Will A Big Canadian Bank Fail?

by Mike Holman

I have to admit that while I haven’t been bothered by the falling markets, today I found it a bit tough for some reason.  It seems like every day the market falls and if it’s only 1 or 2% then that is ok.  Well today the Canadian market fell 9%.  9%!!! That would be a bad year by itself and it was only one crappy trading day of many crappy trading days.  The worst part was the banks – they have been pummelled this year and today the big 5 went down by an average of almost 13%.  13%!!! Very depressing I thinks.

Now, I haven’t gone all anti-Bernstein or anything – I have no plans to sell any equities under any circumstance.  What my concern is now is will one of the big Canadian banks fail? Here are some things I’m worried about:

Canadian banks own bad US mortgages as well

Our banking system was recently named as the best in the world.  Our lending standards were much stricter than the US banks so everything should be ok?  The only problem is that from what I understand, the US banks got in trouble buying investments containing bad mortgages – it wasn’t necessarily all just from writing bad mortgages themselves.

The problem is that the Canadian banks also bought these same investments and have been slowly taking related writedowns all the while not talking about what their real exposure is.  These investments were enough to bring down some big US banks so why can’t they bring down a Canadian bank?  Yes, the Canadian banks have good business models so did Washington Mutual and Wachovia.  They had customers, lots of assets – a normal bank in other words – but they lost it all on the investment side.

A bad dividend trend

The thing that concerns me is that the US banks I mentioned all paid a dividend at one time.  When the stock went down the dividend yield went up…and up and up and up.  First there was a dividend cut and then the bank went out of business.

The dividend yields for the Canadian banks in order are:

  • BMO 8.4%
  • CIBC 7.3%
  • BNS 5.9%
  • Royal 5.6%
  • TD 5.4%

The ones that really stand out for me are BMO and CIBC – 7 or 8% dividends that don’t pay return of capital are too high.  Either they are mispriced or investors are expecting a dividend cut.  Now we haven’t seen the double digit dividend yields enjoyed by the US banks before they went belly up but the yield on BMO and CIBC has roughly doubled over the last year or so.

Summary

I really hope that none of the banks go under but I am concerned about it.  Can anyone please tell me that I’m wrong??

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