# Canadian Banks



## AnonymouslyInvesting (Nov 29, 2016)

Most of the big banks reported fairly solid numbers for 4Q2016. The effects of the recent interest rate rally won't be felt until next quarter and beyond. As of last quarter, the capital ratios of all of the big 6 banks were fairly solid, despite BMO having to revise their Tier 1 Capital Ratio downwards due to an oversight in Basel I rules. Using the minimum allowable leverage ratio, the approximate balance sheet expansion would mean that BNS and RY have the most room for expansion, possibly in the form of M&A.

Mortgage growth is expected to slow to about half of what it was earlier this year given the new Government of Canada and Office of the Superintendent of Financial Institutions (OSFI) rules regarding higher capital requirements for insurers. The new rules, which came into effect on October 17th, require all insured homebuyers (those with less than a 20% downpayment) to qualify at a hypothetical interest rate of 4.64%. The rules apply for 5 year fixed mortgages, which comprise about 67% of new mortgages. Given that this is a new requirement, most of the effects won’t be felt this quarter. While these changes will curtail future growth, they are positive from a credit standpoint at a point in time when Canadian debt-to-income stands at a record high of 167.6% (mortgages represent about 66% of household debt).

Going forward, the Department of Finance is also considering modest lender risk sharing on insured mortgages that would see one of two scenarios:

First-Loss Approach – banks would cover the first loss on defaulted mortgages up to a certain amount, say 5% of the outstanding loan amount
Proportionate-Loss Approach – where banks would cover a set percentage of the loss

The mortgage changes are primarily meant to cool down the hot housing markets of BC and Ontario (ON). National bank has the highest level of insured mortgages on their books, while CIBC has the highest exposure to BC and ON (see below). TD and BNS have slightly higher levels of insured mortgages than the group average, and also have a higher exposure to BC and ON. Therefore, I would remain cautious on these names until the effects of the rule changes become clear.

Credit investors of the Canadian banks should also be cautious, not just because of the aforementioned rules, but because of other legislation. The big 6 banks have been classified by OSFI as ‘Domestic systemically important banks (D-SIBs). There is currently ‘Bail-In’ (Bill C-15) legislation on the table that would allow CDIC to temporarily take control of a bank in extreme circumstances of financial distress and force a mechanism to legacy subordinated debt that would essentially call the bonds and issue bondholders common shares (the mechanism is very similar to new Non-Viable Contingent Capital issues). Currently issued NVCC debt historically trades about 60 basis points wider than the legacy sub-debt, but if the Bail-In legislature passes (expected to in Spring 2017), this gap could narrow. There is currently about $12.1 Billion of legacy sub-debt outstanding.

Canadian banks have been using covered bonds (bonds issued that have assets set aside in a pool to collateralize the debt) as a significant funding source over the past few years. However, OSFI has a mandated maximum of 4% of adjusted assets as an issuance cap, and the banks are getting close to that limit with ~$143B outstanding, up from $109B at the beginning of the year, and a maximum amount of $180B. The banks have been issuing this debt primarily outside of Canada, where interest rates are considerably lower than Canadian rates. Covered bonds are attractive because they are excluded under the potential bail-in regime and have attractive Basil III liquidity classification (only take a 15% collateral haircut in the Liquidity Coverage Ratio (LCR) calculation).
Since the banks are getting close to the limit on covered bonds, I would expect to see more ‘975’ pool type National Housing Association MBS issues. These require qualifying issuers to securitize their fixed rate residential mortgages. Their underlying collateral is a discrete pool of fixed rate amortizing mortgages on residential properties. They will improve the funding profile from NVCC debt, but will have higher interest rates than covered bonds because there is principal prepayment risk (max of 20% per year). However, there is no OSFI limit on NHA MBS issuance, they classify as a zero risk-weighted asset class under Basel III and qualify as Level 1 or 2 of the high-quality liquid assets (HQLA).

Fixed floater (FF) bonds classify as Tier 2B capital as they have a limited life (Tier 1 is permanent capital), and are the cheapest form of this capital classification. They are issued with a 5 year fixed coupon, are callable at that time, and then change to floating rate coupons for the last 5 years. These have traditionally been issued with competitive fixed rate coupons but carry high floating rate spreads. This has caused them to be called after the 5 year fixed period. The new regulations have forced banks to issue these with more competitive floating rate spreads, and thus there is a greater likelihood that banks will leave these issues outstanding as floaters for their remaining life.

The banks have had a big year after loan losses, which were feared to be significant in Western Canada, were less than expected. Rising interest rates will definitely benefit NIMs, but a slowdown in housing resale rates in BC and ON may cause some headline risk going forward. Valuations went from relatively cheap earlier in the year to roughly their 5 year average. While there may be further upside expansion and return potential, we are likely in the 7th or 8th inning and I would be cautious adding new positions here.

There are detailed graphs and charts on my website post.


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## redsgomarching (Mar 6, 2016)

I liked one analyst's view on BNN. Basically buy the lowest performer of the big banks and the next year it generally is the reverse. Example, a few years ago it was CIBC and they jumped back, last year it was Scotiabank and this year Scotia jumped back. This year I picked up RBC and will hold for a year.


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## Just a Guy (Mar 27, 2012)

So if I understand what you are saying...

long story short, banks have made a lot of money, and seem to be on track to make a lot of money, but there may be some risks, so they may not make a lot of money.

Just said with a lot more words (and some big words to sound educated) and a few tidbits to justify why each scenario may happen...


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## yyz (Aug 11, 2013)

Or promoting his blog/website


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## pastorash (Feb 3, 2014)

I smugly sold a portion of my NA stock last Friday for a 31.2% gain in 10 months to fund another purchase. It's now up 39.8%. 

When will I learn...


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## indexxx (Oct 31, 2011)

pastorash said:


> I smugly sold a portion of my NA stock last Friday for a 31.2% gain in 10 months to fund another purchase. It's now up 39.8%.
> 
> When will I learn...


The point is, we CAN'T learn because it's predicting the future! Bears and bulls make money, hogs get slaughtered, and you made a great decision to lock in excellent gains..


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## pastorash (Feb 3, 2014)

indexxx said:


> The point is, we CAN'T learn because it's predicting the future! Bears and bulls make money, hogs get slaughtered, and you made a great decision to lock in excellent gains..


lol, 40.5% now, time to sell the rest? (Just kidding!! Enjoying the good yield rate which is more of why I bought it in the first place)


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## Argonaut (Dec 7, 2010)

redsgomarching said:


> I liked one analyst's view on BNN. Basically buy the lowest performer of the big banks and the next year it generally is the reverse. Example, a few years ago it was CIBC and they jumped back, last year it was Scotiabank and this year Scotia jumped back. This year I picked up RBC and will hold for a year.


I do like this strategy. With the banks there is a lot of mean reversion. On the other hand, there's something to be said for holding 1-3 of them long term and not worrying about it.


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## jaybee (Nov 28, 2014)

Just a Guy said:


> So if I understand what you are saying...
> 
> long story short, banks have made a lot of money, and seem to be on track to make a lot of money, but there may be some risks, so they may not make a lot of money.
> 
> Just said with a lot more words (and some big words to sound educated) and a few tidbits to justify why each scenario may happen...


Yup exactly this, but I suspect he is trying to sound educated because has some sort of blog or something that he's trying to promote.


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## birdman (Feb 12, 2013)

Love those banks. Convinced my son to buy 90 shs of cibc in 2004 at 30.34 which paid an annual divy of $2.00. Total cost was $2700. He has dripped the shs and now has 125 shs Valued at $14,000. The current annual divy is now $5.00. In total the annual divy has increased from $180.00 pa to $600.00 pa.


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## OnlyMyOpinion (Sep 1, 2013)

:encouragement: Added bonus - now he believes you when you say, "father knows best" :smile:


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## Just a Guy (Mar 27, 2012)

jaybee said:


> Yup exactly this, but I suspect he is trying to sound educated because has some sort of blog or something that he's trying to promote.


Why do people think that those who basically say nothing are intelligent? I've got no issues with promoting a blog, I read plenty of them, but at least state an opinion. No one is right all the time, but if you take both sides you're wasting my time. Also, cut to the chase. If I could sum up the statement in a few sentences, why waste my time with hundreds of words.

For example...

Banks are going to continue to go up. The system is tilted in their favour right now. They can lend out multiples of what they have in reserve. They pay out <1% and collect >3% on mortgages (their lowest price spread). Typical multiples are around 10x reserves so they pay out 1% and collect 30%. CMHC protects them, not the home owner, against a bad loans, they face very small risk.

Mortgages are not their most profitable business. The government will be forced to bail them out if anything serious goes wrong. There are a myriad of ways they can reduce taxes and increase profits. They are also very experienced at finding ways around legislation and rules if it interferes with profit. 

Their biggest threat is public perception. Short term, Bay Street can manipulate their share price but, in the long run, there is little that can affect them because they hold the public'S money and the government can ill afford to allow something to happen to the population's "perception" that their money is safe...


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## lonewolf :) (Sep 13, 2016)

Is there a wall of worry with the banks ?


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## humble_pie (Jun 7, 2009)

yyz said:


> Or promoting his blog/website



in objective fairness to Anon Inv we should note that his prior direct links to his website are now gone from his posts.

all this within a few days of arriving in cmf forum with something of an obvious too-hard sell. The above detail - removing one element of the sales material - tones the posts down into useful & valuable contributions to the financial discussions. A nice touch.

banks are universally held by forum members. Even parties holding strict couch potatoes have big bank holdings among the components. Or at least - depending on the fund - parties have big bank proxies among their fund components.

post US election banks are behaving like indestructible powerhouses. Yet in 08/09 they melted like snowmen in april. Banks should be monitored carefully imho. Each & every contribution is welcome here.

.


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## mordko (Jan 23, 2016)

Anyone who states an opinion about the future with 100 percent confidence is a con artist. 

There are strong structural head winds for the big 5. For years they have been able to increase their fees with little competition. People are starting to catch up. Their moat is being eroded by internet banks. 

Also, the housing and hence mortgages could be nearing a peak. And Canadian economy is in a precarious position. 

The banks shares are booming right now because Clinton was going to impose tighter regulations while Trump seems to have a Goldman Sachs administration. Tomorrow is another day.


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## yyz (Aug 11, 2013)

humble_pie said:


> in objective fairness to Anon Inv we should note that his prior direct links to his website are now gone from his posts.
> 
> .


You mean like this one?



AnonymouslyInvesting said:


> This work interesting as a starting point of further investigation but should not be used as the sole basis of any investment decisions. The full publication with graphs can be found at: http://anonymouslyinvesting.com/home/reits-an-opportunity


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## humble_pie (Jun 7, 2009)

yyz said:


> You mean like this one?



to repeat, it appears that AI's links to his website have been edited out of his recent posts. You must be using an older post.

this forum is populated with - stuffed with - finance professionals. A few have obvious aggressive agendas to promote & these parties stick out like unfortunate sore thumbs.

there are many other kind & gentle souls in cmf forum who, transparently, are also finance professionals. Some may be retired or on the point of retiring. They offer wonderful suggestions & commentaries. The forum would be a much weaker place without them.

there are countless members who have blogspots of one kind or another. The forum is a richer place for these, imho.

.


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## Just a Guy (Mar 27, 2012)

humble_pie said:


> post US election banks are behaving like indestructible powerhouses. Yet in 08/09 they melted like snowmen in april. Banks should be monitored carefully imho. Each & every contribution is welcome here.
> .


Yes, they melted down in the financial crisis, but rebounded very quickly. If you didn't buy in within the few months window, you missed the best buying time in the last decade.

As an aside, I want to reiterate that I'm not against a blog promotion, but I'm against people who's opinions basically boil down to a "cover my butt" one of "it will probably go up, unless it goes down". There are enough useless talking heads out there who claim to know what they are talking about and strive to sound intelligent. 

You'll note, the comment I made (true or not) has actually spurred discussion about Canadian banks...


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## OnlyMyOpinion (Sep 1, 2013)

I agree with letting everyone express their opinion/comments freely (Ezra where are you) within the limits of not insulting, making personal attacks (critique the idea not the person) or trying to spam, sell products or services. 
I don't find OP's posts useful but maybe others do. There are already lots of places to find buy recommendations including your own friendly brokerage or investment house, BNN, Stockchase... Some offer more detailed analysis, 12mo target, etc. 
Starting a new thread here by providing a 'cut and paste' from your website and then inviting us to visit it seems disingenuous to me.


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## ian (Jun 18, 2016)

I have always liked Canadian bank stock and done very well with it over time.

Canadian bank fees are outrageous-especially the hidden ones. Canadians are so passive that they do not seem to care and many seem to place the banks on a pedestal. So, we invest in banks, but we do not keep our investments with the bank, other than some on line etrades.


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