The Leverage Ratio of Canadian Banks Has Declined

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The leverage ratio measures the ability of a bank to absorb losses. This ratio is important because soundness of a bank is put to test during a financial crisis and strong banks usually tend to weather storms than weak banks. During the 2008-09 crisis, many small banks in the US failed due to this factor.

From an article published in the Financial Post on the state of Canadian banks:

Canada’s banks, touted as the world’s soundest for eight straight years by the World Economic Forum, have become laggards to global peers on a key gauge of their ability to absorb losses.

The leverage ratio, a standard introduced globally by the Basel Committee on Banking Supervision after the 2008 financial crisis, measures Tier 1 capital as a per centage of total assets. After once boasting world-beating capital levels that helped them weather the crisis and even expand as some global competitors retrenched, Canadian banks’ advantage has dissipated under the new rules.

The country’s six biggest banks’ leverage ratio averaged 3.9 per cent at the end of January, trailing the 4.6 per cent average of Europe’s 15 largest lenders and 6.6 per cent average for the top six U.S. banks as of Dec. 31, according to calculations based on company filings. The higher the lenders’ ratio, the more capital it has available to absorb losses. A year earlier, the U.S. advantage was narrower and European banks were basically on par with the Canada.

“This is the weak spot for the Canadian banks,” said Doriana Gamboa, senior director of financial institutions at Fitch Ratings Ltd. in New York, adding that banks outside Canada have been gaining in capital strength. “Globally, there is a big push by regulators in terms of capital and having banks hold more.”

Source: Once touted as world’s soundest, Canadian banks are falling behind global peers on a key strength gauge, Financial Post, May 10, 2016

Despite the lower leverage ratio, Canadian bank stocks are good to hold for long-term investment. They tend to offer stable and growing dividends with some price appreciation year after year like clockwork compared to other developed world banks particularly in the US.

The five major Canadian banks trading on the US markets are listed below with their current dividend yields:

1.Company: Bank of Nova Scotia (BNS)
Current Dividend Yield: 4.65%
Sector: Banking

2.Company: Bank of Montreal (BMO)
Current Dividend Yield: 4.31%
Sector: Banking

3.Company: Canadian Imperial Bank of Commerce (CM)
Current Dividend Yield: 4.68%
Sector: Banking

4.Company: Royal Bank of Canada (RY)
Current Dividend Yield: 4.36%
Sector: Banking

5.Company: Toronto-Dominion Bank (TD)
Current Dividend Yield: 3.94%
Sector: Banking

Note: Dividend yields noted above are as of May 10, 2016. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure; Long all five banks

Tax Avoidance by Corporate Firms Costs the U.S. Billions in Lost Revenue Each Year

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Tax avoidance by large US firms is a major issue that gets very little attention in the media. Heavy lobbying (lobbying is legal, bribing is illegal) by these firms ensures that the regulators and politicians perpetually turns a blind eye to the issue. Every year billions of dollars in taxes owed never reach the state’s coffers as corporations use all legally available options to avoid them. Since billions are unpaid the state collects these amounts from individuals to compensate for the loss. Hence individuals pay a much higher rate in taxes to the government than corporations. Some of the tax evasion strategies that are perfectly legal have funny names like Double Irish, Dutch Sandwich, etc.

Here are three interesting charts and key points from a report titled “Broken at the Top ” by Oxfam America:

From 2008 – 2014 the 50 largest US companies collectively received $27 in federal loans, loan guarantees and bailouts for every $1 they paid in federal taxes.

From 2008 – 2014 these 50 companies spent approximately$2.6 billion on lobbying while receiving nearly $11.2 trillion in federal loans, loan guarantees and bailouts.7

Even as these 50 companies earned nearly $4 trillion in profits globally from 2008 –2014, they used offshore tax havens to lower their effective overall tax rate to just 26.5%8, well below the statutory rate of 35% and even below average levels paid in other developed countries. Only 5 of 50 companies paid the full 35% corporate tax rate.

These companies relied on an opaque and secretive network of more than 1600 disclosed subsidiaries in tax havens to stash about $1.4 trillion offshore. In addition to the 1600 known subsidiaries, the companies may have failed to disclose thousands of additional subsidiaries to the Securities and Exchange Commission because of weak reporting requirements.

Their lobbying appears to have offered an incredible return on investment. For every $1 spent on lobbying, these 50 companies collectively received $130 in tax breaks and more than $4,000 in federal loans, loan guarantees and bailouts.

a) Share of tax Haven in US Corporate Profits:

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Share of Profit in Tax Havens

b) Corporate taxes vs Federal Support:

Corporate taxes vs Federal Support Received

c) Sources of Revenue for US government:

How US Government Funded

Source: Broken at the Top – How America’s dysfunctional tax system costs billions in corporate tax dodging, Oxfam America

Comparing the Performance of Australian and Canadian Stocks

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The economies of Australia and Canada are similar in many ways. For instance,both are resource-based economies. While Australia is dependent on China for the export of minerals such as iron ore Canada is the largest trading partner of the US and exports natural resources like Crude Oil, Natural Gas, Timber, etc, to the US. I wrote an article many years ago comparing the economies of Australia and Canada.

Therefore it is not surprising that the equity markets of these countries tend to follow each other. The following chart shows the long-term returns of the S&P/ASX All Ordinaries Index of Australia and S&P/TSX Composite Index of Canada:

Click to enlarge

Australia vs Canada stock returns

Source: Yahoo Finance

Canada has a large manufacturing sector compared to Australia. Auto manufacturing is a huge industry especially in the province of Ontario.

Related ETFs:

  • iShares MSCI Canada Index Fund (EWC)
  • iShares MSCI Australia Index Fund (EWA)

Disclosure: No Positions

Is This A Good Time To Invest In Emerging Markets ?

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Emerging markets used to be a hot destination for investors a few years ago. Nowadays these markets have become more of  submerging markets with equities hit hard due to the collapse in commodity prices and other factors. Countries that are major oil exporters such as Brazil, Russia, etc. are suffering with the fall in crude oil prices. Many investors are avoiding from emerging markets as they continue to go from bad to worse. However astute investors can nibble at emerging stocks at current levels since commodities alone do not determine the future of all these countries. Here is an excerpt from an article by Charles Wilson, PhD at Thornburg Investment Management:

Correlation is not causation when it comes to emerging markets and commodities.

The term “risk assets” has become widely used to describe anything that goes up when the U.S. dollar goes down. Perceptions around the pace of U.S. monetary tightening substantially influence the greenback’s movements. In recent years, risk assets have come to include everything from junk bonds to Chinese steel prices or even Italian banks. In our view, many people have mistakenly confused the correlation between asset prices with causation, especially relative to prices of two asset classes in particular—commodities and emerging market equities. The underlying assumption being that emerging markets are driven by commodity prices. We don’t think that’s really the case on a fundamental level. Most countries in the MSCI Emerging Markets (EM) Index benefit from lower commodity prices in general, especially oil. This makes sense considering that about 90% of the companies in the MSCI EM Index are domiciled in countries that are net importers of energy, as shown in figure 1.

Click to enlarge

Oil Price Impact on Emerging Countries

Source: Can Emerging Market Equities Work If Commodity Prices Don’t? by Charles Wilson, PhD, Thornburg Investment Management

The following chart shows the performance of the MSCI Emerging Markets Index:

MSCI Emerging Markets Returns by Year

Source: MSCI

Five constituents of the MSCI Emerging Markets Index are listed below for further research:

1.Company: Ultrapar Participacoes SA (UGP)
Current Dividend Yield: 3.23%
Sector: Oil, Gas & Consumable Fuels
Country: Brazil

2.Company: Banco De Chile (BCH)
Current Dividend Yield: 4.63%
Sector: Banking
Country: Chile

3.Company: HDFC Bank Ltd (HDB)
Current Dividend Yield: 0.59%
Sector: Banking
Country: India

4.Company: Standard Bank Group Limited (SGBLY)
Current Dividend Yield: 9.71%
Sector: Banking
Country: South Africa

 5.Company:Fomento Economico Mexicano SAB de CV (FMX)
Current Dividend Yield: 1.52%
Sector:Beverages
Country:Mexico

Related ETFs:

  • iShares MSCI Emerging Markets ETF (EEM)
  • iShares Core MSCI Emerging Markets ETF (IEMG)

Disclosure: Long BCH

UK’s FTSE 100 Index Has Gone Nowhere Since 1999 ?

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FTSE 100, the benchmark index of the UK equity market peaked at 6,930 in December, 1999. After 17 years, the index closed at 6,125 yesterday, which is lower than where it was in 1999 – when the dot con mania was at the highest level. Does that mean the index has gone nowhere since 1999? Or put another way does this mean investors in UK stocks lost money over such a long period of time?

Well. The FTSE 100 being lower now than in 1999 is true as the chart shows below:

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FTSE 100 Index Long Term Returns

Source: Yahoo Finance

However this does not tell the whole story in terms of investor returns. This is because the FTSE is a price index and measures only the price appreciation of the components. The return of the FTSE 100 does NOT include dividends. So if dividends are included in the index, similar to the DAX index, then the return is much higher and the index now is far higher than where it is now based on price alone. So statements like “The FTSE 1oo has gone nowhere since 1999” are misleading to investors.

The correct way to measure the performance of the FTSE 100 over long periods is to use the FTSE 100 Total Return Index which includes dividends reinvested. Using this index, we can see investors did not lose money since 1999. The chart shows the difference in returns between the FTSE 100 and the FTSE 100 Total Return Index:

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FTSE 100 vs FTSE 100 Total REturn Index Long Term Return

Source: Sharescope

Since UK firms especially those in the FTSE 100 pay dividends it just makes sense to include those in the return calculation. Moreover dividends are an integral part of total returns. Including dividend return is more important in countries like the UK where dividend yields are much higher at around 3.98% which is nearly double that of the US market.

In summary, investors have to dig deeper and understand what an index is comprised of and how the return is measured before coming to any conclusions. Simply looking at the headlines that media report or not including dividends in performance calculations is not a wise strategy.

Related ETF:

  • iShares MSCI United Kingdom ETF (EWU)

Disclosure: No Positions