Canada: Perspectives On The Canadian Banking Industry

In a land of opportunity, what's next?

Coming out of one of the most profound financial crises in history, in 2010, Canada's six largest banks posted solid earnings, and once again demonstrated why they are considered among the most stable in the world. The 2010 combined net income of the Big Six banks was $20.4 billion, exceeding last year's net income by more than $6 billion and eclipsing the previous record of $19.5 billion set in 2007. These results have helped propel some of the Big Six banks into the same league as the world's largest banks by market capitalization with Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), The Bank of Nova Scotia (BNS), Bank of Montreal (BMO) and Canadian Imperial Bank of Commerce (CIBC) making the top 50 global ranking.1

Results in the personal and commercial segments for the banks were strong. These were supported by lower personal and commercial loan loss provisions, a cyclical indicator of a post-recessionary economy. However, 2010 was not without its challenges. Trading and investment banking revenues declined later in the year, as the fixed income market could not sustain the pace set in the previous year, which was aided by a bounce coming out of the recession. At the same time, the overhang of uncertain market conditions made it harder to accurately predict deal flows, which impacted income for most of the Big Six.

Looking ahead, what does the future bring for Canadian banks? Fully armed with capital, how will they take advantage of opportunities, both domestically and abroad, to drive earnings growth and differentiate themselves from the competition?

What lies ahead?

Canadian banks are in a sound position to build on their strength, and the Big Six are implementing various strategies to grow their businesses—both organically and through acquisitions—to gain market share. Many have taken advantage of the downturn to take a look at where they are today and develop a plan for where they want to be in the future. So, what's next for Canada's banks?

As part of their long-term expansion strategies, a number of the Big Six banks will continue to seek foreign acquisitions, snapping up smaller players around the world, and investing in countries where they have existing operations. Banks are also exploring expansion through other niche-growth strategies. Consolidation in the US will likely extend over the next few years as the sector continues to pick up the pieces from the recession. TD and BMO acquired the assets of a number of US banks this year: TD expanded in Florida by acquiring the banking operations, including all deposits of Riverside National Bank of Florida, AmericanFirst Bank and First Federal Bank of North Florida; and BMO's Harris Bank subsidiary acquired the assets and liabilities of US lender Amcore Bank, expanding its presence in Illinois and Wisconsin and most recently announcing the acquisition of Milwaukee, Wisconsin based bank, Marshall & Ilsley Corp. in a $4.1 billion deal.

Foreign markets continue to be a hot bed for expansion. For example, BNS recently announced it would acquire one of the largest banks in Uruguay, Nuevo Banco Comercial, which would make them the first Canadian bank with a retail presence in Uruguay if the deal is approved.

As well, CIBC purchased a minority interest in a Bermuda bank, Bank of N.T. Butterfield & Son Ltd.

Canada's largest banks are also keen to beef up existing profitable operations and product offerings to grow their revenues. Some are interested in expanding their wealth management segment, which has been seen as a beacon while financial markets return to stability and investable assets continue to grow. The acquisitions announced this year of Dundee Wealth by BNS and BlueBay Asset Management by RBC underscore this move and represent significant "tuck in" value to both banks' current operations. CIBC continues to focus on strengthening and growing its credit card business, as seen by the acquisitions of Citigroup's Canadian MasterCard business and the remainder of their interest in CIT Business Credit Canada Inc. this past year. For many of the Big Six, commercial and small business lending is also top-of-mind.

Operationally, the banks are looking inwards at the costs of their networks to ensure that they are running as efficiently as possible, such as upgrading their core banking platforms to reduce costs, while still delivering the best customer experience. To attract customers, keep them happy and sell more services along the way, they are adopting new processes to improve the customer experience across all channels—branch, web, call centres and mobile banking. This will require several banks to undergo innovation to their banking platforms to create a competitive advantage in the future.

A change in consumer sentiment

Underlying all of these strategies however, is a potential change in Canadian consumer sentiment as retail loan growth will likely stall across many segments of the market. While a significant amount of the banks' earnings growth in 2010 was driven by consumer spending and increased borrowing, debt levels are presently at all-time highs in Canada. According to Statistics Canada, household debt in Canada recently surpassed the US for the first time in 12 years, with a debtto- income ratio of 148.1% compared to 147.2% in the US. Both bankers and the Governor of the Bank of Canada have strongly signalled the need for a more conservative consumer in the near future and have already taken tactics to increase prudence in the mortgage market, including stringent qualifying tests. While Canadian consumer debt ratios are still considerably lower than in the US or UK during their pre-crisis peaks, now is the time for a more conservative approach to spending.

According to PwC's Consumer Lending Survey out of over 600 Canadians, 67% are comfortable with their debt level, yet most (64%) intend to decrease this debt over the next 12 months. They will do this primarily by cutting back on, or deferring large-ticket items such as autos, home electronics and housing upgrades.

So, what does this consumer sentiment mean for Canada's banks? It is predicted that the growth rate for mortgages, personal loans and other consumer loans will decline in the next year. With higher debt levels, consumers are more exposed to rapid movements in interest rates or other market shocks—and their willingness to spend and borrow could decrease in a higher-rate environment or if unemployment levels deepen. As we look to 2011, will banks be able to sustain their earnings growth in these areas if Canadian consumers are deleveraging?

With opportunity, comes challenge

Against this backdrop of growth opportunities, Canada's banks face the challenge of managing through new global regulatory reform designed to increase transparency by financial institutions. The recently endorsed Basel III reforms will require banks to retain higher levels of capital and liquidity. All of Canada's major banks already meet the new, tighter requirements; but, each bank is currently assessing the implications the changes will have on their business. The reforms may not only fundamentally impact profitability, but may also require transformation of business models, including process and system changes to achieve upgrades in stress testing, counterparty risk and capital management infrastructure.

With their European Union competitors facing threats over sovereign debt levels and the US market dealing with an ever-tightening regulatory environment coupled with a struggling economy, Canadian banks are in an enviable position of being able to actively pursue their growth strategies. However, they must carefully manage risks to the system, including high debt levels by global governments as well as Canadians' debt loads. Over the coming year, no doubt there will be continued interest in the strategies Canadian banks take.

In February 2011, we will provide our perspective on these opportunities and other issues facing the banks, along with a more detailed examination of the banks' results in our annual publication, Canadian Banks 2011.


1 Source: Bloomberg (as at November 30, 2010)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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