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Canadian Credit Health Update

2011-06-26


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 (bank web sites and OSFI web site).

I am also now adding a section for off-balance sheet derivative exposure of the Canadian banks.

Summary for 2011.Q2

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. Before 2008, these values were under 1%.

Bank

2011.Q2

2011.Q1

2010.Q4

2010.Q3

CIBC

0.92%

0.98%

0.99%

1.09%

Royal Bank

1.31%

1.54%

1.65%

1.68%

TD

1.34%

1.43%

1.23%

1.24%

Scotiabank

1.43%

1.47%

1.50%

1.86%

BMO

1.58%

1.71%

1.80%

1.78%

Average

1.32%

1.43%

1.43%

1.53%



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

2011.Q2

2011.Q1

2010.Q4

2010.Q3

CIBC

0.45%

0.50%

0.52%

0.58%

Royal Bank

0.55%

0.65%

0.69%

0.71%

TD

0.62%

0.66%

0.56%

0.55%

BMO

0.68%

0.74%

0.78%

0.79%

Scotiabank

0.74%

0.80%

0.84%

1.03%

Average

0.61%

0.67%

0.68%

0.73%



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

2011.Q2

2011.Q1

2010.Q4

2010.Q3

CIBC

11.1%

12.0%

12.4%

13.5%

Royal Bank

11.6%

13.9%

14.7%

15.0%

BMO

12.7%

14.3%

14.9%

14.7%

TD

15.2%

16.1%

14.2%

14.1%

Scotiabank

16.0%

17.1%

17.5%

21.6%

Average

13.3%

14.7%

14.7%

15.8%



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

2011.Q2

2011.Q1

2010.Q4

2010.Q3

BMO

5.3%

5.2%

5.3%

5.3%

Scotiabank

4.7%

4.7%

4.8%

4.8%

Royal Bank

4.7%

4.7%

4.7%

4.8%

CIBC

4.1%

4.2%

4.2%

4.3%

TD

4.1%

4.1%

3.9%

3.9%

Average

4.6%

4.6%

4.6%

4.6%

Big Five Bank Analysis

CIBC continues to stand out as having the best loan book (least bad loans).

Scotiabank continues to stand out as having particularly bad loans. They have improved slightly this quarter, but not by much compared to the other banks.

CIBC and TD are the most highly leveraged banks. Notably, CIBC has been increasing their leverage throughout the last few quarters.

Off Balance Sheet Derivative Exposures

The amounts are in trillions of dollars. All amounts are notional amounts, which is the amount of underlying money represented by a contract. These are not prices or market values of actual contracts. OTC exposures are included here because I believe OTC contracts to be particularly dangerous since they are illiquid, difficult to value, and can become worthless if the counterparty (another large bank) collapses.

This derivative exposure is also poorly disclosed and reported, generally stuffed away off-balance sheet where it can't distress investors and depositors.

Bank

2011.Q1


Total notional exposure

OTC notional exposure

Royal Bank

$6.90 T

$6.52 T

BMO

$3.26 T

$2.64 T

TD

$2.98 T

$2.48 T

Scotiabank

$2.24 T

$1.97 T

CIBC

$1.39 T

$1.22 T

Total exposure

$16.77 T

$14.84 T

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. Note however that banks with significant US/international operations have further credit exposure beyond Canada.

Bankruptcy rates continue to decline currently, and are now back to pre-crisis (2007 levels).


- Perpetual Bull, perpetualbull@gmail.com