Canadian Banks – What are we taking about?
- Canada = 35M people.
- 1.2% annum stable population growth since 1972
- (Toronto 2.6/5.6) (Montreal 1.6/3.8) (Vancouver .6/2.3) (Calgary 1.0/1.2)(Edmonton .8/1.1) (Ottawa .8/1.2) (Everywhere else 20M)
- Destination for people and money. 280,681 immigrants in 2010
- Imagine California with only 5 firms in loans, banking, brokerage
- Those 5 banks are all Toronto HQs. A town with terrible commutes
- Bank stocks are an important cornerstone for Canadian investors
Canadian Banks – What the Shorts see
- PICTURE – STBANKX exposed to consumer debt levels equal to US consumer levels in 2007. And housing bubble too boot!
- THE BET – Housing rolls over. ERGO banks will beholding underwater mortgages and consumer debts gone bad. ERGO banks I-statement losses & B sheets losses.
- THE PRIZE – 1989 STBANKX had TRA of -29%USD07/31/89 to 09/28/90, vs SPX -11.5 vs 10yrGCANyield moved from 8-12%!].
- THE PRIZE – Great Recession KBW Bank Index (INDEXDJX:BKX) had TRA -27%01/01/07-03/31/09 vs. SPX -44%
History of the ‘Prize’
Canadian Banks – The short thesis
All housing bubbles crush all banks, everywhere,because it was true in USA last time. [STBANKX 2013-15 = KBW 2007-09 = STBANKX 1989-90]
They are betting that huge wave of Jingle Mail is coming very soon. They have been making this bet, off and on, since 2008.
Many of the most well-known hedge fund managers in the world engage in philanthropy, and in doing so, they often reveal their favorite hedge funds through a review of their foundation's public filings. Bill Ackman's Pershing Square Foundation invested in several hedge funds during the fiscal years that ended in September 2019 and September 2020.
Comparative Housing charts
National Median Family Income is 66k$
These places should have house prices way above National Average, and they do. no problem!
Canadian Banks – Beware of Data Mirages
- This shows, via longer term perspectives, that Vanguard Consumer Discretionary ETF (NYSEARCA:VCR) and YYZ are the problems. Teranet is market cap weighted…average national income is not.
- In fact the correct comparison is not USA to CAD, but NYC to VCR to YYZ.Because VCR and YYZ are also the destination cities for international investment money and money parking. In recent years the TRUMP/Shangri-La/4Seasons brands have all opened their 1st condo hotels in Toronto. Again – pricing these homes against average Canadian Income is a mismatch…because the incomes are not Canadian, the wealth is large, and if there is debt financing, Canadian banks are unlikely to have supplied it.
- ERGO these shorts are betting against an inflection in the FED’s QE4VRpolicy regarding 10yr rates…not against banks Income statements …they are just the pass-through vehicle. In fact even their Balance sheet exposure is passed through.
- YYZ income trades at 25% premium to CDN average. And the house prices are…25% premium too.
Canada Mortgage & Housing Corporation
- Nearly 600$B insurance portfolio, 2/3rds of total.
- CMHC is also overseen by OSFI. OSFI also oversees the banks
- A Crown Corporation, owned by the Federal Government.
- 5% minimum down, even for insured loans
- CURRENT DEFAULT RATES ARE…
- Downtown Toronto is adding jobs, and people,faster than rest of country.
- It is wealthier than rest of the country
- It has higher income than rest of country
- It’s core is pulling from its fringes
- Skyline barely changed from 1990 until 2005. 2huge current projects were 50 years overdue.
- 500k Millenials can live+work w/o cars. Currently no children, and lifetime of earnings ahead.
THOUGHT EXPERIMENT – When does Housing create an Existential Threat to STBANKX?
- 1st 20% down books to the owner.
- Next 53% books to CMHC. Too simple a statement, but illustrative…2/3 of mortgages insured, times 80% LTV, is 53%
- Ignoring the knock- on affects…bank exposure is to the bottom 27% of a fall in house prices,assuming that housing went to zero.
ERGO – the OECD implied 48% correction would hurt, but not kill, STBANKX earnings
Behavioural Framing Issues with “The Bet”
- Income Statements for STBANKX is more than mortgage lending.
- Balance Sheet management is all that banking is really about. And the Canadian banks have a long history of doing it well in conjunction with the OSFI.
- Subprime Lending’ in Canada means LTV=80%. We prime those using CMHC insurance. Canadian bank balance sheets are explicitly indemnified, including legal costs.
- STBANKX are essentially GSEs of OECD’s best house on the street
- Even if 3 years of Real Estate vintage goes sour, the direct impact is only 12% on earnings, for 3 years. So housing is not an existential threat to these banks. Which makes shorting a timing exercise.
- STBANKX current PE is 11. Divvy 4.1%. If we use 8x to represent book value, implied growth is 1.5%. So, how is this expensive versus 2% GDP growth? Paying 5% total borrow cost to find out is counterproductive.
- 50% consumer economy in CAD vs 70% in USA. And a lower CAD value sparks other sections of the economy, which benefits STBANKX.Resources&Manufacturing&Technology&FDI.
- According to Statistics Canada, growth of 25-40yrs old between 2011and 2016 is 6.94% (490k)…these are the condo buyers causing a lot of cranes. 490k/couples/30stories/30units=272 cranes
- Uninsured LeoNovus Inc (CVE:LTV) runs 55% nationally
- No systemic ‘dumb money’ . Securitization is a non-event.
- VCR & YYZ are 35% of housing value annual turnover, yet people compare house pricing to the national income???
- Non standard loans…23% USA 2006, 5% CAN 2005, 7% CAN 2012
- Mortgage vintages have not gone bad.
- STBANKX controls many industries. Exchanges, AUM, Investment Banks, AUA, Student Loans, Credit Cards, Auto Loans, Toy Loans, HELOCs, Insurance, Regulations, Prime Brokerage, etc.
- @ 4% Short Interest, STBANKX reaps 62M$ in cost of borrow from hedgies. [CM is31B$mcap. 4%SI @ 5% Annam is 62M$!!]. @ 1.5% NIM spread, 62M$ is like 4.1B$ in loans
- All borrowers must qualify for a 5 yr fixed… even if they are asking for 3yr float.
- No refi can take homeowners below 20% equity. Spec buying (non owner occupied)requires 20% down + insurance. 25yr max amortization on all CMHC loans.
- No more CMHC backing on HELOCs. No CMHC on homes above 1M$.
Canadian Banks – Before deciding about Bubbles.
- Canada is recourse (except AB). Defaulting homeowners cannot walk. They declare and the bank has claim to other assets if Foreclosure does not make the bank whole as a secured creditor.
- Insurance applications are NOT vintage based. Each deal gets vetted & approved.So – no put backs!
- Borrowers required to prove that the down-payment is theirs.
- Banks do not ‘compete’ to lend in USA sense (no interstate billboards for fishing boat loans). They are relationship lenders, aiming to take the entire fee wallet as recompense on any lowered interest rates offered.
- When large commercial loans made do turn bad, banks will either workout, take the a foreclosure hit, or sell the debt to vultures.
- ALL mortgages are term loans, regardless of amortization period. (3,5,7yrs)
- No NINJAs, No Liar Loans, No Teaser Rates, No Interest expense deductions, Max 2 CMHC’s per person
- VCR out performance began in advance of 1999 Hong Kong hand off, and continues as Asian wealth needs to be stored offshore.
- Condo construction is tiny % of loan books. It is 80% loan to costs instead of LTV.
Canadian Banks – Brian’s Advice to Shorts
Wait for a clear catalyst which could topple theaffordability of consumer debt levels.
- I rate shock
- Employment shock
- US recession
The proper short basket must include Sovereign – CAD and GCB.*remember that GFC = housing bust + short term funding window @ zero + MBS investment writedowns. Not a simple analogy to STBANKX in 2013
By Brian Bosse, CFA. Vice President, Portfolio Manager