A Sobering Outlook for the Canadian Banks

A new angle from one U.S. investor who’s betting big that Canadian bank stocks are going down.

| More on:
The Motley Fool

Canadian investors love their bank stocks, and for good reason given the long-term returns generated by holding these names through thick and thin.

At least one U.S. based investor however has a less-than-rosy outlook for these bluest of the Canadian blue chip names.

Saturday’s Globe and Mail featured an article about a small San Francisco based hedge fund that has staked 95% of his investor’s assets on a wager that will pay off if this country’s banking sector stumbles.

Unlike others who argue an eventual slowdown in our housing market will take a bite out of the banks, the argument presented related to the “risk-weight” of 9.9% that the Canadian banks put on mortgages.  And more specifically, how out of line this weighting is with much of the world.

According to the article, U.S. banks apply a risk-weight of 35 to 75% to mortgages, banks in Australia use 15 to 20%, and Europe averages 20%.

So What?

In the homogeneity seeking world that we live, there is a risk that at some point OSFI, the Canadian financial regulator, will be asked to bring this figure more in line with other jurisdictions.  The implementation of a “risk-weight floor” of 15% by OSFI is suggested.

If this change occurred overnight, an infinitely small probability in my mind, several banks could fall below the minimum capital requirements (currently 4.5% but expected to level off at 6.0% by 2015), forcing them to issue equity or cut their dividends.  Tabled below is the current Tier 1 Capital ratio (Tier 1 Capital/Risk-Weighted Assets) for each.

Company Name

Tier 1 Capital Ratio

CIBC (TSX:CM,NYSE:CM)

12.0%

Royal Bank of Canada   (TSX:RY,NYSE:RY)

11.5%

Bank of Montreal   (TSX:BMO,NYSE:BMO)

11.1%

TD Bank (TSX:TD,NYSE:TD)

10.9%

Bank of Nova Scotia (TSX:BNS,NYSE:BNS)

10.3%

Source:  Capital IQ

While these figures don’t take into account the percentage of risk-weighted assets that is comprised of mortgage loans, you can at least see that if mortgages were to require a risk-weight of say 15% vs. 9.9%, the denominator in this ratio (RWA) would go up, bringing the Tier 1 ratio down.  With mortgage loan exposure factored in, Citigroup expects a higher risk-weight would have the biggest impact on CIBC, Royal, and Scotia.

The Foolish Bottom Line

To bolster the argument against Canadian banks, a negative view on emerging markets and therefore commodities is also expressed by the fund’s manager.  I’m not sure betting 95% of a fund’s assets on what a country’s regulator and commodity prices might do is overly prudent, but if these views come to fruition, the fund’s investors are likely to be a happy bunch.

Canadian banks are a favourite for this country’s dividend investors.  If you’re looking to diversify your dividend exposure simply click here to receive our special FREE report “13 High Yielding Stocks to Buy Today“.  This report will have you rolling in dividend cheques before you know it!

Follow us on Twitter and Facebook for the latest in Foolish investing.

Fool contributor Iain Butler does not own shares in any of the companies mentioned at this time.  The Motley Fool does not own shares in any of the companies mentioned.     

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Investing

$1,000 Ready to Deploy? 3 Quality TSX Stocks for Canadian Investors

Amid improving investors sentiments, the following three Canadian stocks offer excellent buying opportunities.

Read more »

Blocks conceptualizing the Registered Retirement Savings Plan
Dividend Stocks

RRSP Investors: 3 Canadian Dividend Stocks to Buy on Dips

These stocks have strong track records of dividend growth and now trade at discounted prices.

Read more »

concept of real estate evaluation
Dividend Stocks

Beyond Real Estate: These TSX Income Generators Could Deliver Superior Passive Income for Canadians

These two TSX dividend stocks could offer Canadian investors a reliable income stream and strong long-term upside, without relying on…

Read more »

Confused person shrugging
Dividend Stocks

Better TSX Dividend Stock to Own: Manulife or Sun Life?

While Sun Life stock has outpaced Manulife in the last two decades, which dividend-paying insurance giant is a good buy…

Read more »

A plant grows from coins.
Energy Stocks

Got $25,000? Turn it Into $200,000 in a TFSA as Canadian Dollar Gains

This energy stock may not have a high dividend, but it certainly has a high rate of growth to look…

Read more »

coins jump into piggy bank
Dividend Stocks

How to Use Your TFSA to Earn $1,057/Year in Tax-Free Income

Investing $5,000 in each of these high-yield dividend stocks can help you earn over $1,057 per year in tax-free income.

Read more »

data analyze research
Tech Stocks

Is BlackBerry (TSX:BB) a Buy in May 2025?

While its recent downturn might not look pretty, it might be the best opportunity to buy BlackBerry (TSX:BB) stock and…

Read more »

Piggy bank with word TFSA for tax-free savings accounts.
Investing

Where I’d Invest the New $7,000 TFSA Contribution Limit in 2025

If you have $7,000 for the new TFSA contribution increase, here are three stocks I would contemplate adding to the…

Read more »