Canadian Banks

[Viking]

Has anyone been buying Canadian banks recently? RBC has been hit the hardest (largest capital markets business) and is now trading near a multi-year low. Its dividend yield is 5% and normalized PE is right around 10. I like the fact that RBC sold its US retail business as it was just a sink hole losing money and not strategically a good fit. Their focus on wealth management is in their sweet spot. I do question if a Canadian company can muscle in to the capital markets business (versus the 800lb US gorillas) and this is what has stopped me from establishing a position.

 

I do still have a small position in BMO (established shortly after their US purchase). However, with WFC selling off I view WFC now as a better way to play US banking.

 

I did establish a small position in POW (Power Corp) with its 5% dividend yield and PE under 10. POW includes Great West Lifeco and Investors Group (among other things) so is not a bank but more a holding company of financial assets.

 

The Canadian life insurers have once again been crushed... just not sure what the impact to their business is of very low interest rates and falling equity markets (not sure how bad this is).

 

Bottom line, lots of what looks to be very cheap financial companies in Canada.

[CanadianMunger]

I believe that the Canadian housing market will experience mean reversion at some point, although I have no idea when.  As such, I'm staying far away from Canadian banks loaded with mortgages and HELOC's.

 

Besides, don't US banks like WFC and BAC look cheaper?

[Cardboard]

Well, I agree. If the world does not end or if things don't get too bad so they don't have to recapitalize or take a significant cut to their equity, the entire financial sector is cheap. Canadian or U.S.

 

Power Corporation is an interesting one since it is in a net cash position, trades close to book and has a yield around 5.4%. I have not looked at it in details, but since it is a holdco, I assume that they are not liable for any liability at Great West Lifeco which is probably the only thing risky in the whole company. The rest of the organization may see a slowdown, but won't go bankrupt or need capital injections. Of course, if GWO goes BK, then it will be a big negative to their net asset value.

 

The problem I have at the moment is balancing upside vs risk. POW seems like a nice company, relatively safe IMO. On the other hand, I don't even see a double at current price. Kind of a mini Berkshire with very smart people at the helm, well connected and looking to grow the value of the company over time.

 

Cardboard

[TorontoRaptorsFan]

I was visiting Chicago recently and amazed at how many Bank of Montreal Harris (BMO Harris) branches there are in the city. In fact they have more bank branches in Chicago than they do in Toronto. Even if they do 1/5th of the business they do in the Midwest amongst the population it will be equivalent to the entire banking business they do in Canada!

 

TD is building a very strong franchise in the U.S. Northeast. It's amazing how many Americans don't realize these are Canadian banks!

[Guest Hester]

I was visiting Chicago recently and amazed at how many Bank of Montreal Harris (BMO Harris) branches there are in the city. In fact they have more bank branches in Chicago than they do in Toronto. Even if they do 1/5th of the business they do in the Midwest amongst the population it will be equivalent to the entire banking business they do in Canada!

 

TD is building a very strong franchise in the U.S. Northeast. It's amazing how many Americans don't realize these are Canadian banks!

 

I am from Chicagoland and know Harris bank very well (used to live down the street by one). I honestly had no idea they were a part of BMO. I always just assumed they were a regional or large community bank, and never looked into the matter.

[Uccmal]

Viking, alot of topics in one thread  :P? 

 

Re: Canadian banks - having dealt with TD to get a Heloc for renovations just over a year ago, I can attest to the strictness of their review process.  Maxed me at 80% with the mortgage by a third party added on.  Conservatively estimated the home value, pre reno.  Wanted to see our pay stubs going back at least a month. 

 

I don't think they would suffer more than a modicum of damage from any housing downturn.  The mortgage companies were the ones writing underwater mortgages three years ago, such as Xceed, and already got crushed.  Plus, excepting the west, we have been in mild recession already for over 2 years.  WFC and JPM are relatively cheaper.

 

Not a bad bet for an RRSP. 

 

Power financial/power Corp-very well managed - main asset is GWO which is expanding at a measured clip.  I don't know enough about GWO to comment directly on it's bond or equip exposure but on the surface it seems less than MFC or SLF.  I recently sold power financial out of my margin accounts, still have some in  RRSPs. 

 

Other large lifecos.  The low interest rates are bad news for them.  I would wait for MFC and SLF to settle. Should give you a couple of years to review their balance sheets and follow their earnings.

 

All in all, I figure that WFC or JPM offer similar but much better deals than the Canadian Banks or Lifecos.

[SharperDingaan]

Core to Cdn financials is concentration in few hands, & the omnipresence of OSFI. Risk management is extensively examined every year, & there is little tolerance for chronic repeated failures. The result is better financial resiliency, less volatility, & on-going focus on day-to-day business. When Canada hit the debt-wall in the early 90’s, the Cdn financial sector did very well – most would argue that today, the sector is materially stronger than it was back then.

 

It is much harder to get a double on the retail businesses, as you really need a sustained & extreme external event to materially force down the multiple. The businesses themselves are going to reliably continue generating EPS, with at most a 15-20% reduction off the ‘norm’. The source of that EPS is now also increasingly diversified outside of Canada.

 

The big questions are currency & the benchmark. A double in a hard currency may be equivalent to a 4 bagger in a softer currency, but only if FX depreciation goes your way. The unemployment rate, usually trumps a rising dollar – hence a crap shoot as to where FX might go over the mid-long term. OK place to be, if measured against the TSX; a great place if measured against the DOW, DAX, FTSE, etc.

 

If you want 25% compound returns this probably isn’t it. If you’re OK with 15% & some FX risk, there are lots of choices.

 

SD   

 

[biaggio]

Nothing wrong with getting 15%.

 

What's your favorite metric for valuing Canadian Banks?

 

BV?

 

would 2 x BV be max valuation?

 

Thanks.

[value-is-what-you-get]

Here's a nice example of proactivity from our public service wrt public bailouts of banks:

 

http://www.vancouversun.com/Ottawa+seeks+final+foreign+bank+purchases/5760732/story.html

 

 

[mranski]

I think the cdn banks are a good place to be for an average return or better considering the dividend. I like the RBC and BNS strategies the best, Global Investing and Latin America respectively, as opposed to the BMO and TD usa expansion strategy. The usa retail strategy seems too competitive, with too many huge low cost competitors.

 

With the Lifecos , I like Power the best, due to the family ownership and less of the Manulife Asia strategy. With interest rates, it is so hard to know. Superintendent of financial institutions appears to be saying that these rates are the new normal. Not convinced she knows, but if you get 10 year stretches of low rates, you have to wonder if lifecos are a good investment.

[ubuy2wron]

What I like about the Canadian banks is that no one  sitting on the executive floor in a corner office is trying to be a hero with perhaps the exception of TD. We have 5 Wells Fargos in Canada the last gung slingers were fired in 2008 .

[Uccmal]

. Superintendent of financial institutions appears to be saying that these rates are the new normal. Not convinced she knows, but if you get 10 year stretches of low rates, you have to wonder if lifecos are a good investment.

 

Not a good investment.  But then no one can predict interest rates?

[Liberty]

What I like about the Canadian banks is that no one  sitting on the executive floor in a corner office is trying to be a hero with perhaps the exception of TD. We have 5 Wells Fargos in Canada the last gung slingers were fired in 2008 .

 

Could you elaborate a bit on why you think TD is different? It's not a sector I know much about, but I'm always trying to learn :)

[ubuy2wron]

What I like about the Canadian banks is that no one  sitting on the executive floor in a corner office is trying to be a hero with perhaps the exception of TD. We have 5 Wells Fargos in Canada the last gung slingers were fired in 2008 .

 

Could you elaborate a bit on why you think TD is different? It's not a sector I know much about, but I'm always trying to learn :)

TD made some large acquisitions of US regional banks in the 2006 2008 period paid > 2.5  times book and clearly this was a mistake which is not reflected in their income statement or mkt price. BMO has large US exposure but they were have been much more circumspect in when they bought and what they paid. CIBC which was the bank which had the gunslingers in charge changed mgmt in 2007 and the CEO who I have known for 30 years as we both started our careers 30 years ago @ Merrill is determined to have the strongest balance sheet in the industry. The CDN banking industry is in an very interesting position if they could create firewalls between their CDN operations and their foreign subs they could become world leaders and replace the Swiss. The govt. is rightfully afraid of the CDN banks becoming too large as any failure of a CDN bank would be of the too big to bail category if their foreign exposures are not ring fenced.

[Swizzled]

 

A look at Canadian house prices relative to income and rent:

 

http://valueinvestorcanada.blogspot.com/2011/11/canadian-home-price-likely-considerably.html

[Liberty]

TD made some large acquisitions of US regional banks in the 2006 2008 period paid > 2.5  times book and clearly this was a mistake which is not reflected in their income statement or mkt price. BMO has large US exposure but they were have been much more circumspect in when they bought and what they paid. CIBC which was the bank which had the gunslingers in charge changed mgmt in 2007 and the CEO who I have known for 30 years as we both started our careers 30 years ago @ Merrill is determined to have the strongest balance sheet in the industry. The CDN banking industry is in an very interesting position if they could create firewalls between their CDN operations and their foreign subs they could become world leaders and replace the Swiss. The govt. is rightfully afraid of the CDN banks becoming too large as any failure of a CDN bank would be of the too big to bail category if their foreign exposures are not ring fenced.

 

Thanks, very interesting!

[nwoodman]

 

A look at Canadian house prices relative to income and rent:

 

http://valueinvestorcanada.blogspot.com/2011/11/canadian-home-price-likely-considerably.html

 

The Economist's take on housing valuation

 

http://www.economist.com/node/21540231?fsrc=nlw

 

So there are still a few countries with housing more overvalued than Australia  ;)

[ubuy2wron]

 

A look at Canadian house prices relative to income and rent:

 

http://valueinvestorcanada.blogspot.com/2011/11/canadian-home-price-likely-considerably.html

 

The Economist's take on housing valuation

 

http://www.economist.com/node/21540231?fsrc=nlw

 

So there are still a few countries with housing more overvalued than Australia  ;)

Cdn residential real estate especially Vancouver is in a bubble that said the risk lies not with the banks but with the tax payers of Canada through CMHC and through the one public mortgage insurance company. The Province of BC also has a huge contigent liabilty as they have guaranteed the deposits of all the credit unions in BC which will likely implode if the bubble bursts. If I had to make a bet against residential real estate in Canada I would short Genworth Canada but please do not do it on my say so as I have no clear understanding as to what their exposure is.

[ourkid8]

You cannot say it was a mistake as prior to the financial crisis, this was the premium companies were paying for high quality assets.  What do you mean trying to be a hero?  You do not agree with their US strategy which is a low risk retail-focused business model.  Their goal was to build the critical mass to succeed in the states as they saw other Canadian banks try and eventually fail.   

 

Commerce Bancorp came on the market as a surprise since the CEO (Vernon Hill)  had issues with the regulators and the BOD asked him to step down otherwise this bank would not have been in play.  TD essentially purchased Commerce for it's best in class strategy at deposit gathering, not asset generation as is the case with most commercial banks.  (Deposit growth of 28% annual clip which is absolutely unheard of)  This essentially changed TD Banknorth from a company who consistently grew via acquisition to more of an organic growth focused company. 

 

Thanks,

 

S

What I like about the Canadian banks is that no one  sitting on the executive floor in a corner office is trying to be a hero with perhaps the exception of TD. We have 5 Wells Fargos in Canada the last gung slingers were fired in 2008 .

 

Could you elaborate a bit on why you think TD is different? It's not a sector I know much about, but I'm always trying to learn :)

TD made some large acquisitions of US regional banks in the 2006 2008 period paid > 2.5  times book and clearly this was a mistake which is not reflected in their income statement or mkt price. BMO has large US exposure but they were have been much more circumspect in when they bought and what they paid. CIBC which was the bank which had the gunslingers in charge changed mgmt in 2007 and the CEO who I have known for 30 years as we both started our careers 30 years ago @ Merrill is determined to have the strongest balance sheet in the industry. The CDN banking industry is in an very interesting position if they could create firewalls between their CDN operations and their foreign subs they could become world leaders and replace the Swiss. The govt. is rightfully afraid of the CDN banks becoming too large as any failure of a CDN bank would be of the too big to bail category if their foreign exposures are not ring fenced.

[benhacker]

You cannot say it was a mistake as prior to the financial crisis, this was the premium companies were paying for high quality assets.

 

Ourkid, not to disagree with everything you said, but I just wanted to touch on this point that you made.

 

It is true that it is sometimes hard to separate process and outcome after the fact, but I don't think the line of reasoning you are using is ever appropriate.  The premium you are describing for pre-crisis financial assets, and IMO, even the 'quality' designator have been show to been way off base after the fact.  Was the financial crisis an outlier that couldn't have been predicted? ... maybe.  But I think good arguments could be made that much of the buying / selling going on pre-crisis was the opposite of margin of safety - it was only going to work out if the stars aligned.

 

There is no way to defend the purchases by saying "well, that was the price for the assets".  The other obvious choice for financial acquirers pre-crisis (and any time prices are too high) is to just say no.

 

This is one of the many reasons that corporate managers should be paid good money (*if* they do a job well done), they need to have the skill and fortitude to walk away from bad deals even when institutional momentum pushes business toward doing something.  There is a difference from buying BAC at 2x book in '06, vs. 1x poorly capitalized book in '08 vs. adequately (hopefully) capitalized 1/4 of book in '11.  There is a margin of safety variation along those points... There are times when assets are cheap (even quality ones) and times when they are not.

 

At least for me, my expectation for anyone who is an allocator of capital (whether a corporate manager or an investment advisor) is to know the difference between cheap and expensive, and change their buying based on that.  If Canadian banks were trying to get into the US market, it may have been "easier" to buy "quality" assets at 2.5x book, but that doesn't make it right regardless of what was customary at the time.

 

I for one think the managers should be held accountable for those decisions.

 

I'm not an expert on the Canadian banks, so I don't mean to endorse everything said up thread about the banks, but I only meant to comment narrowly on the acceptance of ex-post analysis that absolves management of stupid acquisitions by gesturing to EMT.

 

Ben Hacker

 

Long BAC in various ways (small position)

[alertmeipp]

I don't think why Canadian banks has such a high regard, my understanding is they are pretty much monopoly there in a protected market. They charge crazy fee and currency spread. Customers of them get ripped left and right.

[biaggio]

I don't think why Canadian banks has such a high regard, my understanding is they are pretty much monopoly there in a protected market. They charge crazy fee and currency spread. Customers of them get ripped left and right.

 

Agree. Have felt that way as a customer.

 

I think they are safe investment as long as one does not over pay. They seem fairly valued at 1.5-2 x BV for co that will earn 15-20 ROE, though I find ~ 5% dividend on BMO, RY appealing

[ubuy2wron]

I don't think why Canadian banks has such a high regard, my understanding is they are pretty much monopoly their in a protected market. They charge crazy fee and currency spread. Customers of them get ripped left and right.

Okay they are pretty much a monopoly with a 20 year avg return on capital in the high teens and you still do  not want to invest in them. Right KO just makes sugar water why would one want to invest in that no mgmt. magic there. LOL. I think Warren once said he wants companies that a fool can run because sooner or later fools do show up in the corner office. I think the concept of moats and margin of saftey are lost on some.

[Uccmal]

Article about Sunlife:

 

http://www.theglobeandmail.com/globe-investor/investment-ideas/streetwise/sun-life-to-cut-dividend/article2251861/

 

It is also looking like the Bank of Canada may slash short term rates soon as well.  Pure speculation, not mine.

[Cardboard]

Sun Life may cut its dividend, but then consider it a stupid act or for show. They pay out $600 million a year in cash dividends, the other $240 million is via dividend reinvestment plan, so it is not paid out in cash. For a company with a book value of over $14 billion and $216 billion in assets, saving $600 million a year is not going to do much for the company. The issue is a fundamental one for the company, can they honor their liabilities under the current investing environment? We are talking much more than $600 million if the model has failed.

 

Personally, I believe that there is an over-reaction out there. If things stabilize they will do just fine even if interest rates remain close to these levels. That is the question, where are we going? The same question should apply for BAC or any other financial stock.

 

Cardboard