Friday, August 27, 2010

Canadian Banks Confident Ahead of New Basel Rules

  
Thomson Reuters, 27 August 2010

Canada's banks appear set to handily absorb stiffer global capital and liquidity rules being developed by the Basel banking committee, meaning they could soon begin raising dividends and making acquisitions.

While the new regulations won't be released until November, the CEOs of Canada's big six banks have begun speaking more confidently about their ability to adopt the rules, which will redefine how much capital banks have to hold on their balance sheets.

"Based on what we know and the work we've done to date, we're well positioned on both an absolute and relative basis, to adopt the new rules," Bank of Montreal Chief Executive Bill Downe said on a conference call after the bank released its quarterly earnings this week.

Louis Vachon, CEO of smaller rival National Bank of Canada went a step further in terms of specifics, predicting that the rules will reduce National's Tier 1 capital ratio by 2.5 percentage points, a level that would still leave the lender well capitalized on a historical basis.

"Suffice it to say, that our level of comfort over the last few months has increased significantly," Vachon said.

The language marks a shift from the cautious tone of previous commentary on the Basel III rules, which are being developed to help avoid another banking crisis.

The uncertainty has prompted Canada's bank regulator -- the Office of the Superintendent of Financial Institutions -- to put a moratorium on big capital outlays such as dividend hikes and sizable acquisitions until the new rules become clear.

But the banks' confidence has been helped by signs the new rules may not be as strict as some had worried.

Last month, the Basel committee scaled back some of the toughest proposals, particularly those concerning the definition of Tier 1 capital, which is a key measure of a bank's stability.

The CEOs have also likely taken comfort from the robust levels of capital that Canadian banks have built up over the past year, as they have essentially stockpiled profits.

National's Tier 1 ratio was 13 percent on July 31, well above its normal 9 to 11 percent range and easily capable of withstanding a 2.5 percentage-point hit. A level of 10 percent is well above most global peers.

BMO's ratio was 13.55 percent, while Canadian Imperial Bank of Commerce was at 14.2 percent. Royal Bank of Canada, the country's largest bank, had a ratio of 12.9 percent.

Toronto-Dominion Bank and Bank of Nova Scotia will report their quarterly results next week.

The increasing comfort with the regulatory changes has bank CEOs looking past the November G20 meeting in Seoul, when the rules are expected to be released.

"I think that capital allocation becomes the story in 2011," said John Aiken, an analyst at Barclays Capital.

National Bank's Vachon noted that the bank's dividend payout ratio -- the level of earnings committed to the dividend -- was at the bottom end of its normal range.

"I think it's quite clear what our next step would be," he said.

National, TD, Royal, and Scotiabank are expected to be quick off the mark with dividend hikes, while BMO and CIBC could wait a few quarters.

Acquisitions are also expected, as the banks struggle to grow revenues in the crowded Canadian bank space. The lingering effects of the financial crisis have left attractively priced targets in the United States and Europe, observers say.

"I think all of them are likely to really monitor where else they can use their capital," said Juliette John, portfolio manager at Bissett Investment Management in Calgary.

RBC, for instance, has signaled it is looking to expand its wealth management operations in Europe, while TD has been adding to its retail banking presence on the U.S. East Coast.

BMO's Downe also flagged M&A as a possible focus, pointing to Federal Deposit Insurance Corp-assisted deals in the U.S. Midwest, where BMO already has an established presence with its Harris Bank unit.

"I think there should be some opportunity there," he said.

"BMO views the current environment as an opportunity to strategically expand our U.S. footprint.
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