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Canadian exposure to European sovereign debt

A new report suggests Canadian banks are largely insulated from sovereign debt default.

(Photo: Photo: Nathan Denette/CP)

As Europe marinates in an environment of economic uncertainty, a report by ScotiaMcLeod has dug up some numbers to provide a snapshot into our banking industry’s exposure to the sovereign debt crisis. The results indicate Canadians investors can breathe a sigh of relief, for the time being, knowing once again that prudent investing strategies on behalf of our banks have largely insulated the sector from the fallout of potential defaults and their aftershocks.

According to the report, authored by Geoff Ho, director of Canadian Equities of the Portfolio Advisory Group, the disclosed exposure of Canadian banks to the affected nations (Portugal, Ireland, Italy, Greece, Spain):

“…appears to be fairly manageable against a backdrop of strong capital ratios, diversified revenue streams (by operations and geography), and relatively conservative investment practices that have made the sector an exemplary model within the global financial system.”

Further, the report states that any reductions in the value of sovereign debt holdings would appear minute against the asset bases of our banks.

The data provided in the report, obtained through regulatory filings and transcripts of conference calls, shows Royal Bank (RY) and the Bank of Montreal (BMO) as having the largest amount of direct exposure. As of April 30, 2011, Royal Bank had loans to Ireland and Spain totaling $267 million ($175 and $92 million, respectively). But against a market capitalization of over $77 billion, any write-downs should be able to be absorbed rather effortlessly. Bank of Montreal, with a market cap of $34 billion, is showing a little more skin with $189 million in direct credit exposures. Of this amount, $86 million is tied up in Portuguese, Irish, and Greek financial markets – just as their respective governments are receiving or in line to receive bailout funds from the EU and/or the International Monetary Fund (IMF).

The remaining banks cited in the report: Bank of Nova Scotia, TD Bank, CIBC, and National Bank, all appear to have either little to no direct exposure to sovereign debts of the indebted nations. However, CIBC, with a market cap of approximately $30 billion, appears to have some direct non-sovereign exposure totaling $282 million in bank deposits, derivative market-to-to receivables and letters of credit. Additionally, CIBC has an indirect exposure through $564 million in collateralized loan obligations (CLO) – a form of securitization where cash payments from a number of middle and large-sized business loans are pooled together and passed on to different classes of owners.

For contrast, the Globe and Mail reported in June that, “French and German banks held $493-billion and $465-billion, respectively, in exposure” to the economies of Portugal, Ireland, Greece, and Spain, accounting for 61 per cent of all exposure amongst euro zone banks.

All said, the report reinforces the demonstrated and worldwide perception of the Canadian banking industry as a beacon of stability and sound management. But fears remain, as the authors believe that “risks associated with the European debt crisis reside at a more macro level.” This is an allusion to the widespread fear of “financial contagion,” an instance where foreign banks with greater exposure are forced to take losses on their investments, undermining investor confidence, and eroding the price levels of various asset classes. In this instance, Canadian financial institutions may suddenly find themselves exposed to the crisis on a greater level. Further, the report’s author says perceived exposure of the U.S. or European banking system can be described as “opaque at best (particularly given various derivative products plus selective disclosure)”. However, some insight was given earlier this month when The Economist outed some of the major holders of Greek debt, including Paris-based BNP Paribas – at the time holding approximately $6.8 billion (CDN) in Greek debt – making it the country’s largest foreign bondholder.

Nevertheless, Canadian financial institutions may be able to find opportunity in the wake of European misery, the report says. The relatively great performance of the TSX versus other exchanges during the 2008 meltdown may provide incentive for investors to dump their cash into Canadian equities. Additionally, as foreign counterparts shed some risk, “a European debt crisis could present opportunities to acquire non-core assets of other banks, as Bank of Nova Scotia did in purchasing assets from both RBS (Royal Bank of Scotland) and BNP Paribas during the recent recession.”