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Baraka_Guru · 03-25-2009, 08:37 AM

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You Can Bank On Canada (RY, TD, BNS, CM, BMO)
March 24, 2009 | by Will Ashworth

Seventeen banks have failed in the U.S. in the first three months of 2009, giving banking counterparts north of the border unprecedented opportunity. Four out of the top 10 North American banks by assets are now Canadian. They've come a long way since 1999, when not one qualified in the Top 10. Back then, Canadian banking executives argued that they should merge to become more competitive with their larger U.S. counterparts. The Canadian government said no, and it has worked out well. According to the World Economic Forum, held last October, Canada's financial system is the best in the world, while the U.S. ranked 40th. The experts suggest you can bank on Canada. But should you?

Exceptionally Profitable
Canada's six biggest banks all made money in the first quarter ended January 31, 2009. The top five banks' earnings totaled $2.8 billion. In comparison, Citigroup (NYSE:C) lost $17.3 billion, Wells Fargo (NYSE:WFC) lost $2.55 billion and Bank of America (NYSE:BAC) lost $1.79 billion in their most recent quarters. Bank of Nova Scotia's (NYSE:BNS) return on equity topped the Canadian banks at 16.9%, while the Canadian Imperial Bank of Commerce (NYSE:CM) was the lowest at 4.0%.

Scotiabank's CEO, Rick Waugh, had this to say about its future in 2009 and beyond: "We are in good shape not only to weather this unprecedented storm, but to come out in a very strong position with the ability to capitalize on growth opportunities relative to many of our global competitors." Translation: It's taking market share in those countries where it competes. America's loss is Canada's gain. (Be sure to check out the Return On Equity section of our Profitability Indicator Ratios Tutorial to learn more about these measures.)

How Did It Happen?
Canada's banks have outperformed their U.S. counterparts in part due to tighter regulations. Conservatively managed, their average asset-to-capital ratio of 18-to-1 is half that of some American banks and less than a third of some European banks. Add to this, Tier 1 capital-to-risk-adjusted assets of 9.8%, higher than its American and European competitors, and you have the ingredients for safe, successful banking.

Royal Bank (NYSE:RY) and Toronto-Dominion Bank (NYSE:TD) are two of Canada's oldest financial institutions, both paying annual dividends since 1870. However, Canadian banks are more risk-averse, not to mention more expensive, than those south of the border. For example, Canadian bankers (I say this only half-joking) will lend you a dollar, but only if you give them two; and they have little reluctance service charging customers to death. (For more on bank service charges, be sure to read The Ins And Outs Of Bank Fees.)

[...]

Solid For Now
As a group, they've added $7.3 billion in equity to their balance sheets over the last six months, including $161 million for the Royal Bank in early March - and none has yet to take aid from the Canadian government. In fact, Royal Bank and Toronto-Dominion both have triple-A ratings from Moody's, two of only seven anywhere in the world. They're in good shape as long as the recession ends sometime in 2010. Even the best banks would have trouble surviving another two years like the last two.

In terms of actual first-quarter earnings, Bank of Nova Scotia did the best, increasing net income 15% to $842 million with over half generated outside Canada, Mexico and the U.S. It's definitely the most international Canadian bank. The other first-quarter success story was at CIBC, where net income was $147 million, a huge turnaround from a loss of $1.46 billion in the same quarter last year. It seems the sub-prime troubles from its U.S. operations are mostly behind it. The remaining three banks, including the biggest, Royal Bank of Canada, all saw their earnings decline in the first three months of the fiscal year, although profits averaged $662 million, which is nothing to sneeze at.

Bottom Line
The five Canadian banks' stocks are down an average of 44% in the past 52 weeks. Traditional yields are 3-4%, making their current returns unusually high. Some believe they will cut or suspend dividends in the near future to preserve capital should the economy worsen - hence the lower stock prices. It's a great theory, but one I find very difficult to swallow. You don't stop paying dividends after 138 years of doing so. You just don't.

Read Is Your Dividend At Risk? to learn of several telling factors that can help you answer this question and avoid losses.

By Will Ashworth

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work. At the time of writing Will Ashworth did not own shares in any of the companies mentioned in this article.

You Can Bank On Canada (RY, TD, BNS, CM, BMO) | March 24, 2009 |By Will Ashworth - Investopedia Advisor

Within just 10 years, 4 Canadian banks are now amongst the top 10 banks in North America. This is, in part, due to the failure of some (to the tune of 17 so far in 2009) banks in the U.S., but it is also because of Canada's conservatively regulated banking system, which is ranked the best in the world by the World Economic Forum (the American system is ranked 40th).

So what I'd like to explore here is the contrast between the Canadian and American systems. What is probably amongst the biggest differences between the two systems is related to regulation. I'm not about to go down a laundry list of comparisons in detail, but what I'd put forth here is that the right kind of regulation is a good thing. Regulation in this context is the regulation of risk for the benefit of stability and security. Canadian banks have weathered this economic storm relatively well so far.

Do you think the current status of American banking is a result of weaknesses in the banking system or is it mainly due to wider economic factors?
Should the American system take a chapter (or far more) out of the Canadian system?
Within such an economic juggernaut as the American economy, why is the American system ranked 40th by the World Economic Forum?
If the American system had been akin to the Canadian system, would those 17 banks have failed by this point?
Does this article change your opinion of regulation? How or why not?