Are Your Bank Stocks Exposed to “Unpredictable Losses”?

Moody’s sounds the alarm about three banks’ exposure to capital markets.

| More on:
The Motley Fool

In Canada, there are three banks that have significant exposure to capital markets (CM) activities: Royal Bank of Canada (TSX:RY)(NYSE:RY), Bank of Montreal (TSX:BMO)(NYSE:BMO) and National Bank of Canada (TSX:NA).

Recently, David Beattie, vice-president and senior risk officer at Moody’s, issued a report that raises concerns about these exposures. He claims, rightly so, that CM activities expose the banks to higher earnings volatility and unpredictable losses. Certainly this is something for shareholders to watch out for.

Each of the banks have a slightly different approach to the CM business, which present their own opportunities and risks.

Royal Bank – The most international

RBC not only has the largest CM business in Canada, but one of the largest in the world. The bank made a big push into capital markets back in 2007, right when most of the major banks worldwide were in retreat. RBC emerged from the crisis relatively unscathed and well-capitalized, allowing the bank to make significant inroads. Currently the bank ranks 11th on Dealogic’s list of global investment banking revenue.

Of all the Canadian banks, RBC’s CM business is the most international – Mr. Beattie estimates that 71% of revenue comes from outside Canada. This exposes the bank to “large and unpredictable” losses. But RBC’s capital markets business accounted for only 21% of earnings in 2013, compared to 56% for Canadian banking. So it still has a nice cushion to fall back on.

Bank of Montreal – The most American

Sitting at number 18 on Dealogic’s rankings is BMO Capital Markets, which accounted for 26% of the Bank of Montreal’s total earnings in 2013. The United States has been a particular focus for BMO, and last year accounted for nearly a third of total CM revenue. The bank wants to become the top investment bank for mid-cap issuers in the US.

Mr. Beattie pointed out that BMO derives a larger proportion of CM revenues from trading products, making revenues “the most volatile in the peer group”. Also BMO does not have as large a cushion to fall back on as RBC. Its Canadian banking business accounted for 44% of total earnings.

National Bank – The most exposed

National Bank’s CM business accounts to 35% of total net income, making the bank more exposed to CM than any of its large peers. This is something that investors must remain very wary of; Mr. Beattie said that this leaves the bank “more exposed to rapid credit profile deterioration.” National also has the lowest capital ratios among the big banks. It’s no wonder that its price to earnings ratio is also the lowest amongst its peers.

Foolish bottom line

On a global standard, Canada’s banks are still relatively stable. They all have very profitable and secure Canadian banking businesses to fall back on, which should make their shareholders sleep more easily. But investors, especially the ones that count on smooth earnings, must always be aware of these kinds of risks and exposures.

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

Target. Stand out from the crowd

2 Canadian Stocks I’m Buying Lots of This Year

I’m looking to snatch up exciting Canadian stocks like VieMed Healthcare Inc. (TSX:VMD) throughout 2023.

Read more »

grow money, wealth build
Dividend Stocks

Got $3,000? 3 TSX Growth Stocks to Buy in January 2023

Top TSX growth stocks that look appealing for 2023.

Read more »

woman data analyze
Dividend Stocks

Need Passive Income? Turn $15,000 Into $851 Annually

This passive-income stock is already climbing higher, up 16% in the last three months! Yet it's still valuable, so you…

Read more »

Senior Man Sitting On Sofa At Home With Pet Labrador Dog
Dividend Stocks

Retirees: 3 Reliable Canadian Dividend Stocks to Buy Now for Passive Income

Top TSX dividend stocks now appear oversold.

Read more »

A red umbrella stands higher than a crowd of black umbrellas.

2 TSX Stocks Safer for Investing in a Recession

These consumer companies will likely beat the broader market averages amid a recession. These stocks offer stability, income, and consistent…

Read more »

Dividend Stocks

For $100 in Passive Income Each Month, Buy 1,500 Shares of This REIT

REITs such as Northwest Healthcare can enable investors create a passive-income stream as well as benefit from capital gains.

Read more »

A colourful firework display
Dividend Stocks

2 Canadian Growth Stocks (With Dividends) to Start 2023 With a Bang

Here are two of the best dividend-paying Canadian growth stocks you can invest in at the start of 2023 and…

Read more »

sale discount best price
Dividend Stocks

4 Insanely Cheap Canadian Stocks to Buy for Passive Income

The recent bear market has created some incredible bargains, especially for those looking for passive income. Here are four cheap…

Read more »