With two Wall Street giants falling, and a third apparently on the brink, Canadian investors are casting a wary eye toward their domestic financial institutions. But analysts say Canadian banks should be able to avoid the trouble of their American counterparts.
Much of Canada’s capital markets are intimately tied to the “Big Five” Canadian banks, and if they were to suffer a crisis similar to what’s happening in the U.S., the effect on Canadian investors would be devastating. There are no signs that this will happen; however, investors should expect Canadian bank prices to take a haircut, says Chris Blumas, an equity analyst with Morningstar Canada who covers Canadian financials.
“Operationally, I don’t think there is a huge effect on the Canadian banks. This is really about the investment banking space in the U.S. It does create a negative sentiment on financial service companies. That’s what really affects the stock prices,” he says. “It creates a treacherous environment and creates a lot of headline risk for the banks. You’ve seen all the Canadian banks down today around 2.5%.”
If anything, Blumas says, with the acquisition of Merrill Lynch by Bank of America and the acquisition of Bear Stearns earlier this year by JPMorgan, the U.S. banking scene is beginning to take on the appearance of Canada’s more stable banking sector.
“With Bank of America buying Merrill Lynch, the U.S. banking industry seems to be moving towards the model we have in Canada, where all the banking functions fall under one roof,” Blumas says. “For investment banks, it’s difficult to stand on their own if there is a liquidity crunch. In Canada, everything is brought together. Our Canadian banks have a broader platform. They do investment banking; they do retail banking. It creates a more stable foundation.”
Still, in the short term, Blumas says, investors can expect a decline in Canadian bank prices, as investors try to determine if there was any counterparty exposure to Lehman Brothers. He expects RBC Financial’s and TD Financial Group’s stock prices to have the toughest time since they have large operations in the U.S., where profit margins will be tighter.
“Banks that operate down there are going to have to pay more for their deposits and more for their funds,” Blumas explains. “That will compress profit margins even more. That will be the biggest short-term impact on the Canadian banks.”
Having said that, he expects the direct spillover for the majority of Canadian banks to be relatively small. “There could be some peripheral effects we don’t know about yet, particularly if Lehman was counterparty to any of our banks. Nobody has been disclosing that they had counterparty risk with Lehman in the past; it was more about their exposure to monoline insurance companies,” he says. “The two companies that will likely be affected the most are Royal Bank and TD because they have a big U.S. presence.”