Will Steve Eisman's Big Short On Canadian Banks Become The Big Hurt?

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Includes: BBCA, BNS, CM, EWC, FCAN, FLCA, HEWC, LRCDF, QCAN, RY, TD
by: Dale Roberts
Summary

Steve Eisman is famous for his role in calling the US financial crisis, and he provided the storyline for the film The Big Short.

He could see the obvious real estate house of cards leading into the US financial crisis, and he profited handsomely.

Mr. Eisman has been calling for rough times for the Canadian banking sector. He's mostly been wrong to date.

Mr. Eisman dares to go where shorts get hurt - the big Canadian oligopoly banking sector.

Canadian analysts and bankers say he simply does not understand our banking sector.

Off the top let's get my big Canadian bank and home bias out of the way. I am a Canadian who has worked for Canadian banks. I am still an investor in the three largest Canadian banks - Royal Bank of Canada (RY), Toronto-Dominion Bank (TD) and Scotiabank (BNS). I added monies recently when ironically I had a retirement group plan fund transfer arrive from Tangerine, a division of Scotiabank. Here's What I Did With The $42,000 That Arrived In My Retirement Account.

From that article, you'll see that I have a combined 25% of my RRSP retirement fund (think IRA/401(k)) in Canada's three largest banks.

Those monies had been invested in what I liked to call Tangerine's Big Juicy Dividend Portfolio.

My wife's accounts hold all of the Canadian banks as we use a Canadian High Yield Dividend ETF and a (Toronto Stock Exchange) TSX 60 ETF.

Steve Eisman's Big Hurt.

While not a new venture, Mr. Eisman went on BNN Bloomberg to once again lay out his thesis for shorting the big Canadian banks. Many Canadian analysts and bank CEOs and executives were quick to respond and mostly jumped all over Mr. Eisman's assertions with what they saw as errors and misstatements and omissions of relevant facts.

But first off let's get to the "star" of The Big Short and his take on Canada's big banks and the Canadian debt and real estate story.

Here's the Eisman interview on BNN Bloomberg.

Out of the gate, Mr. Eisman states that he is NOT calling for the Big Short Canadian edition. He is calling for a correction in the banks and in the Canadian real estate sector. He feels the Canadian balance sheets are not prepared for any meaningful real estate and mortgage market correction. He also feels that the Canadian economy is weak.

Mostly, Mr. Eisman takes issue with the Canadian banks' loan loss provisions, and mostly their stage 1 provisions that they have scaled back. Mr. Eisman states that the "scale back" was responsible for the boosted earnings in 2018 over 2017. He suggests that balance sheet move was responsible for 90% of earnings gains year over year.

And once again he is not calling a banking sector Armageddon similar to what happened in the US financial crisis. When pressed, Mr. Eisman suggested we might see stock price declines of "20% plus". There's going to be no need for a bailout. He admits to the oligopolistic nature or Canadian banks as per Australia where we see friendly regulators.

It's nice to know that Mr. Eisman's "attack" on Canadian banks is nothing personal. He states that we Canadians are very nice. He even comes up to Canada twice a year. I'll add - that's nice.

Where Mr. Eisman falls short

In the Bloomberg interview, Mr. Eisman stumbled a few times. Many of the mortgages that the banks hold are covered by insurance. Mr. Eisman stumbled to find the name of the body that covers those mortgages; it's called the CMHC - the Canadian Housing and Mortgage Corporation. He stumbled for a few seconds trying to find the name and settled for "Canadian Government". And actually the CMHC is a Crown Corporation. Canadians who put down less than 20% of the initial home purchase price must have the mortgage insured.

And Mr. Eisman missed an opportunity to mention where CMHC is taking on additional risks. In an attempt to help new homeowners, the CMHC is even taking an ownership position for new builds. That certainly increases the risks. The CMHC has actual skin in the game.

On the uninsured mortgage book, Canadians are usually very solid on that front. We like to own our homes.

Here was perhaps the most troubling statement or claim:

"There isn't a Canadian bank CEO that knows what a credit cycle looks like." - Steve Eisman

Actually all of the current CEOs were in senior positions in the banks in the real Big Short Correction of 2007-2009 and one of the CEOs more than knows what a credit cycle looks like; he lived the last cycle as CEO.

He went on to say that psychologically the Canadian banks CEOs are ill prepared. Good thing to know he is also a psychologist and has had those Canadian bank CEOs lie down on the couch to pour their hearts out. :)

For the record Mr. Eisman and/or his firm is short Royal Bank, CIBC (CM), and Laurentian Bank (OTCPK:LRCDF).

The managing director at National Bank suggests Mr. Eisman's thesis is nonsensical

Here's the page with many of the response videos from analysts and CEOs of the big Canadian banks.

Gabriel Dechaine says Steve Eisman's thesis is nonsensical.

Again, Mr. Eisman's main theme is that the Canadian banks are lessening loan loss provisions when in actuality, according to Mr. Dechaine, when you factor in all stages of loan loss provisions, they were increased last year for the Canadian banks as a whole. Mr. Dechaine also states that loan loss rates are at a historical low.

Mr. Eisman's call is that loan loss rates will increase to levels that were not even seen in the Financial Crisis. On one hand he's not calling for anything close to a Big Short replay, but with some metrics, he calls for a Canadian scenario that is worse than the Financial Crisis.

That just doesn't seem to add up.

No matter what happens, if the big Canadian banks fall 20% or more, so what? If you're a long-term investor who adds monies on a regular schedule, you will be able to buy these wonderful, long-term oligopoly investments when they go on sale. If you need the banks to help fund retirement, those generous dividends might continue to do the trick.

What do you think? How does this short call end? Will the Canadian National Film Board one day release The Big Short, Canadian Style, or will this short go Up In Smoke? Mike at the Dividend Guy (a former Canadian banker and advisor) states that he's not really buying the short thesis.

Author's note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. If you liked this article, please hit that "Like" button. Hit "Follow" to receive notices of future articles.

Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, BLK, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.