True North_

Looking for a Few Good Banks

Just a follow up on this article - here are the views (for what they are worth) of one of the Canadian analysts (Ian de Verteuil at BMO Nesbitt Burns). I offer for for consideration, and no more.

On collective loan losses by Canadian banks:

"From our perspective, we don’t believe that the peak levels of loan
losses will be much different than in the past. Better diversification
is good, but not if the recession is more broad-based (which it is). The higher consumer exposures should be a positive in Canada—unfortunately, more of the consumer books are now outside of Canada. The argument of the loan book being “higher quality” is hard to prove or debate. Our highly simplistic view is that it is hard to believe that, after 18 years in Canada without a recession, loan books have no excess. In summary, we estimate loan losses of over $16 billion in 2010."

On the potential risk to dividends:

"Dividend Concerns – Against a backdrop of rising loan losses,
and tough spreads, it is clear that the risk of bank dividend cuts
is rising. We would put that risk at 20% overall currently, with
BMO somewhat above this. Canadian banks [by which he means the big five ] haven’t reduced their dividends since the Great Depression and could well ride out the current storm by scaling back risk-weighted asset growth, implementing DRIPS and raising non-common capital. This could work, but if the economic outlook continues to deteriorate or if the recovery is further delayed, bank boards may well move to reduce payouts."

His top recommendations:

"Stock Picking Remains Difficult – We have traditionally been reluctant to change ratings excessively, but in a world of sharp price moves and a very tough overall market environment, we have succumbed with a downgrade of CIBC (Market Perform rated) and an upgrade of TD (Outperform rated). We still think the latter has challenges on its U.S. loan book, but with additional focus on balance sheet growth and internal capital generation, the banks should be able to ride out the storm. BMO (Outperform rated), despite the above-average risk of a dividend cut, is simply cheap in our view and should be able to hold value unless the charges are bigger than we expect."

If anyone wants to see his more technical discussion on capital ratios, let me know.

Looking for a Few Good Banks

A good review. Nice to see what's going on elsewhere in the Commonwealth as well. With respect to TD (or other Canadian banks), I would suggest some patience. TD was available for about US$26-28 over the course of the last quarter. I expect you will be able to pick it up in that range again over the course of the next year. Canada is lagging the US in this recession/depression; we'll probably see some brutal macro economic numbers over the next quarter or two, which will provide a buying opportunity for those looking to hold long. TD also has one of the lower dividend pay-out ratios based on current and projected earnings, which gives them more room if the recession/depression proves longer lasting than people are hoping (and the projections are so all over the map, it's hard to see it as anything more than hope).

From a US perspective, the other advantage is that owning either a Canadian or Australian bank provides some protection against US dollar devaluation. Canada increasingly seems to be considered a "commodity" currency: when the global economy emerges from the current train wreck, commodity prices will begin to increase (some may well spike because of the lack of current investment in exploration & production), and the Canadian dollar will likely appreciate against the US dollar (as it did in 2008).

On the issue of capital ratios - treat them with a bit of care because the numbers are not entirely comparable. Different countries have different standards / requirements for what constitutes tier 1 capital. Canada has recently moved to permit Canadian banks to use more perpetual pref shares as Tier 1 capital (I think it's moved from 25% to 40% of total tier 1 capital - which brings Canada more in line with other OECD countries). Consequently, over the past quarter there have been a number of pref share issuances, including two by the TD bank. I think it's fair to say that TD found its capital ratios under a bit of pressure last year as a result of the move to Basel II calculations of capital (the risk-weighted assessment methods), and its acquisition of New Jersey-based Bancorp.

For mdpath: the writer indicated that he is looking to go long on some bank stocks and this was his analysis before purchasing.

Canadian Banking System: An Oasis of Financial Calm

All financial companies are currently stressed; some more so than others. Canadian banks are doing well in a relative sense, but caution is warranted given that the global economic storm clouds ahead are hardly clearing. Most Canadian analysts have suggested that this will the the Banks' best quarter of the year and their results will deteriorate from here. Their Tier 1 capital ratios are generally pretty good (most have added to their capital bases over the fall/winter), and only BMO & CIBC have really material exposure to the toxic structured products markets. There is likely long term value, though as always the entry point can be a challenge. There are some tidy dividends and IF the earnings predictions are sound for 2009/10, they appear maintainable.

Two comments above: BMO has not cut its dividend; and the reference to the acquisition of Commerce Bank by TD was not (as suggested by Graham Burge: "Mr. Skousen pardon me if i am wrong but i disagree with your claim that the Toronto Dominion Bank owns the Imperial bank of commerce") a suggestion that they had acquired CIBC, but referred, of course, to their acquisition of US-based Commerce Bancorp announced in October 2007 and consumated in early 2008.

The Global War Against Shorts: Canada Bans Short-Selling

John's concern is valid - shorts play a important market role and confidence that the rules will not be dramatically altered without notice is critical to the proper operation of the markets in the long term. Redwood_12's point needs also to be considered, though, as naked shorts are a form of market abuse. They are tantamount to an investor "issuing" additional shares of a company, which is inappropriate. A pity the SEC hasn't moved on these more aggressively in the past, given their potential for abuse.

That being said, the OSC did not have much choice. If you read the order, the only stocks which are covered are those that are inter-listed between the US and Canada. If short selling of an inter-listed stock was banned in the US, then it also had to be banned in Canada. The OSC's aim, quite appropriately, is to prevent what they are calling "regulatory arbitrage" - a concern that seems real given the current circumstances.

Don't we live in interesting times?