Canada’s banking culture has mostly insulated the Big Six from U.S. problems

The position of the Big Six is nothing like Silicon Valley Bank, but they are being affected by interest rates

The buzzwords of the U.S. banking crisis – uninsured deposits, losses on bonds, interest-rate risk – could be used to describe the banking industry in Canada as well.

Canada’s Big Six banks have nearly $30billion in what are called “unrealized” losses in their securities portfolios, according to analysts’ reports. More than two-thirds of the losses are at the two banks that are currently expanding their already-significant operations in the United States: Toronto-Dominion Bank, which has about $12-billion, and Bank of Montreal, which has about $9-billion.

The key for the two Canadian banks’ health is that the losses are offset elsewhere on their balance sheets by financial hedging instruments that have produced profits, even as their bond portfolios have declined.

That overall picture of Canadian banks’ balance sheets reveals once again how the country’s distinct banking culture has largely insulated its big financial institutions from the problems facing the United States.

“Having a large, concentrated banking sector here ... may not be advantageous from a competitive standpoint and from an innovation standpoint, but from a position of when the banking system is in somewhat of a crisis, this structure really is proven, right?” said Carl De Souza, a debt analyst for DBRS Morningstar. “There’s not that onus here for them to go and take excessive risks like they do in the U.S.”

Mr. De Souza and his DBRS Morningstar colleagues produced a report that examines the Canadian banks’ numbers in some of the key areas that have contributed to the current crisis of confidence in the United States, after the collapses of Silicon Valley Bank and Signature Bank. The analysts concluded the Canadian situation is “manageable.”

Silicon Valley Bank was an outlier even by U.S. banking standards. It had an unusually high proportion of uninsured deposits, from a small number of customers concentrated in the tech industry. It used those short-term deposits to buy a large amount of long-term government bonds, mismatching the timing of its liabilities and its assets.

The bonds fell sharply in value as interest rates rose, creating an unrealized loss – that is, a potential loss that becomes an actual loss only when the underlying assets are sold. That might not have been a problem if the bank had been able to hold the bonds until they matured, allowing it to keep those losses unrealized. But when depositors began pulling their money, first out of concern and then in a panic, the bank had to sell investments, realizing the losses – and wiping out all its capital in the process.

The unrealized losses for TD and BMO are big numbers, but small in the context of the banks’ capital. Mr. De Souza applied the unrealized losses to the banks’ capital levels and suggested their common equity Tier 1 capital ratios – a primary measure used by regulators to assess bank health – would fall by a couple of percentage points if somehow the banks had to take all the losses. But both would still be well above the minimums set by Canada’s banking regulator.

As part of BMO’s just-completed acquisition of California-based Bank of the West, and TD’s pending deal for Tennesseebased First Horizon, the banks have been creating interest-rate hedges and buying U.S. treasury bonds. The strategy is designed to guard against interest-rate changes that could cause their capital ratios to decline between the time of the deals’ announcements and their closings. While the losses on the treasuries show up in one place on the banks’ financial statements, the gains from the hedges show up in a different place.

For BMO, which has aggressively used the hedges, the gain on the interest-rate swaps is $5.7-billion, according to recent investor presentations. That has offset more than half of the reported unrealized losses on its bond portfolio.

TD’s hedging gains are smaller: Just $765-million through the most recent three quarters, according to investor presentations. TD has unrealized losses of just under $7-billion on the balance sheet of its existing U.S. subsidiary, according to Veritas Investment Research analyst Nigel D’Souza, who has also looked at the matter of unrealized losses.

BMO and TD did not comment for this story.

For the other Canadian banks, unrealized losses are smaller. RBC has $5.1-billion, versus more than $78-billion in Tier 1 capital, according to Veritas’ Mr. D’Souza. More than one-third of that is on the balance sheet of U.S. subsidiary City National Bank. (RBC did not comment for this article.) Canadian Imperial Bank of Commerce, National Bank of Canada and Bank of Nova Scotia each have unrealized losses of about $1.5-billion or less.

None of this matters if depositors feel safe and sound, which Canadians generally do. It’s when uninsured depositors fear they’ll lose their money and begin withdrawing it rapidly, forcing a bank to sell assets at a loss, that problems start.

On average, Canadian banks have a greater proportion of uninsured deposits than U.S. banks do. It’s understandable, given that the Canadian Deposit Insurance Corp. has a $100,000 limit on deposit insurance, versus the US$250,000 from the U.S. Federal Deposit Insurance Corp.

DBRS Morningstar’s Mr. De Souza said that overall about 65 per cent of Canadian deposits at the Big Six banks are uninsured. He estimates only about 25 per cent of deposits at Canada’s medium-sized banks – Canadian Western Bank, Equitable Bank, Home Capital Group and Laurentian Bank – are uninsured.

By contrast, many of the large U.S. banks rated by DBRS Morningstar have less than 50 per cent of their deposits uninsured, with several below 30 per cent.

While regulations do not prohibit lenders from disclosing their amounts of uninsured and insured deposits, Canada’s Big Six banks do not make that information public, unlike in the United States. DBRS Morningstar has access to that data through confidentiality agreements signed with the banks, Mr. De Souza said.

The Globe and Mail asked the 10 largest Canadian banks to disclose the proportion of uninsured deposits they hold. Equitable Bank spokesperson Deborah Chatterton said about 15 per cent of her institution’s deposits are uninsured and about 85 per cent are insured. All other banks declined to provide exact numbers on the record, or did not respond.

On average, Canadian banks have a greater proportion of uninsured deposits than U.S. banks do. It’s understandable, given that the Canadian Deposit Insurance Corp. has a $100,000 limit on deposit insurance, versus the US$250,000 from the U.S. Federal Deposit Insurance Corp.