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O, Canada: Banks Look Healthier

By John Jannarone WSJ
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March 9th, 2010

The hunt for profitable banks in America has left many pockets empty. Would a snow shovel clear the way to more lucrative prospects?

Canada's three largest banks posted healthy profits last fiscal quarter while many of their U.S. counterparts struggled to survive. The key has been their limited exposure to toxic assets and conservative mortgage lending. The banks could yet weather the recession with a chance of staying profitable.

While Canadian bank valuations exceed those on U.S. lenders, they don't look pricey. Royal Bank of Canada, the country's largest bank, has a market value of $31 billion, higher than all but three U.S. banks. It earned $850 million in the three months through January and trades at 1.5 times book value. Toronto-Dominion Bank, Canada's second largest, also profitable in its latest quarter, trades at book value.

The higher multiples, at least compared with U.S. banks, look deserved, because Canadian banks tend to hold healthier assets and had stronger capital heading into the crunch.

This stronger footing comes partly from more stringent regulatory requirements. In Canada, regulatory constraints stopped leverage ratios going too high. And loans tended to safer. Canadian mortgages require 20% down payments unless they have been guaranteed by the government.

And those that are government-guaranteed account for around 20% of all loans at Canadian banks. Subprime lending reached a peak of just 3% of all outstanding loans in Canada in 2006 compared with 25% in the U.S., according to Toronto-Dominion Bank.

Of course, Canadian banks aren't going to escape higher loan-losses as unemployment rises. And UBS
economists expect the jobless rate to hit 8.3% this year.But the banks have been able beef up their capital. . This fresh equity didn't come from the government,which means investors don't have to worry too much about political interference. Royal Bank of Canadaraised C$2.3 billion in common stock last quarter, while Toronto- Dominion Bank raised C$1.4billion.

Canada's banks already have taken big write-downs on their toxic securities. Royal Bank of Canada says it has C$3 billion in net exposure to U.S. subprime and risky "Alt-A" mortgages. The exposure, while substantial, wouldn't necessarily cause serious stress even if the full amount were written down over time.

And exposure to the U.S. market is limited. Some 28% of Toronto-Dominion's loans are in the U.S., while they are about 15% of the mix for Royal Bank of Canada.

Canadian banks potentially offer investors more than just survival. Their mainstay lending business will suffer as the economy suffers, but they will be able to take market share as wholesale-funded lenders pull back.

Bank loans to private companies rose C$22 billion in 2008, the largest amount on record. Canada's open economy traditionally catches pneumonia when the U.S. sneezes. Maybe less so this time around -- because of the sturdy constitution of Canada's banks.

Write to John Jannarone at WSJ.

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