The Best Banks In North America Probably Aren't Where You Think

by Tony D'Altorio

The Best Banks In North America Probably Aren't Where You Think

by Tony Daltorio, Investment U Research

Thursday, February 25, 2010

At the turn of the century, U.S. banks like Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), and Bank of New York Mellon (NYSE: BK) dominated the list of the world's highest-valued banks.

Of course though, the financial crisis and resulting recession altered all that. So by the end of the decade, that pecking order changed... a lot. Suddenly, a slew of Chinese and Brazilian banks had made the cut. For that matter, so had several Canadian financials, including the Royal Bank of Canada (NYSE: RY) and the Bank of Nova Scotia (NYSE: BNS).

These big Canadian banks typically generate return on equity between 13% and 20%. And they rarely produce negative returns on equity. In contrast, their comparable competitors in the U.S. ranged between 10% and 25% on their returns.

Knowing that, it suddenly makes sense why so many investors are taking their money north of the border...

How Canadian Banks Survived the Financial Crisis

Canadian banks survived the financial crisis without any infusion of government money. And since then, they have relied far less on liquidity support than either U.S. or European banks.

With a vast and stable domestic retail base, they also limited their exposure to more volatile money markets and securitized funding, even while most other western countries were loosening their standards. By law, Canadian banks had to meet tough regulations such as:

  • Tier-one capital targets of at least 7%
  • Leveraging ratio of debt-to-equity of no more than 20-to-1
  • Capital requirement quality, where 75% of Tier-one capital had to be in common shares.

As a result, Canada's five biggest banks - Royal Bank of Canada, Bank of Nova Scotia, Canadian Imperial Bank of Commerce (NYSE: CM), Bank of Montreal (NYSE: BMO) and Toronto-Dominion Bank (NYSE: TD) - now have millions of excess capital.

Those five built up their capital cushion through fund raising forays and retaining earnings over the past two years. Their thrifty actions left them with the strongest balance sheets in the world... not to mention enough left over to maintain normal dividend payments to shareholders.

UBS banks analyst Peter Rozenberg believes Canadian banks represent the best of western banking institutions in a "new world." This new world, he suggests, involves not only investors that want to see decent profits and dividends with strong capital bases, but also regulators that actually take risk into consideration for a change.

The Canadian Approach to Regulatory Systems

Canada might not be having much luck in its Olympic quest for domination, but it can teach the U.S. a thing or two in other matters... like its well-coordinated regulatory system that works together, despite being comprised of four separate branches:

  • The central bank, the Bank of Canada, which maintains stability of the overall system
  • The Superintendent of Financial Institutions, which oversees financial institutions in particular
  • The Canadian government Finance Ministry, which sets the broad rules on ownership of financial institutions and the design of financial products
  • The Financial Consumer Agency of Canada, which acts as a consumer protection agency

All four meet regularly to ensure that loopholes don't exist for Canadian banking executives to sneak through... a concept that the U.S. could learn a thing or two about. And they actually seem to care about enforcing those rules instead of just talking about them, focusing on the spirit of the law instead of just the letter.

Julie Dickson, the head of the Office of the Superintendent of Financial Institutions recently spoke bluntly on the subject:

"Having lawyers looking at this line or that clause and debating about whether something is doable or not is not the right conversation to have. The right conversation is the principle. You have to know what risks you are undertaking."

And CEO Ed Clark, whose Toronto-Dominion Bank has significant operations in the U.S., can testify that she means what she says. "The message in the U.S. is it's your responsibility to meet our rules," he delineated. "In Canada, the responsibility is to run the institution right."

That refreshing perspective means they strictly govern financial institutions instead of pampering them. The banks have to figure out how to make a profit all by themselves... yet another lesson that U.S. regulators should probably learn.

Fortunately, investors don't have to hold their breaths waiting for the U.S. to get it. They can begin investing in Canadian banks now and enjoy holding stock in financial institutions that actually can stand on their own two feet.

Good investing,

Tony Daltorio

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