Canadian Diversified Financials | Stephen Boland, Equity Research Analyst

Equity Research Analyst Stephen Boland joins the podcast to discuss the Canadian diversified financials sector. We also touch on the recent news about US regional banks (e.g. SVB), including:

1. With the recent news about some US banks, are there any similar concerns for Canadian companies?
2. Tier 1 capital levels/liquidity of the banks compared to US peers.
3. Contagion risk of the SVB issue on the Canadian banking sector?
4. Measures currently in place to protect consumers/depositors – e.g., CDIC.
5. How are Canadian financials responding to the current interest rate environment?
6. Is there a big worry about how Canadian consumers will be able to service their loans and mortgages?
7. Strength of the sector as a whole.

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Transcript

Chris Cooksey: Hello and welcome to the Advantaged Investor, a Raymond James Limited podcast. A podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long-term success. We are recording this on March 13th, 2023.

I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department, and today I'm looking forward to chatting with equity research analyst Stephen Boland. Steven covers diversified financials and today we'll be discussing the Canadian financial sector as well as the recent news about Silicon Valley Bank in the us. Welcome, Steve. How you doing today?

Stephen Boland: Pretty good. It's been a busy few days. Maybe not as much as our US analysts that have been probably working very hard over the weekend.

Chris Cooksey: A little shocking I imagine. Come Thursday evening, Friday morning type situation.

Stephen Boland: Yes, I mean, it's hard to say, I think if you look back a go back a week certainly there were warning signs the things that were happening in the US and certainly it, accelerated.

And, and that can happen very quickly. We've seen it here in Canada very rarely. Where you get a run on the bank happened about six, seven years ago with two of our smaller banks. Home Capital and Equitable Bank. Where they had some problems with depositors taking out money at a quick pace.

And that's sort of what happened with, several of these banks in the US.

Chris Cooksey: All right. Well, maybe let's just start there with the US banks since, as you mentioned, they're all, it's all over the financial press and the press in general, but maybe you can just give us a quick overview of what happened.

Stephen Boland: Yes, I mean, to be honest, you know, again, I'm not a, I'm not the analyst on the stocks, but to me it, it, it's bad regulation to be honest. Silicon Valley, its deposits. Were mostly tech firms venture capital firms that, had really no ties. In terms of duration, in terms of being locked in, in terms of getting their deposits.

And these companies are struggling and so they're pulling their money out and it's been going on not just from the last week. It has been going on since probably the 12 months ago when the, when the tech market kind of crashed. So they have had outflows. And, you know, that just accelerated in more recent days.

On the other side, the bank was invested in mortgage backed securities, a long duration securities where they weren't getting the yield. And so their net interest margin had become quite thin. It wasn't being able to derive profitability. And the duration of those mortgage backed securities were quite long and so they weren't being able to renew them on a quick basis.

We don't have things like that here. I would say going back in history, There was probably one bank and without a 40 year history of the banking in Canada, but we had one bank back in 2007 called Dundee Bank. It had less than $2 billion of assets and it had customer deposits, but on the other side it was invested in mortgage backed securities and asset backed commercial paper.

And at one point, as the credit crisis started to loom, those securities started to fail and the regulator did not let the bank go under. But that bank was, ended up, ended up being sold to Scotia Bank right back in the, I guess it was 2007. So, that was really one bank that had. I would say an improper balance sheet.

And I think the regulators here learned that if, if they're going to give up bank licenses that it's got to have proper asset liability matching the securities as well as the duration of the, the portfolios on both sides.

Chris Cooksey: Okay. Now, in terms of the Canadian market I think we learned during the financial crisis and whatnot that regulations help the Canadian market did, I guess, comparatively I don't know want to say well or decent, but stood up a bit better, I guess.

So maybe we can just go over, you know, tier one capital levels and the liquidity within the Canadian banks and, and how that compares to the US just to give a, an idea to, to the listeners.

Stephen Boland: Yes, I think if you look back at Canada, the last banks that failed were in the mid eighties and the government and the regulators have been doing much better like we just talked about in terms of making sure that the banks are, have the right types of deposits and also have the right types of assets.

And also strengthening regulation. We mean the one positive thing that we had here in Canada was a good portion of our mortgages, through the credit crisis. And so, the Canadian balance sheet, the government balance sheet was on you know, protected us from, from actually having any bank losses or failures.

And I think since the credit crisis, the regulators have been doing even more to protect the big banks. And so, we have tier one ratios probably in the 14 to 16% range. If you look at the US banks, even the large US banks, that number's considerably. And so the, the, the regulator here has made sure that one our, our capital levels are higher, two, that we have a sufficient amount of liquidity baked into the balance sheet as well.

So, you're going to see, you know, anywhere from five to 10% of a balance sheet of a bank. Invested in liquid securities, they may not yield the most, but in the event there is maybe pockets of deposits coming out. The banks are going to have the balance sheets to protect against a run on the bank, so to say.

Chris Cooksey: Now, in terms of contagion with what's gone on in the US and specifically with Silicon Valley Bank is there a risk that spreads to Canada and into our sector at this stage?

Stephen Boland; There, there's always a risk when you're, when you're a deposit taker that the deposits don't renew or they, or they go away.

I think the Canadian banks are, are certainly you know, being aware. I would, I would say the customer service is being quite strong right now to make sure that retailers know retail deposit holders. No they are. You know, I talked to Canadian Western Bank today. They had no kind of change in the deposit taking behaviour.

It would be similar with the other banks, I would say, but customer service is probably very important today. And so there, there's always a risk, but I think again, Silicon Valley, their deposits or even Signature Bank, were not consumer, you know you know, down in the US it's F-D-I-C insured. Here we have the C-D-I-C, which ensures the deposit holders.

And so, I'd say the banks are doing a very good job at just making sure that they're holding on to those deposits and letting them know there's no risk to them in terms of losing their money.

Chris Cooksey: And as you became more aware of what was going down in the US, are there any metrics you're monitoring more closely? Bring out the old calculator a little more often, maybe today, and figure things out.

Stephen Boland: We, we, we kind of have a A because most of the loans that, our banks have are, residential, single family, maybe it's multi-unit residential. They're, you know, all the banks do have commercial.

We tend to look at for most of the banks unemployment, unemployment rates which do come out once a month. But we're always looking for news on unemployment. We're always looking for loan to values on when the banks report, whether it's the big banks or the, or the mid-size banks in terms of what's happening, especially with house prices down, you know, anywhere from 15 to 20% depending on the region.

So pressure on housing prices is something we look at that the, the portfolio's conservative and really what that means if the bank has to repossess. That they can get their money out and they wouldn't take a loss on the loan. But most of the management teams you talk to at the banks will say unemployment is, is the real key, bankruptcies things of that sort.

And those are the, the, the major metrics that we look at just to make sure that, you know, single family you know, industry is still comfortable and it's, it's still thrive.

Chris Cooksey: Okay let's switch more Canadian focus now. In terms of financials in Canada, how are they responding to the current interest rate environment?

Obviously rates went up really quick. Now we're on pause. Maybe more in the future. Who knows? So how's the sector handling that?

Stephen Boland: Yes, there's, there's a slowdown in in housing activity. For sure. I mean, housing prices have gone down. We're also seeing that the, the number of housing transaction has slowed as well. And so the beauty of what happens here in Canada is that if you have a mortgage with a bank, they'll tend to renew it even with a higher rate. And so, that contributes to people just staying in the same house. Maybe if they were thinking of moving they're not going to do that.

But what we did see with the big banks reporting recently, that there is a portion of their portfolios where the mortgage is not paying off any principle. It's only paying the interest and even to a point where that loan amount is increasing as you know, your mortgage payment is still not even covering the interest portion.

But I would say that through the credit crisis you know, optics for Canada for in the banking sector are very, very important. I would say the government has been very clear to the big banks. They don't want to see a rash of repossessions. They want to help Canadians, so, I don't think we're in the same sort of have the same issues as, as something in the US the, the Canadian banks are going to protect the Canadian consumer and work with them and try and, basically look to get them another mortgage and ways for them to make it.

Chris Cooksey: And as you mentioned, there's always a risk. But there doesn't seem to be a big worry right now from what you're saying that Canadian consumers are not going to be able to service their mortgages at least. What about loans?

Stephen Boland: I think it's pretty much the same, but the most, the most important is definitely somebody's mortgage you know, in, in terms of what's happening with the big banks.

And so, you know, personal loans… we'll look at credit cards, you know, unsecured home equity lines. But it all flows in into the same ability to pay. And, though we have seen debt arising with consumers, the banks are going to be very good with consumers to, to make sure that, you know, they can continue to pay loans or mortgage.

Chris Cooksey: Now you, you mentioned you know, one of the big worries would be employment and obviously the financial sector, financial services sector in Canada is a huge employer. Any concerns that they're going to start cutting back staff?

Stephen Boland: I think the, the one thing again, optics play a very big part of Canadian banks and the government they are almost like utilities.

The big five or big six as you, as you may want to include number six. And so, If anything, the, the banks would just hire slower. You know what I mean? There's not going to be mass layoffs in my opinion because that's optically, that's just not good for the banks. And listen, they're very profitable here in Canada.

And they know that, when they're making billions of dollars a profit you know, if, if they have 3% too many employees, well, you know, it's basically suck it up.

Chris Cooksey: Yes. Wait for some retirements.

Stephen Boland: Exactly, and I think that's been happening over time. We've seen the big banks especially invest a lot more in technology trying to get more digital.

They're all coming out with digital apps that you can bank online. Even the smaller banks are doing that now. It's fairly competitive, but you know, it's shifting talent away from maybe traditional tellers to technology people in, in the background to run all the different systems.

Chris Cooksey: And lastly, what would you leave investors, Canadian investors looking to go in this sector? What would, what would you tell them right now?

Stephen Boland: I would certainly with it, if you're looking for, for stocks I don't think you know, today if you bought on the open, you're, you're losing money. I'd be, you know, as time goes on the US government gets their hands around the, the weaker ones.

The Canadian banks are, are all going to be putting up press releases and, and ensuring consumers that they you know, there's really no, you know, risk of them going under. And I think over time then maybe not this week, but certainly next week, these are going to be great stocks to own. They've all come down the, you know, it's a sea of red for the last three or four days in, in financials.

And there's going to be opportunities to make money on these stocks going forward.

Chris Cooksey: Especially over the long term. I would imagine Canadian banks and financial insurance companies have done pretty well over the years.

Stephen Boland: Yes. Exactly. Yes. When they're, when they're cracking a billion dollars of profit, almost a quarter it's, it's a pretty good indication that they've got things pretty, pretty well here in Canada.

Chris Cooksey: Well, awesome. Thank you for taking the time today, Steve. That's a lot of great information. Really appreciate the overview, especially around the start, what's going on in the US and I hope you'll join us again.

Stephen Boland: Yes, anytime. If our clients have any questions, I'm certainly available to respond.

Chris Cooksey: Excellent. Reach out to us at the advantage investor pod@raymondjames.ca. Subscribe to the Advantaged Investor on Apple, Spotify, or wherever you get your podcast. Please contact your advisor with any questions you have. On behalf of Raymond James and the Advantaged Investor, thank you for taking the time to listen today.

Until next time. Stay well.

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