How Canada Beats the U.S.
Throughout the financial crisis that pummeled most of the world, Canadian institutions not only survived, they thrived. That success, credited to a mix of regulatory and cultural forces, may offer insight to U.S. institutions and investors.
“All we have to do is look north and we can see a really good model for how to do business as a country,” says Peter Maris, CFP, founder and principal of Resource Financial Group in Wilmette, Ill.
“They are more conservative as a nation than we are and a lot less greedy, if I may use that term,” he explains. “They don’t have adjustable-rate mortgages in Canada. Ninety percent of the banks hold their mortgages to maturity, whereas in the U.S.a loan is originated and then sold off as soon as possible to get it off their books. They are more conservative, and that made for a more stable system when the bottom fell out. Eighty percent of their mortgages were prime mortgages, as opposed to what happened here in the U.S.”
Maris points out that the Canadian banking system is ranked No. 1 in the world by the World Bank.
“They are very conservative in terms of who they lend to,” he says. “If somebody wants an aggressive loan, they will probably come to the U.S. and head to the junk bond market here.”
John Taft is CEO of RBC Wealth Management, a subsidiary of Royal Bank of Canada that has more than $160 billion of assets under administration. RBC is Canada’s largest bank as measured by assets and market capitalization.
He believes three factors — business practices, regulatory environment and the management cultures at financial institutions in Canada — insulated the country during the financial crisis.
Looking at Canada, Taft says, the “biggest difference was that there really wasn’t a securitization market for Canadian home mortgages.”
“Also, Canadian home mortgages are not deductible against your income, so there isn’t an implicit subsidy of mortgage finance and housing ownership the way it was in the U.S.,” he says with a nod toward the subprime-mortgage-based origins of the recent Great Recession. “Most of the mortgages in Canada are also held on the balance sheets of financial institutions. They originate and hold, as opposed to originate and distribute the way it happens in the United States. The consequence of that is that underwriting standards were, in retrospect, a lot more rigorous and more prudent than they were in the United States.”
The majority of mortgage lenders in Canada also still require a 20% down payment, a practice that had been virtually abandoned in the U.S. and is only now starting to become standard again.
“Canadian banks entered the financial crisis with mortgages on their balance sheet that were performing assets, that were actually contributing to the profitability. They didn’t have mortgages that were distressed and needed to be written down, which was a source of a lot of the trouble American banks had.”
Taft points out that even with more rigorous standards, and the avoidance of securitization, Canadian homeownership, as a percentage of the population, is almost identical to that of the United States — roughly 62%.
“The world, not just the U.S., is taking a page from the Canadian regulatory experience,” Taft says. Simply put, that means higher levels of capital, lower levels of leverage and more liquidity for financial institutions.
“The Canadian model certainly proved to work,” he says. “No Canadian banks failed and, in fact, none of the major Canadian banks even cut a dividend.”
“Canadian corporate culture is very different, and I think that is stimulated by the banks as a whole,” says Chris Kichurchak, vice president of Ohio-based Strategic Wealth Partners. “It is less driven by the pursuit of short-term riches. It really seems to be more focused on sustainable growth rather than short-term profitability.”
Kichurchak cites the economic premise that once a country’s debt-to-GDP level crosses 90% it will inherently have a substantially slow growth for the ensuing decade. In 2008, Canada’s ratio was around 50%; today it is near 60%. In the U.S., the ratio sits at about 96%.
“That shows us that Canada’s old-school mentality really is taking hold, and that’s what we see as one of the big reasons why it has been able to really protect itself from all of the financial problems that have been going on,” Kichurchak says.
Taft cites a “stewardship culture” that takes hold at the “very top of the financial system.”
“There is no question that the Canadian bank executives manage their banks with one eye on what’s good for the country as a whole,” he says. “There still is a very strong sense of community at the national level in Canada. The financial institutions believe they are responsible for facilitating economic growth and for the health of the economy. That kind of stewardship ethic is exactly what you need at major financial institutions if we are going to avoid future crises and the excesses that led to them. No amount of regulation and no amount of legislating, though it may help is, fundamentally, the answer in and of itself. You actually have to have the stewardship culture that exists in Canada. It needs to be replicated.”
Opportunities for investors
While U.S. Investors pore over global markets, weigh the benefits of Brazil and analyze China, they may overlook the opportunities that lay a border away.
Kichurchak cites the country’s rich array of natural resources — among them oil, timber, zinc, potash and wheat — as a key draw for investors.
“Canada is the biggest supplier of oil exports to the United States,” he says. “Canadian exports of oil is just going to become a stronger and stronger place for investors to put money in.”
In terms of an energy play with Canadian exposure, Kichurchak suggests Kinder Energy Partners, with a 6.3% yield, 14 consecutive years of dividend increases and a 7% dividend growth rate.
ETFs with a Canadian focus include the iShares MSCI Canada Index Fund, the Guggenheim Canadian Energy Income ETF and CurrencyShares Canadian Dollar Trust , a play on the strength of the “loonie.”
“With Canada you get a natural resource play. Their natural resources are abundant,” Maris says. “When you invest in an ETF for Canada you are getting the natural resources, you are getting the banking system and even some industrials like the company that makes the Blackberry, Research in Motion. You are getting sort of a trifecta. We have replaced a lot of our European holdings with Canadian holdings in terms of an international allocation.”