Are Canadian Banks Better Than European and American Banks?

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The Canadian banking system remained strong and stable during the Global Financial Crisis (GFC) of 2008. Unlike many European and American banks, banks in Canada did not require any form of bailout and the regulatory system won praise from many countries and global institutions such as the IMF. Since then however some have raised doubts about the strength of the Canadian banking system. I wrote a couple of articles on this subject last year which can be found here and here.

Recently Tyler Durden of Zero Hedge wrote an article saying that the majority of Canadian banks are also in bad shape based on the Tangible Common Equity(TCE) ratios. The following chart shows the top global banks ranked by TCE ratios with the lowest at the top:

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Source: Zero Hedge

Except Bank of Montreal, all the other four Canadian banks have TCE ratios of less than 4%. Tyler looked for banks that will have their equity wiped out with a reduction of 4% or less in their value of assets. Based on this logic, except Bank of Montreal Canadian banks are just as risky as their European and American peers.

In an article titled Is Zero Hedge looking at the wrong numbers? Boyd Erman of The Globe and Mail argues that Zero Hedge may have looked at the wrong numbers to make that conclusion. From the article:

In a simple analysis that generated a great deal of commentary, a blogger at Zerohedge.com, an oddball but widely followed financial site, suggested that Canadian banks were as leveraged as European banks because they have low ratios of tangible common equity to total assets.

But there’s an argument that looking at that ratio is the wrong way to judge a bank’s strength because it ignores the composition of the assets.

A better number might be the ratio of tangible common equity to risk-weighted assets.

In times of stress, analysts have focused on tangible common equity as a baseline measure of strength. It is calculated as the amount of equity a bank has, after excluding preferred equity and intangibles (whose value might be questionable in a crisis). Set that tangible equity against a bank’s assets, and you can see how much wiggle room a bank has if its assets start to go bad.

But what’s the best measure of assets? Is it total assets, as the Zero Hedge analysis assumes, or is it risk-weighted assets?

An argument for total assets and against risk-weighted is that risk-weighted involves judgement calls on the riskiness of loans and investments. In many cases, the judgements are made by banks and overseen by regulators. Assets such as Treasury bonds are judged much less risky than a loan to a consumer, for example. Banks with low-risk assets can carry less equity.

There’s no judgement in total assets. They are an absolute.

The argument the other way runs that by using total assets you are lumping in Canadian banks’ assets like mortgages with the Greek bonds on the balance sheets of European banks. In other words, while you think you’re getting an apples to apples comparison, you’re not adjusting for the fact that some apples are fresh and tasty and some are rotten.

Interestingly, a 2009 study by McKinsey found that, when looking at the global banking crisis from 2007 to 2009, the ratio of tangible common equity to risk-weighted assets was the best predictor of bank distress.

To answer my title question I would say that Canadian banks are indeed better than European and American banks based on the above analysis and many other factors. For example, mortgage loans in Canada are full recourse loans and hence banks can go after homeowners if they default on their mortgages. Canadian banks also have effective risk management policies and do not engage in reckless lending (subprime) or play the derivatives market.

Bank of Nova Scotia(BNS), Bank of Montreal(BMO), Canadian Imperial Bank of Commerce(CM) and Royal Bank of Canada(RY) currently have dividend yields of over 4% and Toronto Dominion Bank(TD) yields close to 4% based on Friday’s closing prices. TD is expanding big in the U.S. and Scotia bank has a strong presence in the Caribbean and Latin American countries.

Related article:
Canada’s banks: Next dominos to fall?

Disclosure: Long BNS, BMO, CM, RY, TD

The Top 20 Foreign Direct Investment(FDI) Receiving and Investing Countries

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The chart below shows the top 20 FDI recipients in 2010:

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In 2010, half of the top 20 host economies were from developing countries. China and Brazil continue to attract the most capital among developing countries. For the first time, Indonesia entered the top 20 list underscoring its growing significance in the global economy.

The chart below shows the top 20 FDI investors in 2010:

The U.S. maintains the top position in investing abroad. While high FDI helps the U.S. economy in some ways in other ways it hurts the economy. For example, companies pouring billions of dollars into developing countries create millions of jobs in those countries leading to lack of job growth in the U.S. In addition, companies are unwilling to repatriate most of the profits earned abroad due to tax implications. As a result, billions of  profits earned by U.S. corporations overseas remain there. Developing countries such as China, Russia and India are in this list as they become major investors themselves.

Source: World Investment Report 2011, UNCTAD

The Investable Universe in Africa

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The investable universe in Africa is listed in the graphs below:

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Source: Africa’s Investable Universe, Nick Ndiritu, Allan Gray Asset Management, South Africa

The aggregate market capitalization of all African markets excluding South Africa as shown in the first graph is about US$250 billion, or about 20% of GDP. In many countries a very few sectors have a high concentration in the country’s stock market capitalization. For example, in Nigeria banks account for about 50% of the total equity market.

South Africa has the largest economy in Africa and accordingly has the largest market capitalization as shown in the second graph. Some of the South African companies trading on the US markets include AngloGold Ashanti(AU), Gold Fields (GFI),Harmony Gold (HMY), Randgold Resources(GOLD) and
Sasol (SSL).

To put the African market caps in perspective, excluding South Africa the equity market capitaliztion of all the individual countries are less than that of the market capitalziaiton of Apple which is at about $340 billion.

Related ETFs:

Market Vectors Africa Index ETF (AFK)

PowerShares MENA Frontier Countries Portfolio (PMNA)

iShares MSCI South Africa Index Fund (EZA)

SPDR S&P Emerging Middle East & Africa (GAF)

Disclosure: No Positions

The Top 30 Non-Financial State-Owned Trans-National Companies

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State-owned Trans-national Companies (TNCs) are enterprises in which the government holds a majority controlling interest.In 2010, there were at least 650 State-owned TNCs operating around the globe.

The total number of the state-owned firms in developing world is high.However the developed economies particularly in Europe also have a high number of state-owned TNCs. For example, in France there are some 900 State-owned enterprises.In China there were 154,000 companies in which the state has ownership interest in 2008.

The Top 30 Non-Financial State-owned TNCs ranked by foreign assets in 2009 are listed below:

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Source: World Investment Report 2011, UNCTAD

The U.S. government owns a majority stake in General Motors(GM) as a result of the bailout of the company when it went through a bankruptcy reorganization.Companies such as Petronas of Malaysia, China National Petroleum Corporation of China, multi-utility Vattenfall of Sweden are 100% owned by the respective countries. The Brazilian government owns about 40% of the integrated oil major Petrobras (PBR) and hence earns billions of dollars in revenue each year for the state. Similarly Norway holds a 67% stake in Statoil (STO) which pumps billions into Norway’s sovereign wealth fund making it the world’s largest sovereign wealth fund outside the Middle East.

Disclosure: Long PBR