. Fitch also noted in its report that some of Canadians’ “personal loans” are secured against housing.

The combination of rising debt and rising property prices has sparked speculation about what could happen should credit conditions suddenly tighten. Some worry about a potential vicious cycle of falling prices and foreclosures as has happened in the US since 2006.

Of course, none of these are immediate concerns for Canada’s banks, which are making record profits for everything from loans and deposits to wealth management. And so long as there is a gloomy consensus, we can all but rule out the kind of wrong-way leverage that makes a 2008-magnitude crash possible.

The fact that Canada’s bankers are talking about such issues means they’re preparing for such a possibility as well. Last month, for example, Bank of Canada Governor Mark Carney warned Canadians need to become “more careful” about the amount of debt they take on. And Scotiabank has launched a marketing campaign urging, in the words of one executive, a “need to get back to saving and get back to debt reduction.”

It’s hard to imagine a greater contrast to the marketing by US banks on the eve of the great property meltdown of the last decade. And Canada’s big banks have matched those words with deeds.

For one thing, even as mortgage rates have fallen underwriting standards for loans have remained quite stringent. The subprime loan market was less than 3 percent of total Canadian mortgages going into the 2008 meltdown and is basically negligible today. And putting up at least 20 percent of a home’s value in a down payment is the rule in Canada rather than the exception, the opposite of what is all too often the case in the US.

Canadian regulators have also established higher capital requirements for Canadian banks than those specified under Basel accords. The big banks are borrowing at the lowest rates in recent history, pushing out debt refinancings and cutting interest costs. And as Scotiabank’s CAD1.5 billion share offering announced this month attests, the cost of equity capital also remains quite low, particularly compared with major banks elsewhere around the world.

Check out my free report, Canadian Income Trusts after the 2011 Conversion, for more on investing in Canada’s top companies.

Roger Conrad is the preeminent financial advisor on utility stocks and income investing. He is the editor of Big Yield Hunting, Australian Edge, and Canadian Edge, as well as Utility Forecaster, the nation's leading advisory on electric, natural gas, telecommunications, water and foreign utility stocks, bonds and preferred stocks.

Mr. Conrad has a track record spanning three decades, delivering subscribers steady double-digit gains of 13.3% annually since 1990. And he’s done it all with a focus on capital preservation and risk minimization by investing in big dividend stocks including Canadian Income Trusts, high-yield REITs, MLP investments, among many others.

Mr. Conrad has a Bachelor of Arts degree from Emory University, a Master's of International Management degree from the American Graduate School of International Management (Thunderbird), and is the author of numerous books on the subject of investing in essential services, including Power Hungry: Strategic Investing in Telecommunications, Utilities and Other Essential Services

© 2012 Copyright Roger Conrad - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

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