31 March 2009

Global Bank Regulators Likely to Strengthen Capital Standards Over Time

RBC Capital Markets, 31 March 2009

Global banking regulators are committed to strengthening capital requirements over time.

• The Basel Committee on Banking Supervision put out a press release yesterday providing colour on initiatives banking supervisors might undertake long term in response to the events of the last two years.

• We had highlighted most of these issues in a July 2008 report ("Bank capital ratios high but face pressure"), and do not believe that they have implications for share prices near term.

• The new capital requirements, if implemented, would lead to lower and more stable ROEs for the global banking system versus the pre-crisis model, in our view.

• The impact on Canadian banks is less clear as they already operate under stricter capital constraints than many of their global peers.

Key highlights and some colour:

• Reforms would be phased in over time as regulators do not want to further disrupt the banking system in the near term.

• Supervisors want to increase how much capital is in the global banking system AND the quality of the capital. All else equal, this has negative implications for ROE.

• Canadian banks already operate under higher minimum capital requirements than most of the rest of the world, and must have more of their capital as common equity than most of the rest of the world.

• Specific areas to be addressed for higher capital requirements include securitization activities and trading books. Higher capital requirements have negative implications for ROEs.

• The Committee wants to introduce a non-risk based measure to supplement risk-weighted approaches such as Tier 1. In other words, a non-risk adjusted leverage constraint would keep banks from putting on outsized balance sheet leverage on the premise that the assets are low risk but then finding out that they are not low risk, which is what got many European banks in trouble.

• Canadian banks already operate with a leverage constraint – not just risk-based ratios.

• The Committee is spending more time on banks' liquidity management practices. More cautious liquidity management generally leads to greater holdings of cash and short term securities and/or more holdings of Government securities, both of which are detrimental to margins in our view.

• Other areas of potential interest to bank investors that are addressed in the release (which can be found on http://www.bis.org/review/r090330a.pdf ) include pro-cyclicality, transparency and supervision process.
Bloomberg, Doug Alexander, 31 March 2009

The Group of 20 countries may agree to impose tighter lending limits on banks when they meet this week in London, said Royal Bank of Canada Chief Executive Officer Gordon Nixon.

“Coming out of this, you will have global standards which will place leverage tests across financial institutions,” Nixon said in an interview today in New York. “That’s a good thing.”

U.S. President Barack Obama and his G-20 counterparts aim to merge their national plans’ strengthened regulation into a united front to rein in hedge funds, derivatives trading and excessive risk-taking by financial firms.

Nixon said global leaders may borrow from the Canadian banking model, which limits bank lending to about 20 times their capital base. He said these restrictions have helped Canadian lenders avoid most of the writedowns and credit losses that have buffeted global banks.

“The leverage ratios in Canada, clearly, have proven to be a positive as the asset problems worldwide have spread, simply because we’ve had a little less leverage on our balance sheets.”

The country’s six biggest lenders reported less than C$20 billion ($15.9 billion) in debt-related writedowns since the credit crisis began in 2007, about 2 percent of the $914 billion recorded by banks and brokerages worldwide.

Canada’s government may adopt a G-20 recommendation to revamp the country’s financial system regulation. The banks are regulated by the Office of the Superintendent of Financial Institutions, or OSFI.

Nixon said he doesn’t expect the central bank to take on the role of regulating the nation’s banks.

“There’s almost been this impression that the Bank of Canada is going to be a ‘super regulator’ of financial institutions and banks and displace a lot of activities” of the regulators, Nixon said. “I don’t think that’s the case at all.”
The Canadian Press, 31 March 2009

Amid a sinking economy and a crash in the car business, the chief executive of the Bank of Nova Scotia continues to exude confidence about his bank and the Canadian banking sector as a whole.

"We are maintaining our 2009 targets, which are going to be challenging but provide for growth," Rick Waugh told a financial services conference Tuesday.

"The operating businesses are performing satisfactorily."

Scotiabank has become the seventh-largest bank in North America – courtesy of the shrivelling of big American competitors – and the banking sector in Canada "is still in fine shape," he said.

"We are starting to see repricing in our asset portfolios," and first-quarter earnings were held flat by higher costs of funding, he added, but corporate lending is "in better shape than in previous downturns."

"We do expect, obviously, our loan losses to increase," but ``taking risk is part of our business, it's part of our cost, and it's built into our spread."

With revenue flows "less predictable," Waugh said, Scotiabank is maintaining stringent risk management and putting greater emphasis on cost control.

"We have cut back substantially our travelling and our marketing; we are slowing down what I call our non-critical projects, and we have also slowed down our new branch openings, both here in Canada and internationally," he said.

"This does not mean, though, we're going to stop looking to the future; we're not going to stop looking at what we can do in terms of growth initiatives," in particular in wealth management and international operations.

And "we don't have to do the slash and burn" that other banks and other industries are enduring.

Canadian banks as a group entered the global downturn with the most solid balance of loans to core capital in the world – their Tier 1 ratios were nine to 10 per cent, above the Canadian regulatory minimum of seven per cent and far above the four per cent ratios at many global peers – and Waugh said Scotiabank's loan book has become more conservative in recent years.

Corporate and commercial loans amount to 45 per cent of the total portfolio, down from 55 per cent in 2000. And within the retail portfolio, residential mortgages now represent 75 per cent of assets, up from half.

Asked about exposure to the troubled automotive sector, Waugh said, "We are an auto bank – it's been a great business for us over many decades," and he predicted that "like houses, people will buy cars."

He said Scotiabank's loans to automakers are minimal, with its main exposure being to individual car buyers, parts suppliers and auto dealers.

On the positive side, he said, parts makers "have been under pressure for a long time" and most have built their businesses beyond the Detroit Three to Japanese and other customers, while dealers in Canada generally carry multiple car lines.

Scotiabank's strategy is "being there for customers who want to drive a car," and "that market its looking very attractive to us" as non-bank competitors fall by the wayside.

In the vehicle segment as a whole, "I think we're in the end game, and that's dealing with the legacy issues that are in the three big (U.S.-based) manufacturers."

Overall, the economy is likely to start reviving by the end of this year, though "there's lots of people who've got lots of different views and I respect them all," Waugh said.

"When we come out of this crisis – and we will, crises do end ... I see ourselves in a great position to maximize what I think will be some outstanding opportunities."
The Toronto Star, Rita Trichur, 31 March 2009

Canada's slumping economy, including escalating job losses and personal bankruptcies, is weighing on consumer lending at major banks.

Industry executives told a financial services conference in Montreal today that more cracks are appearing in credit-card lending. Faced with higher loss rates, banks are moving swiftly to mitigate their risks by stepping up collections and cutting credit limits to high-risk clients.

Confirmation that more consumers are falling behind, though, is bound to fuel the debate on whether the federal government should step in and regulate the credit card industry.

Canadian Imperial Bank of Commerce, which administers Canada's largest credit card portfolio, is accepting fewer new clients and is keeping a watchful eye on existing accounts.

Sonia Baxendale, head of CIBC's retail operations, said higher unemployment and bankruptcy rates prompted the bank's proactive stance.

"While the overall industry growth rates have slowed, we have intentionally reduced our growth faster and deeper than our competitors in light of our size and economic uncertainty," she said.

CIBC began curbing credit-card lending during the second half of fiscal 2008 and will remain prudent this year.

"Collection activities have increased and so we're managing our collection processes differently," Baxendale said.

"(We are) monitoring our accounts earlier and ensuring that we get to our clients and either assist them in other ways of managing their credit ... or simply reducing the available credit where we feel that is absolutely necessary."

Robert Sedran, the conference's host and an analyst with National Bank Financial, said the industry's credit-card loss rates already appear to be outpacing levels recorded in previous recessions. "Already, where we are seems to be worse," he said.

Baxendale, however, said CIBC's loss rates are matching those of previous downturns. Nonetheless, she conceded the sputtering economy is impacting other aspects of the bank's loan book. Mortgage lending has slowed amid the cooling housing market, while more consumers appear to be relying on their personal lines of credit.

"We are seeing the natural draw down of lines of credit authorized over the past two years," she said. "Our average authorized line of credit to home value is approximately 60 per cent and we continue to see well below 50 per cent of the total available facilities being utilized."

The Bank of Montreal is also taking action to limit loan losses, said Frank Techar, head of personal and commercial banking.

"We've maintained conservative underwriting practices over the years and over the last 12 months we've made targeted adjustments to lending strategies to ensure our underwriting is appropriate given the environment," he said.

BMO has increased staff in its collection department and its proactively identifying "high-risk" accounts.

"The consumer loss ratio is rising but it is expected to remain within historic loss," Techar said. While credit-card losses are certainly picking up pace, BMO's losses are less severe than those of other banks.

"In fact, for the last three months that data is available, we are 100 basis points better than the average for the Canadian banks for credit-card loss," Techar said.

"We're ready to do everything we can for our customers that are in distress to get them back on their feet."

The Bank of Nova Scotia, meanwhile, is tightening up its overall risk management strategy and cutting back on expenses. That involves "countless stress testing" in numerous portfolios and slowing down new branch openings.

Despite those measures, Scotiabank's overall loan losses are expected to increase this year, conceded chief executive officer Rick Waugh. "They have to reflect the realities of this market."

Those market conditions, however are looking increasingly grim. Mounting job losses pushed the national unemployment rate to 7.7 per cent in February and some economists believe it could climb as high as 10 per cent before the economy rebounds.

Those shrinking payrolls are also fuelling an increase in consumer bankruptcies. According to the Office of the Superintendent of Bankruptcy, there were 7,944 consumer bankruptcies in January, almost 22 per cent more than a year earlier.

Against that backdrop, Ottawa is facing growing pressure to regulate the credit card industry. A Senate committee is holding hearings again this week on that topic and the NDP is signalling plans to introduce a consumer bill of rights.

"While banks and credit card companies are entitled to earn a fair profit, it shouldn't be generated by ripping off consumers and forcing them into accepting higher interest rates and inexplicable fees," said NDP consumer critic Glenn Thibeault in a release last week.

Credit card companies, however, are warning that heavy-handed regulation in the credit and debit markets will stifle innovation and consumer choice. Yesterday, Tim Wilson, head of Visa Canada, told a Toronto business audience that government regulation would ultimately hurt consumers by limiting competition.