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Canadian Credit Health Update

2012 Q4


Go to the most recent report: 2016 Q4

Health of Canadian banks: stable (green)

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.

This report contains: big five Canadian banks' balance sheet health, off-balance sheet derivative exposures, and national bankruptcy rates with a chart.

Summary for 2012 Q4

Big Five Banks: Balance Sheet Health

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

2012.Q4

2012.Q3

2012.Q1

2011.Q4

2011.Q3

2011.Q2

2011.Q1

2010.Q4

2010.Q3

Royal Bank

0.58%

0.55%

0.62%

0.78%

0.79%

1.31%

1.54%

1.65%

1.68%

TD

0.60%

0.57%

0.63%

0.70%

1.32%

1.34%

1.43%

1.23%

1.24%

CIBC

0.73%

0.76%

0.79%

0.94%

0.91%

0.92%

0.98%

0.99%

1.09%

Scotiabank

0.95%

0.98%

0.99%

1.32%

1.38%

1.43%

1.47%

1.50%

1.86%

BMO

1.15%

1.12%

1.09%

1.29%

1.11%

1.58%

1.71%

1.80%

1.78%

Average

0.80%

0.80%

0.82%*

1.01%

1.10%

1.32%

1.43%

1.43%

1.53%

* Note: banks switched accounting standards in 2012.Q1 (impaired loans didn't suddenly improve that much!)

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

2012.Q4

2012.Q3

2012.Q1

2011.Q4

2011.Q3

2011.Q2

2011.Q1

2010.Q4

2010.Q3

Royal Bank

0.27%

0.26%

0.29%

0.32%

0.32%

0.55%

0.65%

0.69%

0.71%

TD

0.31%

0.30%

0.33%

0.32%

0.60%

0.62%

0.66%

0.56%

0.55%

CIBC

0.47%

0.49%

0.51%

0.52%

0.49%

0.45%

0.50%

0.52%

0.58%

Scotiabank

0.54%

0.54%

0.55%

0.71%

0.74%

0.74%

0.80%

0.84%

1.03%

BMO

0.57%

0.53%

0.49%

0.56%

0.48%

0.68%

0.74%

0.78%

0.79%

Average

0.43%

0.42%

0.43%*

0.49%

0.53%

0.61%

0.67%

0.68%

0.73%

* Note: banks switched accounting standards in 2012.Q1

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 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

2012.Q4

2012.Q3

2012.Q1

2011.Q4

2011.Q3

2011.Q2

2011.Q1

2010.Q4

2010.Q3

Royal Bank

6.1%

5.9%

6.7%

6.7%

6.9%

11.6%

13.9%

14.7%

15.0%

TD

8.1%

7.9%

8.9%

7.7%

15.0%

15.2%

16.1%

14.2%

14.1%

Scotiabank

10.4%

11.3%

12.1%

14.3%

15.3%

16.0%

17.1%

17.5%

21.6%

BMO

11.5%

11.3%

10.9%

10.7%

9.4%

12.7%

14.3%

14.9%

14.7%

CIBC

11.7%

12.0%

12.4%

11.4%

11.1%

11.1%

12.0%

12.4%

13.5%

Average

9.6%

9.7%

10.2%

10.2%

11.5%

13.3%

14.7%

14.7%

15.8%

D. Tier 1 Leverage ratio (lower = more leverage, higher = better capitalization): 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 more leverage (lower % here) translates to greater overall risk. The banks with the worse loan books (above tables) should exhibit less leverage (higher % here), otherwise it means they are being too aggressive for their condition.

Bank

2012.Q4

2012.Q3

2012.Q1

2011.Q4

2011.Q3

2011.Q2

2011.Q1

2010.Q4

2010.Q3

TD

3.8%

3.7%

3.7%

4.2%

4.0%

4.1%

4.1%

3.9%

3.9%

CIBC

4.1%

4.1%

4.1%

4.6%

4.4%

4.1%

4.2%

4.2%

4.3%

Royal Bank

4.5%

4.4%

4.3%

4.8%

4.7%

4.7%

4.7%

4.7%

4.8%

BMO

4.9%

4.7%

4.5%

5.3%

5.1%

5.3%

5.2%

5.3%

5.3%

Scotiabank

5.2%

4.8%

4.5%

5.0%

4.9%

4.7%

4.7%

4.8%

4.8%

Average

4.5%

4.3%

4.2%*

4.7%

4.6%

4.6%

4.6%

4.6%

4.6%

* Note: banks switched accounting standards in 2012.Q1

Off Balance Sheet Derivative Exposures

Amounts are in trillions of dollars. All amounts are notional, which is the face value of a contract (the amount of underlying money represented by a contract). These are not prices or market values of contracts. In other words, $1 trillion of notional exposure does not mean the bank could lose $1 trillion; however, it shows the magnitude of derivative contracts.

OTC exposures are included here because I believe OTC contracts are particularly dangerous since they are illiquid, difficult to value, and become worthless if the counterparty (another bank) collapses.

This derivative exposure is hidden off-balance sheet where it can't distress investors and depositors. The standard excuse given by banks is that they are long some derivatives, and short others – and the two (thanks to financial engineering) perfectly balance out risk, resulting in minimal net exposure. But in reality, banks can only maintain such perfect hedging during exceptionally low volatility. A spike in volatility, or a counterparty failure, can suddenly create enormous derivative book losses. This happened in 2007-2009 (wiping out several banks), and will probably happen again. More derivative exposure means more risk.

The below data comes from: OSFI, financial data – banks, quarterly derivative components.

Bank

2012.Q3


Total notional

OTC notional

Royal Bank

$7.21 T

$6.75 T

TD

$3.77 T

$3.44 T

BMO

$3.68 T

$3.30 T

Scotiabank

$2.71 T

$2.45 T

CIBC

$1.73 T

$1.40 T

Total exposure

$19.10 T

$17.34 T

Bankruptcy Statistics

These numbers from the government lag, but they are still valuable: this shows total Canadian bankruptcies over time. Bankruptcy rates closely relate to bank loan quality and losses. Note however that banks with significant US/international operations have further credit exposure beyond Canada, which isn't reflected in this graph.

Bankruptcy rates have been declining in 2010, 2011, and 2012. There is no sign of a bankruptcies problem.




- Perpetual Bull, perpetualbull@gmail.com