Canada Banks Not Immune to Crisis Fallout

Date: Wednesday, October 1, 2008
Author: Lynne Olver, Thomson

†TORONTO (Reuters)óWith European banks getting propped up almost daily, unimaginable U.S. bank and insurance failures and growing economic uncertainty, Canadian bank investors have a back seat on the global roller coaster.

Canadian banks are not likely to tap directly into a U.S. government bailout plan, assuming lawmakers can eventually agree to a rescue package. Even so, Bay Street institutions are likely to feel the fallout from widespread uncertainty about the global financial system that is expected to persist, no matter what Congress does to alleviate the stress.

The Canadian banks are caught up in severe swings in investor sentiment and rising concerns about their business prospects in a weakening North American economy. While some analysts think they have a rare opportunity to make U.S. acquisitions at bargain-basement prices, deals may not occur until some of the dust settles.

"There's a growing recognition of the impact of the credit crisis on the global economy. We've got some major economies on the verge of recession, if not in recession," said Patricia Croft, chief economist at money management firm Phillips, Hager & North in Toronto.

Canada is not expected to escape an economic downturn, meaning consumer and business demand for loans will slow and credit losses will rise. Canadian financial stocks were hammered on Monday [Sept. 29], led by a 9.3% drop in Bank of Montreal shares, which closed at $42 a share, and Canadian Imperial Bank of Commerce, which dropped 8.5% to 56.90 Canadian dollars ($53.67).

Some of those declines were reversed on Tuesday morning [Sept. 30], with bank stocks springing back. The S&P/TSX financials index, composed of banks, insurance companies and asset managers, rose 3%.

"We are in uncharted territory, unprecedented events, and so I think volatility is going to continue until we get some sense of resolution around the credit crisis," Ms. Croft said.

Canadian banks are being tarred with the same brush as global financial companies, even though they have strong balance sheets and greater stability, she said. "I think ultimately there will be some stratification in valuation and Canadian banks should do well," Ms. Croft said.

No Decoupling

The fortunes of the big Canadian banks are connected in various ways to the U.S. markets, said Ohad Lederer, a bank analyst at Veritas Investment Research in Toronto. Some of them, including Bank of Montreal and CIBC, hold complex debt securities tied to U.S. corporate credit, while Royal Bank of Canada and Toronto-Dominion Bank are large lenders in U.S. markets.

"There is no decoupling here," Mr. Lederer said. "While the direct impact of the bailout attempt (on Canadian banks) is not large, I think people are now starting to fear for the indirect effects."

Those effects include pressure on the banks' wealth-management units if investors pull their money out of volatile markets, Mr. Lederer said.

Rob Sedran, a bank analyst at National Bank Financial, agreed that the "direct implications" of U.S. developments to ease the financial crisis may not be significant for Canadian banks, but economic instability is.

Three of them have significant operations in the United States: RBC in the Southeast, Bank of Montreal's Harris Bank in the Chicago area; and TD Bank's retail focus in the New England and Mid-Atlantic states.

"At the end of the day Royal Bank doesn't need a financial bailout, BMO doesn't need a financial bailout, TD doesn't need a financial bailout," Mr. Sedran said. "It's the indirect impact on the underlying economy that we're more concerned with."

Mario Mendonca, an analyst at Genuity Capital Markets, cut his 2009 earnings per share targets for the Canadian bank group early on Monday, citing fallout from the U.S. economic slowdown.

The Canadian economy will likely experience "a soft landing" in terms of unemployment, housing starts and housing prices, compared with steeper U.S. declines, Mr. Mendonca said in a research note. But a soft landing "does entail some pain," Mendonca added. He raised his forecast for the Canadian banks' loan-loss provisions while cutting his retail loan growth forecast.

Mr. Mendonca said his 2009 bank earnings estimates are now "noticeably below consensus," particularly for Bank of Montreal and Bank of Nova Scotia.

Waiting for Stability

Canadian banks have frequently been touted as being in a superb position to make U.S. bank acquisitions, as their conservative management styles, integrated investment and retail banking models and other differences have left them better capitalized. This is reflected in their valuations. Shares of the largest five Canadian banks are trading at twice their book value, while U.S. large-cap regional banks are trading at less than book value, according to TD Newcrest.

But Canadian executives may wait for a more stable environment to do deals, National Bank Financial's Mr. Sedran said. They might forgo some upside, but they'll also forgo some of the risk, he said.

"They seem to be a lot more prudent in terms of allocating capital into this crisis, and would prefer to see the way clear a little bit before becoming more aggressive," Mr. Sedran said.

Even regional Canadian banks with no capital markets businesses, no U.S. operations and no complex debt holdings saw their stock prices get whacked on Monday. Canadian Western Bank, the seventh largest Canadian bank by market value, dropped 8.3% to close at 19.71 Canadian dollars, after touching a 52-week low, and was little changed on Tuesday morning.

Despite Monday's plunge, Canadian bank stocks have done slightly better than the main index of the resource-heavy Toronto Stock Exchange this year. As of Monday's close, the S&P/TSX banks index had fallen 13% in 2008, versus an 18% drop in the S&P/TSX composite index.

By Lynne Olver