Will A Big Canadian Bank Fail?

by Mike Holman

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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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{ 19 comments… read them below or add one }

1 Four Pillars

MM – thanks for the encouraging words!

My question is – how do you know the Canuck banks don’t have the same exposure as the US banks. They haven’t exactly been all that forthcoming with their issues.

I’ll have to do another post since I forgot to add it to this one but is anyone buying the Canadian banks now?

2 Four Pillars

I definitely agree that the government would probably either prop up a failing bank or supervise a merger. While that would avoid an outright failure, the end result would be the same for equity shareholders.

3 guinness416

I’m pretty paralyzed right now too, and will be interested in following the comments. I have a big bonus sitting ready to invest and can’t bring myself to pull the trigger. Maybe we should just throw it at the mortgage. I am seeing CIBC’s chief economist speak in a few days, and am saving up some questions for the poor guy.

4 Four Pillars

Guinness – you are not alone! I personally don’t have much of a problem with investing now but I can’t imagine putting money in anything other than a broad index fund/etf.

I do own some individual stocks (which is against Bernstein’s advice) and now I can definitely feel the extra risk that comes with that.

You should ask the CIBC economist why he didn’t predict the subprime fiasco. :)

5 Nurseb911

Failure is “possible”, but I still remain convinced that its improbable. I think Power, Manulife and Sunlife (if they avoiding failure as well) would be throwing themselves at the government to take over any CDN bank close or near failure.

I expect the banks, now, to trade down to BVPS as they nearly did in 1990 and this crisis is much worse. That would put most of them still lower from where they are now and yields would also increase. BMO is close, same with NA, but we’ll have to see. I still think they all benefit from strong retail operations despite their losses and they’re not in the habit of shooting themselves in both feet & then cutting off their arms as many of the US & European banks have done.

6 Nicolas

Here’s an article from the Financial Post on the topic. In a nutshell, Canadian banks deal mainly with deposits and have strict regulations about capital ratios to deal with. They are not afraid of going under (although not impossible) but instead, they are afraid to get in trouble with the Office of the Superintendent of Financial Institutions. You don’t respect the rules, look at what we do to your chart.

http://www.financialpost.com/story.html?id=391367

Banks in Canada and the US are apples and oranges. Don’t lose any sleep.

Nicolas

7 Four Pillars

Thanks Brad. By the way, for anyone else who also didn’t know what BVDS is – it’s the book value of the bank.

Nicolas – pretty good article. They are comparing apples to oranges though when using Bear Stearns as an example.

8 Canadian Capitalist

Anything’s possible with the banks, of course but I agree with Brad that the probability of failure is low. I’d caution against valuing anything based on recent price action. The market is just mad. Look at valuation: TSX earnings is estimated at $900 for 2009. Assume it’s totally out to lunch and earnings comes in at only $600. That’s an earnings yield of 7.7%, double that of equities.

Now consider that $600 is an earnings estimate for a down cycle, not “normal” earnings and it’s clear that stocks are an incredible bargain here. That tells us nothing about the short-term but sooner or later, valuations will matter. And the markets will reflect that.

9 Jerry Hung

I know they won’t fail, but dropping at 10% daily rate is too uncomfortable

And with Quarterly earnings coming out soon, oh boy, bad will become worst, and good news will only keep it sideways

I think I may wait to buy bank stocks with my TFSA. Already got burned by TD @ $49… sob sob

10 Paolo

BVPS (not BVDS) = book value per share.

11 Four Pillars

CC – some great points. Your method isn’t foolproof however – what if earnings drop to 1/4 of what they are now?

Jerry – hang on buddy…hang on! TD is supposed to be the strongest bank.

Paolo – PS, DS, BS…whatever. :) Thanks for the clarification.

12 Melanie Samson

I wanted to pull money out of my RRSP to help come up with the downpayment on my first house, but it’s valued at so much less than I put in that it just doesn’t seem like a good idea. Any chance of an upswing in the next 10 months?

13 Four Pillars

Melanie – there’s always a chance but nobody knows for sure.

I’m sure you’ve already learned (the hard way) that money needed in the short term should not be invested in equities.

14 Melanie Samson

Pillars – Yes, if I didn’t realize it before – I know now. The thing is the initial money invested in the RRSPs was meant for the long-term, but my circumstances have given me a reason to use it short term – with terrible timing.

Looks like I’ll just have to save up the down payment via my ING account and being frugal and leave the money there for retirement. I’m over 25 years from retirement, so the markets should have time to recover before then!

15 Four Pillars

Melanie – I sincerely hope the market recovers before 25 years….I’m hoping to retire in around 15 years myself.

16 moneygardener

Absolutely no way that the gov. would let a CDN bank fail.

As far as dividends go, you really never know, but my gut tells me that dividends are at risk at BMO and CM. I feel that the other three will end up maintaining dividends with the safest being TD.

17 Mark

I have wondered as well why Canadian banks have not suffered as much as other global banks. If all economies are interrelated; shouldn’t Canada have been hit as well?

18 Banker

You’re WRONG! (there I said it to you).

Canadian banks will not go belly up because they have a strong balance sheet and are well above the required capital adequacy ratio.

19 Tony

@Banker,

You’re a total idiot. Take a look at the CDS of each bank. CIBC will very likely be the first to fail. The haven’t got the deposits to cover their shorts. They won’t make it till the end of 2011. Then, the real carnage will being in 2012. Every Canadian Bank is TOAST. Watch the Doug Casey interview, (http://youtu.be/giv7ZcVoEx8) and research what James Sinclair is saying. Total bank failure world-wide in 2012 and Gold to $12,000 an ounce.

Basically, if you don’t own Gold & Silver Bullion, you’ll be slaughtered.

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