A Different Kind of Bank ~ Canada

When Bailout-phobie Earns You 30% in Eight Months…


Canada exports mainly commodities and automobile parts. The world’s second-largest country (by geographical landmass) is also home to the best hockey talent, the best maple syrup and — since 2007 — the best banking model.

Aside from Japan, which already went through a crippling deflation of its banking system in the 1990s, Canada is the only G-7 country that doesn’t require a bank bailout. No Canadian bank has failed since August 2007 and most have not even suffered a losing quarter.

Canada has largely escaped the wrath of toxic mortgage-backed securities and sharply declining real estate loans. That’s because the Canadian banking system, though not immune to global volatility, is far more regulated than its U.S. and international counterparts.

Indeed, Canada had limited exposure to toxic mortgage assets and its banks have already written-off these securities: housing markets are indeed declining since late last year but continue to require a 25% down-payment — something that was unheard of in the United States or the United Kingdom until recently.

Canadian banks, however, did suffer approximately C$32 billion ($25 billion) in losses tied to short-term asset-backed commercial paper markets starting in mid-2007. Though not completely resolved, Canadian regulators are working to address these losses by restructuring the terms of outstanding commercial paper.

Approximately a third of these losses have already been written off by the country’s banks. As asset markets improve, banks hope to cap these losses.

Still, despite a severe recession south of the border, most Canadian banks are not overly exposed to U.S. commercial real estate. Instead, they are actually sitting on the sidelines, seeking to expand their portfolios of distressed American property in 2010.

Some of the Last Banks Standing
Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD) are among only seven banks worldwide that still carry a Moody’s AAA credit rating. None of the five largest Canadian banks has cut its dividend since WWII. And despite plunging more than 35% collectively since peaking in 2007, Canadian banks have outperformed essentially insolvent international banks like Citigroup and Lloyds by 30% or more.

Canada’s banking system has received kudos from global governments and regulators alike. It also served as a regulatory framework at the April G-20 meeting in London. Indeed, the industrialized world looks to Canada for a model of successful bank supervision, after the total collapse of intermediary relationships sparked by the 2007 subprime fiasco.

The Toronto-listed iShares Canadian Corporate Bond Index or XCB holds 54% of its assets in senior Canadian bank debt, and it’s a great way to get some exposure to this opportunity.

In addition to holding 54% in Canadian bank debt, XCB also holds 12% in energy, 12% in infrastructure and another 20% in communications, securitization and industrial bonds. All bonds are rated investment-grade securities by Moody’s and Standard & Poor’s.

The iShares Canadian Corporate Bond Index holds 262 issues and pays a weighted average yield to maturity of 5.23%. The weighted average duration, which measures interest rate sensitivity, is only 4.8 years — a conservative duration. The ETF’s total expense ratio, which includes all fees, is just 0.40% with $485 million in assets.

The ETF’s biggest holdings include Toronto-Dominion Bank, Bank of Nova Scotia, Royal Bank of Canada, Canadian Imperial Bank of Commerce and The Bank of Montreal.

Another plus: the Canadian dollar has plunged by a third against the U.S. dollar since last July along with other currencies amid a massive de-leveraging process.

This safe-money play has delivered a return of roughly 30% since it was added to our Sovereign Individual portfolio this past May. It’s a big winner not just in terms of capital appreciation, but currency diversification as well (since it’s denominated in Canadian dollars). At present, this play is more of a “hold” since the Canadian dollar is near par with the USD. But a little more short-term strength from the dollar could once again make Canadian bank debt a stellar play.



Eric Roseman, Investment Director for The Sovereign Individual