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Canadian Credit Health Update

2010-12-08


Introduction

These Canadian Credit Health Updates are released every quarter. In these reports, I apply the same analysis techniques that I used when watching the American financial system through 2005-2009. If American and European-style problems develop in Canada, I expect that these metrics will show early warning signs just as they did in the USA. All data comes from public financial reports.

Summary for 2010.Q4

Why watch these numbers?

In the modern economy, credit is the key factor. Credit (loan) quality ties directly to bank health and can indicate problems long before a bank is pushed to the brink of insolvency. But this isn't just about bank health and safety of deposits. Loans backed by real estate collateral underpin balance sheets throughout the economy. This means that loan quality problems translate into losses at banks, business, households, and the national Treasury (for example the US Government pays Fannie Mae's ongoing mortgage losses). On top of this, impacts of credit are amplified through leverage, both personal and bank. Canada is very highly leveraged, and this is why we need to watch the situation.

Big Five Bank Data

A. Gross impaired loans / Gross loans (higher = worse loan book): A rough measure of how bad the loan book is. Pre-crisis, these values were under 1%.

Bank

2010.Q4

2010.Q3

CIBC

0.99%

1.09%

TD

1.23%

1.24%

Scotiabank

1.50%

1.86%

Royal Bank

1.65%

1.68%

BMO

1.80%

1.78%



B. Gross impaired loans / Total assets (higher = worse balance sheet): A quick measure of deterioration on the asset side of the balance sheet. In the USA, banks started having major problems at 1.5%, and critical problems including insolvency above 2.0%.

Bank

2010.Q4

2010.Q3

CIBC

0.52%

0.58%

TD

0.56%

0.55%

Royal Bank

0.69%

0.71%

BMO

0.78%

0.79%

Scotiabank

0.84%

1.03%



C. Gross impaired loans / Tier 1 capital (higher = worse balance sheet): This measure is very similar to the Texas Ratio, and compares the bad loans to adjusted Tier 1 (Basel II) capital, the core measure of bank capital which is primarily equity. If bad loans are a large % of the bank's capital, it means the bank can not easily absorb the losses.

Bank

2010.Q4

2010.Q3

CIBC

12.4%

13.5%

TD

14.2%

14.1%

Royal Bank

14.7%

15.0%

BMO

14.9%

14.7%

Scotiabank

17.5%

21.6%



D. Tier 1 Leverage ratio (lower = more leverage): This doesn't measure loan quality, but rather the bank's leverage and aggressiveness. Tier 1 leverage = tier 1 capital / total assets. This measure is included because higher leverage translates to greater overall risk. The banks with the worse loan books (above tables) should exhibit lower leverage, otherwise it means they are being far too aggressive for their condition.

Bank

2010.Q4

2010.Q3

BMO

5.3%

5.3%

Scotiabank

4.8%

4.8%

Royal Bank

4.7%

4.8%

CIBC

4.2%

4.3%

TD

3.9%

3.9%

Big Five Bank Analysis

Scotiabank, BMO, and Royal Bank have the worst loan books. This is unchanged from last quarter. However, Scotiabank and Royal Bank have seen improvements in their loans.

Scotiabank still stands out as having particularly bad loans, although they have improved this quarter.

On leverage the situation is sensible, with TD and CIBC (best loan books) showing the highest leverage. This is unchanged from the last quarter.

Bankruptcy Statistics

These numbers lag by a full quarter, but they are still valuable: this shows total Canadian bankruptcies over time. Bankruptcy rates closely relate to bank loan quality.

Bankruptcy rates have come down sharply from the peak of the crisis and continue to decline currently. This is a good situation, and bank loan books are also generally improving.




Big Five Use of Emergency Fed Loans

During the 2008 Financial Crisis, the Federal Reserve introduced a number of short-term credit and liquidity facilities to help stabilize markets. Some of the transactions under these facilities provided liquidity to “institutions whose disorderly failure could have severely stressed an already fragile financial system”. In other words, these emergency facilities were offered to troubled institutions to help prevent their collapse.

Details of these borrowings were recently made public and original tables are available at the Federal Reserve's web site.

The Big Five Canadian banks appear among the list of largest borrowers, implying that they were under some distress in 2008-2009. The American divisions of the banks were borrowers within the Federal Reserve system, and the totals shown are consolidated totals for the parent company.

Specifically, Canadian banks borrowed from the Term Auction Facility (TAF) which provided 28-day loans against a broader range of collateral than Fed open market operations normally allow. Depository institutions could have borrowed from the Fed discount window, but there is a stigma associated with this borrowing. In the Fed's words, “many banks were reluctant to borrow at the discount window out of fear that their borrowing would become known”. In response, the Fed created a new facility (TAF) and details of TAF use remained secret until December 2010.

Presumably, then, borrowing from TAF also has a stigma associated with it ... now that it's actually public. Here are those emergency loans from 2008-2009:


Bank

TAF loans

Total TAF

Approx. total bank assets

Borrowed as % of assets

CIBC

10

$5.3 billion

$295 billion

1.8%

BMO

12

$6.9 billion

$369 billion

1.9%

TD

19

$27.5 billion

$489 billion

5.6%

Scotiabank

51

$27.8 billion

$426 billion

6.5%

Royal Bank

55

$43.6 billion

$595 billion

7.3%

Notes about this data:


Some of these banks borrowed very substantial amounts. It appears that TD, Scotiabank and Royal Bank all made heavy use of the (undisclosed) emergency loan facility, borrowing as much as 7% of their balance sheet! Was this borrowing for leisure, or necessity? If the TAF use was necessary, then it's hard to believe that Royal Bank would have remained solvent without $44 billion in emergency loans.

- Perpetual Bull, perpetualbull@gmail.com