Why Canada Can Avoid Banking Crises & the US Can’t

The Wall Street Journal, Victoria McGrane, 9 April 2013

Since 1790, the United States has suffered 16 banking crises. Canada has experienced zero — not even during the Great Depression.

It turns out Canada can thank the French for their stable system, according to a paper by Columbia University’s Charles Calomiris, presented at the Atlanta Fed’s 2013 Financial Markets Conference.

When it became a British colony, the majority of Canada’s population was of French origin — and the French inhabitants hated the British government.

So to keep the colony firmly within the Empire, British policymakers steered toward a government structure that would limit the power of the French-majority while also giving Canada more and more self-government. The eventual result was a highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces, the paper argues.

That anti-populist political system — known in political science as liberal constitutionalism or liberal democracy — is a key ingredient in Canada’s stable banking track record, Mr. Calomiris contends in his paper, which is a summary of a much longer book he’s written with Stephen Haber due out in September. That’s because this kind of political system makes it difficult for political majorities to gain control of the banking system for their own purposes, the authors contend.

Populist democracies like the U.S., on the other hand, tend to create dysfunctional banking systems because a majority of citizens gain control over banking regulation that steers credit to themselves and to their friends at the expense of the citizens that are excluded from the banking system, he said.

The contrast between the U.S. and Canada was part of Mr. Calomiris broader argument that dysfunctional banking systems — which are by far the norm rather than the exception around the world — are the result of political factors.

“Whether societies have dysfunctional banking systems is really not a technical issue at all. It’s a political issue,” Mr. Calomiris said at the conference, introducing his premise as “we do know how to avoid dysfunctional banking but that we make political choices – you might even say consciously” not to have functional banking systems for most of the modern era in most countries of the world.

The history of the U.S. banking system is one in which the government forms partnerships with different interest groups at different points in history, and those coalitions jointly influenced the way the banking system was regulated, Mr. Calomiris argues.

“In populist democracies, such as the United States, the regulation of banking is used as a political tool to favor some parties over others. It is not that the dominant political coalition in charge of banking policy desires instability, per se, but rather, that it is willing to tolerate instability as the price for obtaining the benefits that it extracts from controlling banking regulation,” he writes in his paper.

Backing up their argument: Only six countries – including Canada — have been crisis-free and at the same time have banking systems that provide abundant credit. Three of these – Singapore, Malta and Hong Kong – are small, island-bound city-states where the homogeneity of the population makes it politically difficult to create losers. The other three – Canada, Australia and New Zealand – all share histories of liberal democracy.

Mr. Calomiris argues that in the U.S., a coalition that emerged in the 1990s of government, big banks and activist consumer groups came helped fuel the housing crisis. Regulatory changes opened the door to a wave of mergers and acquisitions that created today’s megabanks. But banks still had to get approval – usually from the Federal Reserve – to complete those mergers and outside groups were able to weigh in on the wisdom of the deal as part of the Fed’s decision-making process.

Community groups, with the Clinton administration’s encouragement, used the Fed’s approval process to extract binding concessions from banks to loosen underwriting standards for poor, urban communities – concessions to which the Fed agreed, Mr. Calomiris argues. The banks had to apply the looser standards to everyone. That helped fuel an explosion in poorly underwritten mortgages that contributed to the depth and severity of the housing crisis, he contends.

All in all, Mr. Calomiris’ theory is a bleak one for the ability of financial reform efforts to make much of a difference.

“Smart economists with their regulatory ideas are sort of dead on arrival,” he said. “Political coalitions will decide — not whether you’ve got the right VAR model — [but] whether a banking system is going to be set up with rules that will lead it to be stable and have abundant credit or not.”

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TD Bank’s US Expansion Hasn’t Come Cheap

The Globe and Mail, Scott Barlow, 5 April 2013

The impending ascension of Bharat Masrani to the CEO chair at Toronto-Dominion Bank underscores the strategic importance of U.S. operations for the company as a whole, and provides an excellent opportunity to assess just how well TD Bank’s $17-billion (U.S.) foray into foreign territory is going.

The bottom line: It still faces considerable challenges. While U.S. expansion provides the bank with a useful counterbalance to its Canadian base, the venture is – for now – still a work in progress.

One question: can TD Bank maintain loyalty among its U.S. consumers? The Wall Street Journal recently published a brief report highlighting increasing customer dissatisfaction at its U.S.-based branches.

Meanwhile, return on equity (ROE), the most widely used measure of a bank’s profitability, has been running at about eight per cent per year on the company’s approximately $17-billion in U.S. acquisitions since 2004. This pales in comparison to TD Bank’s overall ROE of 14.8.

To be fair, the consumer data highlighted by the Journal is anecdotal and an ROE of eight per cent is perfectly acceptable for a relatively new expansion. But what does seem clear, with the benefit of hindsight, is that TD Bank paid a generous price for its primary U.S. assets.

The broader U.S. banking sector currently trades at an average price-to-book value of 1.2 times, according to Bloomberg data. TD Bank’s two major acquisitions south of the border, Banknorth Group Inc. in 2004 and Commerce Bancorp Inc. in 2007, were completed at far higher book value multiples of 2.6 and 2.8 times, respectively.

TD Bank spokespeople emphasize that the bank’s U.S. acquisition strategy is part of a long term initiative and that it was not trying to time the market when it made its U.S. purchases. Nonetheless, management can’t be thrilled with the evolution of U.S. book value multiples.

According to Brad Smith, analyst and head of research at Stonecap Securities, TD Bank’s U.S. operations have also required considerable financial support from the Canadian parent company. He estimates that TD Bank, N.A., the U.S. based holding company under which the bank’s U.S. operations legally sit, have required approximately $8.6-billion in loans – one assumes on favourable terms – from Toronto.

Mr. Smith also notes that the U.S. regulatory environment is likely to change. Foreign-owned bank holding companies south of the border are currently exempted from the U.S. regulatory system. But under the Collins Amendment, part of the Dodd Frank Financial reform bill, this exemption will end in 2015.

TD Bank spokespeople are correct in pointing out that rule changes will not be certain until the legislation is fully implemented. But under the Collins Amendment, TD Bank, N.A. would have to double its level of tier 1 capital to be considered “well capitalized” by U.S. regulators.

Mr. Masrani, who has been group head of U.S. personal and commercial banking, is well aware of all these issues, and he’s backed by a deep management team that has proven remarkably adept at running the bank’s Canadian operations.

Barring another financial-sector catastrophe, TD Bank N.A.’s balance sheet and its profitability are likely to improve as trust in the U.S. financial system is restored. The question is how high the upside is for the bank’s U.S. arm. To date, blind faith in the bank’s ability to repeat its domestic success in the U.S. appears misplaced.

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TD Bank Faces Loss of Luster

The Wall Street Journal, Suzanne Kapner, 3 April 2013

For two decades, Joanny Campbell of South Philadelphia was satisfied with her bank.

Then her lender, New Jersey's Commerce Bank, was acquired by TD Bank NA, a unit of Toronto-Dominion Bank of Canada. The parent company had no U.S. locations as recently as 2000 but now operates the ninth-largest U.S. bank by assets, a major player in large cities including New York and Boston.

Unhappy with customer service, Ms. Campbell closed her TD account late last year.

"The Commerce employees called me by name," said the 38-year-old Ms. Campbell. "The TD employees didn't know me, and they didn't care to know me."

A TD Bank representative declined to comment on specific interactions with customers.

Ms. Campbell's decision to find a new bank highlights the challenges facing TD as it looks to build on an expansion nearly unmatched in the banking industry, at a time of slow economic growth, profit-crunching low interest rates and intense competition.

The company bills itself as America's Most Convenient Bank, with unusually long hours and many branches open every day except New Year's Day, Easter, Thanksgiving and Christmas. Its branch count has surged 23% in the past five years, a time in which many other large lenders have retrenched.

Toronto-Dominion said Wednesday that the architect of its U.S. expansion, Chief Executive Ed Clark, will retire next year and be succeeded by Bharat Masrani, TD's U.S. head of personal and commercial banking, who has pledged to keep the company expanding.

"If there are three banks on each corner of an intersection and the fourth corner is unoccupied, we would love to have that corner," Mr. Masrani told The Wall Street Journal in January.

But TD's profitability has lagged behind that of many of its peers, and the company's once-sterling reputation for customer service has declined since the 2008 purchase of Commerce.

Although TD Bank NA's net income increased 14% in 2012, to $775 million, compared with $681 million earned the prior year, 90% of its peer group earned more, according to the Federal Deposit Insurance Corp. TD says the numbers reflect in part its low-risk strategy.

Toronto-Dominion avoided getting hit in the U.S. mortgage meltdown, thanks to its conservative lending practices. But some analysts say competition has intensified now that large U.S. rivals have recovered from the crisis.

"It was easier to take share away when competitors were struggling," said Brian Klock, an analyst with Keefe, Bruyette & Woods. "Now, the competition has woken up, and it's going to be a tougher fight."

Mr. Masrani said he is satisfied with TD's performance relative to other banks. "I feel as long as we grow our franchise in the U.S., the returns will take care of themselves," he said Wednesday.

Both Commerce and TD were known for their attention to customers. TD retained some popular Commerce practices, operating coin counters known as Penny Arcades and giving customers pens, dog biscuits and lollipops.

But the products and pricing changed. TD increased minimum-balance requirements on some accounts and started charging for out-of-network ATM use. And it made no apologies about aggressively peddling mortgage and credit-card loans to account holders, a practice known as cross selling that Commerce eschewed.

Some customers have taken to websites Consumeraffairs.com and MyBanktracker.com to complain, using the word "hate" to describe their feelings about what TD has done to Commerce.

TD executives say then-and-now comparisons are unfair given that the environment in which Commerce once operated differed from the low-margin banking world of today.

"With margins compressed, you have to do something," said Linda Verba, TD's executive vice president of retail operations and service programs. Rather than being annoyed by TD's attempts to cross sell, Ms. Verba said, "customers want us to tell them what we have to offer."

TD ranked at the top of its class in customer satisfaction surveys compiled by J.D. Power & Associates, a West Lake Village, Calif., research firm, for four straight years in the 2000s. But TD hasn't held the honor since 2009.

Mr. Masrani acknowledged that TD made mistakes in its $8.5 billion purchase of Commerce, including a botched attempt to transfer data that prevented customers from checking their account information online for two days.

"When you bring banks together, there are cultural things that you have to overcome," Mr. Masrani said in January. A TD spokeswoman added Wednesday that the bank has retained the vast majority of customers it inherited from Commerce.

TD recently opened its 100th branch in New York City, making it the sixth-largest lender in the Big Apple by retail outlets and the fifth by a measure of retail deposits known as capped deposits. TD has plans to open 50 more branches in New York City and become No. 3 in capped deposits by 2015. Similar expansions are planned for parts of Florida and Boston.

Mr. Masrani said in January he isn't worried by the competition: "When they are closed, we'll be open."

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CIBC’s Stay-at-Home-Strategy Could Prove Costly

The Globe and Mail, Sean Silcoff, 3 April 2013

With Toronto-Dominion Bank CEO Ed Clark announcing his impending retirement, it’s too early to declare TD’s big bold foray into U.S. retail banking a success – returns are still low and it has yet to prove it can increase its relatively weak loan business. But looking ahead, few would doubt the wisdom of diversifying out of Canada, at a time when a long runup in the growth of household debt appears to be peaking.

If a solid Canadian economy and ever-growing borrowing by Canadians has lifted all Big Five banks for years, a receding one will split them into two groups: TD, Bank of Nova Scotia and Bank of Montreal, which are more heavily exposed to growing retail banking operations in the U.S., Latin America and Asia and poised to do better; and Royal Bank of Canada and Canadian Imperial Bank of Canada, which are much more exposed to Canada.

But among the second tier, CIBC would likely stand alone as the clear underperformer in the Canadian recession scenario. Poor CIBC earned a reputation last decade as the bank most likely to run into sharp objects. Then CEO Gerald McCaughey committed to make it the most risk-averse bank of the Big Five by retreating largely to its home market.

Unfortunately, CIBC might have to dust off the Kick-Me sign once again. The low-risk strategy seems destined to put CIBC at the greatest risk among its peers of suffering the worst effects of a drifting Canadian economy, should that happen. Fully 66 per cent of CIBC’s estimated earnings for 2014 will come from the Canadian personal and commercial banking sector – the next highest is Royal at 52 per cent, TD and BMO in the low 40s and Scotia at 29 per cent, according to National Bank Financial analyst Peter Routledge. About half of CIBC’s total assets are loans to households, compared to about one-third or less for other banks.

The biggest risk is CIBC’s credit card portfolio, which stood at $14.8-billion as of Jan. 31. That only amounts to about 6 per cent of the bank’s outstanding loan book, but that is much higher than other banks and accounts for more than 15 per cent of its profits, Mr. Routledge estimates. Typical credit card losses in the 3 to 4 per cent range could easily double in bad times, taking a big bite out of profits. Commercial loans would also likely take a relatively bigger hit than other Canadian banks.

Fear not, this wouldn’t be a crisis situation: CIBC’s earnings growth rate would flag but its capital situation wouldn’t be threatened. Even the worst of the Canadian banks is still a solid performer by many standards. The difference is that three of them have figured out strategies to grow beyond Canada and create substantial long-term value by deploying their capital adventurously. RBC won’t be far behind. At some point, CIBC will have to have to find ways to do the same. The head-in-the-sand strategy worked for a while; perhaps a Canadian recession will prompt CIBC to take a second chance at becoming a first-tier bank again.

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