Banks from Citigroup Inc. (C:US) in the U.S. to BNP Paribas SA (BNP) in France are racing to shed assets and raise money ahead of new global capital rules that start taking effect in 2015. For Canadian lenders, these moves have created the opportunity to go on a shopping spree.
Canada’s six largest banks have spent $37.8 billion since 2008 on about 100 acquisitions at home and abroad, Bloomberg Markets magazine reports in its June issue.
“We and our Canadian competitors are only able to do that because we have some flexibility as a result of our strength,” says Gerald McCaughey, chief executive officer of Canadian Imperial Bank of Commerce, which bought JPMorgan Chase & Co.’s minority stake in asset management firm American Century Investments last year. “Over the longer term, this should actually help to maintain the strength of the Canadian banking system and its competitiveness.”
CIBC (CM) was No. 3 in Bloomberg Markets’ second annual ranking of the world’s strongest banks, followed by three of its Canadian rivals: Toronto-Dominion Bank (TD) (No. 4), National Bank of Canada (NA) (No. 5) and Royal Bank of Canada (No. 6), the country’s largest lender. Bank of Nova Scotia ranked 18th, and Bank of Montreal was 22nd.
OCBC Is No. 1
Singapore’s Oversea-Chinese Banking Corp. retained the title of the world’s strongest bank for the second year, followed by BOC Hong Kong Holdings Ltd. (2388) Two other Singaporean lenders -- United Overseas Bank Ltd. (UOB) (No. 7) and DBS Group Holdings Ltd. (DBS) (No. 8) -- were also among the strongest. “Singapore’s economy has performed quite stably and quite well, and for the Singaporean banks, we have real economic activities to finance,” Oversea-Chinese Banking CEO Samuel Tsien says. He credits the bank’s strength partly to its risk management practices.
No other country dominated the list as did Canada: The nation of 34.7 million people has only eight publicly traded banks, two of which are regional lenders. Only three U.S. banks -- JPMorgan Chase (JPM:US) (No. 13), PNC Financial Services Group Inc. (PNC:US) (No. 17) and BB&T Corp. (BBT:US) (No. 20) -- made the top 20. Four European banks were included: two from Sweden and one each from the U.K. and Switzerland.
$100 Billion or More
For the ranking, we considered only banks with at least $100 billion in assets. We weighed and combined five criteria, comparing Tier 1 capital with risk-weighted assets, for example, and nonperforming assets with total assets. Tier 1 capital includes a bank’s cash reserves, outstanding common stock and some classes of preferred stock, all of which combine to act as a buffer against losses.
Banks that posted an annual loss for last year or that failed government stress tests weren’t eligible for consideration.
Canadian banks invoke their strong capital levels, the country’s conservative lending culture and strict regulatory oversight under a single supervisor as reasons for their showing. The supervisor requires Canadian banks to hold a higher level of capital than do international standards.
Major banks around the world follow the rules of the Basel Committee on Banking Supervision -- an arm of the Bank for International Settlements, based in Basel, Switzerland, that draws banking regulators from 27 nations to set standards for lenders. The committee issued its first internationally accepted capital guidelines in 1988.
Those rules, known as Basel I, focused on credit risk: the possibility that borrowers might not pay back their bank loans. The committee required banks to hold total capital, at least half of it in Tier 1 capital, equal to at least 8 percent of their risk-weighted assets.
Canada’s regulator, the Office of the Superintendent of Financial Institutions Canada, has gone beyond those levels in its requirements, a stance that has shielded lenders from some of the financial follies that undermined other global banks, especially in 2008. As far back as January 1999, OSFI sent a letter to Canadian banks telling them to set aside at least 10 percent of total capital as a cushion for losses. “I do not think it was popular at the time,” says Julie Dickson, OSFI’s superintendent. “That’s where having a supervisor with a pretty clear mandate allows you to take those unpopular decisions.”
The Canadian regulator also set criteria on the quality of banks’ assets, requiring them to hold 75 percent of their capital in equity. “When the crisis erupted, we realized we had stuck to a fairly basic rule, which was that the bulk of Tier 1 capital had to be in equity,” Dickson says. “That turned out to be very, very important.”
Some of Canada’s lenders elected to exceed OSFI’s requirements. Investors criticized Bank of Nova Scotia (BNS), CEO Richard Waugh says, for holding too much cash. “So many people in 1999 and 2001 said: ‘Scotia, you’ve got excess capital because you’re way above Basel, way above OSFI. You should do stock buybacks and extra dividends,’” Waugh recalls in an interview at an annual investor meeting in Saskatoon, Saskatchewan. “We said, ‘It’s not excess, because it was getting 18 percent return on capital, which was a very good place, and our shareholders would have had a difficult time reinvesting elsewhere.’”
Waugh credits the high returns to profits spread equally among four main businesses: global wealth management and domestic, international and wholesale banking.
Since 1988, the BIS has further tweaked global rules. The 2004 Basel II accord set more guidelines on how to address and quantify the risks of a bank’s assets -- allowing them to use internal models, for instance.
And in 2010, regulators rewrote the rules again to address shortcomings that arose out of the financial crisis. The group will require banks to hold 7 percent of their assets as core reserves, or equity core Tier 1 capital, by 2019 when the latest rules -- known as Basel III -- are fully implemented. Banks will be required to have minimum Tier 1 capital of 6 percent starting in 2015.
While having strong capital is crucial, Canadian banks will prosper only if they can expand their reach, Waugh says. “Because if you don’t grow, you’re going to eventually have some issues on capital and strength,” he says. Scotiabank has units in about 50 countries and is looking in particular at Latin America and Asia, says Waugh, who’s also vice chairman of the Washington-based Institute of International Finance.
Expanding in the U.S.
Canadian banks spent $14.4 billion last year on acquisitions, many of them aimed at growth in the U.S. “Having conservative capital standards in Canada going into the downturn clearly was a competitive advantage,” TD Bank CEO Edmund Clark says. He says Canada’s second-biggest bank was ferocious at managing liquidity.
TD Bank has accelerated a U.S. expansion strategy that Clark began in 2004. In 2008, the bank took over Commerce Bancorp of Cherry Hill, New Jersey, in a $7.1 billion transaction that helped give the Canadian lender 1,284 branches in the U.S. today -- more than the 1,150 it currently has in Canada. TD’s green logo is now a common sight on the streets of New York, where it aims to become the city’s third-largest lender by number of branches within four years, and in Boston, where its name adorns the TD Garden, home to the Boston Celtics basketball team and Boston Bruins hockey team.
“We were in there and said: ‘We have a once-in-a-lifetime opportunity. Let’s take advantage of it,’” Clark says. Toronto- Dominion -- one of four banks globally to boast the top Aaa long-term debt rating from Moody’s Investors Service -- added further to its U.S. clout last year when it acquired auto lender Chrysler Financial Corp. from Cerberus Capital Management LP.
Bank of Montreal (BMO), Canada’s fourth-largest lender, also ramped up its presence in the U.S. by buying Marshall & Ilsley Corp., a Milwaukee-based bank, last year for $4.19 billion. Prior to that, its main U.S. asset had been the small Chicago- based Harris Bank franchise it bought in 1984.
Royal Bank has also been active. In April, it agreed to buy the 50 percent of RBC Dexia Investor Services Ltd. it didn’t already own from Banque Internationale a Luxembourg SA for about C$1.1 billion ($1.1 billion) in cash.
As they flex their muscles with acquisitions, Canadian banks may face tougher times ahead. Consumer lending is slowing this year. RBC Capital Markets predicts that Canadian bank profits will rise 7 percent in 2012, slightly more than half the 13 percent rate in 2011.
Canadian bank stocks have outperformed those from south of the border. In the four years ended on Dec. 31, the Standard & Poor’s/TSX Composite Commercial Banks Industry Index (STCBNK) that tracks Canada’s eight traded banks rose 4.8 percent compared with a 56 percent decline for the 24-member KBW Bank Index (BKX), which includes the biggest U.S. banks.
Canadian banks haven’t been completely immune to the woes faced by their counterparts in the U.S. and Europe in recent years. CIBC had more than C$10 billion in writedowns following the U.S. mortgage-related financial crisis of 2007, more than any other Canadian bank. CIBC also was one of the first to rebuild its balance sheet, selling C$2.94 billion of stock nine months before Lehman Brothers Holdings Inc. collapsed and markets seized up. Still, writedowns at Canadian banks were a fraction of the $2.08 trillion taken by financial companies worldwide.
There’s no reason for Canadian banks to become smug, the country’s banking regulator says. “Complacency is a real danger for Canada,” OSFI’s Dickson says. “The bar is always rising in risk management, and if you become complacent, you may say you’re doing a good enough job and you don’t really have to change anything.”
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