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Discussion Starter #1
I haven't seen much discussion about this yet, but I think we're entering a bad time for Canadian banks. Reasons:

1. they are highly leveraged during a sharp contraction
2. collapse of the energy sector
3. sharp increase in unemployment
4. loan deterioration / loan losses
5. and if we get a housing bear market too, disaster for the banks

I think the loan losses are going to be immense and I think it's going to play out over several years. This can't possibly be over quickly. People and businesses are currently still in "shock" mode and financial reality hasn't set in yet. It will be 1 or 2 quarters from now by the time we see these effects in bank earnings reports.

I predict that bank stocks will underperform the TSX. I am underweight banks.
 

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I agree, however a lot of credit is home secured, nobody wants a real estate crash.

I think TD has a large US component, and BNS has South American assets, which should help diversify a bit.

Hopefully they wind up CERB quickly and get people back to work.

Also the government has been "encouraging" banks to be lenient and provide liquidity, if they follow the guidance, the government has an obligation to help them. I don't think they'll get bailed out, but there could be other concessions.

I'm not too concerned if the banks lose a year of profits, in 10 years I think we'll see this whole mess as just a blip that we pretty much forget about. If you're looking at a time horizon of 1-2 years, then you shouldn't have been in equities anyway.
 

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We'll all find out at the end of the month after they report earnings. everything else is speculation.
 

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TD and BNS, I did buy both this time around. Hoping in 10yrs when I retire, these would be among my well timed buys. Seemed safer than buying VCN.
 

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Depends on the time frame...might go lower in the next few quarters but in the long run will make you wealthy...any graph will show past instances of the phenomena...the important thing is to act
 

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At least our banks are honest about loan losses. And you may notice that US banks are pre-emptively taking loan losses as well, like JP Morgan. This recession is potentially going to wipe out maybe half of the profits over the next year. Good thing the banks are already cheap at maybe 7-8 times normalized EPS and at or with only a small premium to book value.

You know who isn't taking any loan losses? European banks. Many of them still haven't taken loan losses from the 2008 recession and are working effectively on low, zero, or even negative equity.

If you're into technical analysis, you may know that markets almost never move up "without the leadership or participation of the financial sector", leadership being even more bullish than participation. If you think the Canadian banks will lag, you may want to reduce your exposure to the index.
 

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Discussion Starter #8
I continue to hold a large RY position as part of my 5-pack. I'm not getting rid of my bank holding, I just think we're going to see some really bad results from them.

I don't make strategic / market timing changes to my asset allocation either. My equity allocation, and 20% banks, remains intact.
 

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Can't disagree with your feelings on Bank stocks but also feel that the dividends are safe and it hard to beat the 5% return these days. A quick search indicated that Net Interest Income accounted for less than 50% of their income and I expect the rest comes from brokerage, insurance, forex, service charges, etc and Bank earnings do not come solely from interest income.
 

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Discussion Starter #11
A quick search indicated that Net Interest Income accounted for less than 50% of their income and I expect the rest comes from brokerage, insurance, forex, service charges, etc and Bank earnings do not come solely from interest income.
Yes it's true that revenue streams might break down in this way, so "standard lending" might be only a part of their revenue. But the problem isn't the revenue side.

The issue is loan losses during a broad economic shock. The spike in non-performing loans can be immense. They will see a large increase in bad loans across: mortgages, personal lending, corporate lending.

So even while their "diversified revenue" continues, they will suddenly get large loss items. This first shows up as loan loss provisions, which milhouse just linked to in TD's guidance. This is when huge amounts of negative income start hitting the earnings.

Based on what I observed in 2007-2009, it doesn't stop there. Those are just the loss estimates. As loans continue to deteriorate, you keep having to write down the loans and take more charges. So you get hit, over and over again, with more negative income.
 

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Discussion Starter #12
~~ Illustration of bank leverage (TD example) ~~

Banks are highly leveraged. This is why they have an "amplified" reaction to both up-cycles and down-cycles. I think I can illustrate using a simplified bank balance sheet. I actually based this off TD's financials so it's pretty close to TD's reality:

Assets = $100
... $8 of which is cash and assets that aren't like loans
... $92 which are loans, packaged loans, and derivatives
Liabilities (debt/deposits) = $95
Equity (share capital) = $5

The first thing to note is how insanely leveraged the bank is. $100 assets are supported by $5 equity, about 20x leverage.

The next thing to note is how nearly all their assets are loan-like. So now you can see the problem. You've got $92 of assets subject to loan losses but only $5 capital.

Loan losses in normal times run at below 1%, so that's already baked in. Now let's say that loan losses spike to 5%. What happens?

5% loss * $92 loans = $4.60 of losses

Once the bank acknowledges this (and they will delay it and drag their feet so that executives can keep collecting bonuses) they are required to reduce their assets accordingly. Suddenly we see a bank with $5 equity but $4.60 loan losses. Uh oh...

Now their assets are: $8 non loan stuff + $87.4 loans = $95.40 assets

How much equity is left in the bank? There is now $0.40 equity left, a decline of 92% in bank equity

An easier way to think of that is that at 5% loan losses, the asset side of the balance sheet deteriorates by (92/100)*5% = 4.6%. Since they are leveraged 20x, that's 92% loss. The bank is wiped out.

A more optimistic scenario of say 2% bad loans results in more like 37% equity loss which I think is very likely.
 

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Assets = $100
... $8 of which is cash and assets that aren't like loans
... $92 which are loans, packaged loans, and derivatives
Liabilities (debt/deposits) = $95
Equity (share capital) = $5
CBA says around 44% of gross revenue is made from loans.
 

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Discussion Starter #15 (Edited)
And here's data across several countries, showing how bad loan losses got during the last financial crisis. Look at the red lines in the chart. You can see that impaired loans in several countries hit 5%, but not every country. In Australia, they never even got to 2%.

For TD bank you can estimate the drop in equity (drop in book value) using the formula:

Code:
0.92 * (IMPAIRED - 1) * 20

.........................^ leverage factor
.................. ^ accounting for existing 1% provision for losses
..........^ the impaired loans you project, e.g. 5%
^  portion of assets exposed
In the 2% scenario, you get 18% equity loss <---- current expectation?
In the 3% scenario, you get 37% equity loss <---- current expectation?
In the 4% scenario, you get 55% equity loss.
In the 5% scenario, you get 74% equity loss.
In the 6% scenario, you get 92% equity loss.

We'll have to see how bad loan losses get. Canadian loan losses in 2007-2008 were not anywhere as bad as Europe, so I think investors are currently expecting more like the 2% and 3% scenarios above, which is not catastrophic.

It all depends on how bad impaired loans get. It's way too early to tell, but my own projection is around the 4% level, resulting in about 55% equity loss. Not catastrophic.

 

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I’ll leave it to others who enjoy research (or know more off-hand facts) but I recall that a large percentage of executive comp is tied to the share price and deferred share units. I recall a former colleague who earned units, but they were paid out after 3 years....right during a major home Reno in 2009. He was obviously expecting almost double to be paid. Does that make sense....that a large portion of comp is tied to the stock price 3 years away (when vested)? I also recall a requirement that senior executives need to hold a certain amount of shares for 3 years after they retire.....this was the “leave it better than you found it approach”. TD also ties approx 20% of comp to customer service scores. Not sure all this is 100% accurate but leads me to believe the execs are very focused on longer term results 3+ years, rather than focusing on each quarter. The CEO is sitting on 800,000 shares (deferred or otherwise)......I suppose he’s more focused on the long-term, then the quarterly losses that may result in a recession.

i suspect comp at most large firms is similar.
 

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Good article in the Globe. A good time to buy banks is when loan loss provisions peak in fact.

The first major peak in loan-loss provisions on the chart occurred in September, 2002. In the following 12 months, the bank index jumped 30.3 per cent, including dividends, outdistancing the S&P/TSX Composite return (not shown on chart) by almost eight percentage points.

The same trend of bank out performance occurred after the second peak in provisions in June of 2009. The next year saw banks climb 16.6 per cent compared with the TSX’s 12-per-cent total return. Banks also outperformed after the smaller peak in provisions in June, 2016, with a 23.2-per-cent rise that beat the S&P/TSX Composite by 12 per cent to the end of June, 2017.
20156
 

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Discussion Starter #18
That G&M graph isn't useful because it just shows the loss provisions in absolute numbers. What really matters are the loss provisions (or impaired loans) versus gross loans. There was a ton of loan growth since 2010 and this has to be taken into account.

Contrary to what that graph suggests, bad loans at Canadian banks have been steadily trending downward since the 2010-2011 peak. In the most recent quarter, banks reported some of the lowest numbers ever for impaired loans as % of all loans.

It will take many quarters for banks to start reporting the full situation and loan losses may not peak for a while -- in the typical credit cycle, this would take years.

I don't want to give the wrong idea... I think the banks will still remain viable. I'm thinking we might see bank equity suffer a 50% hit but that's not catastrophic.
 

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I'm thinking the bad news will be front loaded like most quarterlies lately. Seems with Covid in the air companies are as immune to bad news as JT's recent election campaign.
 

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Banks are backed by the taxpayer. Nothing to fear for them. I suggest people read the creature from. Jeckal island to get a better idea of how the monetary system actually works.
 
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