The June issue of Bloomberg Markets discusses the results of its second annual report on the World’s Strongest Banks. Not surprising is the fact that not one American bank makes the top 10 and only three make the top 20. Surprising is that Canada — with a tenth the population of its biggest trading partner — has four in the top 10 and six in the top 22. Its dominance of the rankings is even more amazing when you consider there are just eight publicly traded banks north of the border.
It turns out Canada is more than hockey pucks, beer and maple syrup.
Canada’s banking system is successful because it is national in scope, protecting against regional downturns in different parts of the country. All six of the banks mentioned in Bloomberg’s report operate across the country, lending on a case-by-case basis to those who have the capacity to repay their loans.
There are two bank regulators in the country: the Office of the Superintendent of Financial Institutions, which ensures the banks are operating appropriately and the Financial Consumer Agency of Canada, which helps Canadians become financially literate. Living here, I can tell you it’s not perfect by any means. However, it does provide most Canadians with the ability to bank anywhere in the country with relative ease. The same can’t be said about the U.S.
A recent Forbes article highlights the differences between the two countries when it comes to banking practices. In Canada, we have been using debit cards for what seems like an eternity. In fact, 94% of Canadians have one. In the U.S., that number is somewhere around 70%, though it’s difficult to get an accurate count.
The fees charged by banks for debit card use in the past has made them less attractive for average Americans, and Forbes points out that you aren’t protected to the same extent as you are with a credit card should someone use it fraudulently. Again, in Canada, the banks tend to protect victims of debit card fraud in virtually the same manner they would credit card fraud. It’s not that Canada’s banks don’t make money from service fees, it’s just that they are more closely regulated.
To understand the difference between a Canadian bank and a U.S. bank, I’ll examine how Canadian Imperial Bank of Commerce (NYSE:CM) — the third-strongest bank, according to Bloomberg — compares with JPMorgan Chase (NYSE:JPM), the 13th strongest.
If you have a look at Bloomberg’s report, you’ll see that of the five factors that went into the rankings, CIBC had better scores on three occasions; only in the case of loan-loss reserves to nonperforming assets did JPMorgan Chase have a better score. However, Tier 1 Capital to risk-weighted assets — which played a big part in the most recent stress test results by the Federal Reserve — has CIBC at a ratio of 14.7%, 240 basis points higher than JPMorgan Chase.
Since January 1999, at the request of OFSI, Canadian banks have been putting aside at least 10% of their total capital to protect against loan losses. Interestingly, CIBC is the top Canadian bank on the list despite $10 billion in writedowns (the most of any Canadian bank) related to the U.S. mortgage crisis of 2007. On the flip side, CIBC also was one of the first banks to shore up its balance sheet, selling almost C$3 billion in stock nine months prior to the collapse of Lehman Brothers.
Canadian bankers tend to be risk-averse. So much so that there’s a saying about them: “They’ll lend you an umbrella, but only when it’s 80 degrees and sunny outside.”
Where Canadian banks are most vulnerable, in my opinion, is regarding residential mortgages. You see, in Canada, any mortgage with less than a 20% down payment must have mortgage insurance before it will be approved. In many cases, this mortgage insurance is supplied by the Canadian Mortgage and Housing Corporation, an agency run by the federal government. In recent years, the growth in CMHC-insured mortgages has ballooned to more than $500 billion of the $1.1 trillion in residential mortgages existing in Canada. That alone has had an upward effect on house prices.
So concerned is the federal government about the rising levels of mortgage insurance on its books that it has had the OFSI take over regulating the agency, hinting that it will get out of the mortgage insurance business altogether. If that happens, you can be sure Canadian banks will lose one of their major domestic revenue and profit generators. If so, they won’t appear nearly as attractive.
The Canadian banks you want to focus on are those growing internationally. Canadians have one of the highest debt-to-income ratios in the world, and eventually that problem is going to come home to roost. It’s not that I think we’ll have an economic meltdown like the one experienced in the U.S., but Canadian banks won’t be able to rely on the tried-and-true methods used to generate profits in the past because we’ll be forced to trim our debt.
The three banks that have made the biggest strides outside Canada are:
- TD Bank (NYSE:TD), which now has branches up and down the entire east coast of the U.S. Its stock is up about 10% year-to-date
- Bank of Montreal (NYSE:BMO) acquired Marshall & Ilsley for $4.1 billion in 2011, doubling the number of branches it operates through its U.S. subsidiary, Harris Bank. Its stock is up 7% year-to-date.
- Bank of Nova Scotia (NYSE:BNS) has the best model of international expansion, choosing to compete in Latin America and Asia, rather than the hyper-competitive U.S. markets. In Mexico alone, Bank of Nova Scotia has 710 branches and $9.4 billion in outstanding loans. Travel anywhere in the Caribbean, and you’ll see BNS’ red-and-white bank signs. Its stock is up more than 7% year-to-date, and BNS has a current yield of almost 4%.
All three banks are well run. However, I find Scotiabank’s business model the most durable and sustainable. The company understands emerging markets, and that’s where the real growth is.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.