A year ago, a short-seller who had made money betting against banks in New England and Arizona considered taking a short position in some of Canada's big institutions.

"My analyst friends talked me out of it," he recalled. Most of the banks up there are too big to fail."

As it turned out, the short-seller was getting good advice: The Toronto bank index urged 31% last year.

The six big Canadian banks that control 190% of the nation's banking assets are well capitalized; their businesses are diversified; and they enjoy relatively benign regulation, the investor's Canadian friends told him.

Olympia & York's Impact

Still, an opportunity to make some money by selling Canadian bank stocks short did arise recently. Rumors began to circulate that Olympia & York Developments Ltd., a favored client of all but one of the country's six nationwide banks, and run into a severe cash shortage.

What with profit taking and jitters related to Olympia, the Canadian financial stock index fell 20%, from a peak of about 3,500 in January to a nadir in early April near 2,810, before stabilizing in the 2,850-2,950 range.

Asset quality, which had been declining gradually during Canada's persistent recession, deteriorated in a hurry in the second quarter, as Olympia's troubles hit bank's balance sheets. With investors in a near panic, the banks broke their customary silence about customer relations and released details of their $2.57 billion exposure to O&Y. Of that, $1.77 billion in loans was placed on nonaccrual status.

The developer ultimately threw its Canadian operations into bankruptcy and was struggling to restructure some $12 billion of realty-related debt, in all.

Vulnerable on Realty

Toronto Dominion Bancshares, the only major bank with no exposure to O & Y real estate, saw its nonaccrual loans continue to rise in its second quarter, ended April 30, while its net interest margin shrank precipitously, to 2.87%, from 3.16%, as it wrote off $51 million of preferred stock investments.

The situation underscored the biggest bank's vulnerability to real estate problems at home and in the United States. It also prompted some mainstream analysts to reevaluate their positions.

Salomon Brothers analyst John Leonard, for example, said Olympia was merely the most glaring instance of real estate's burdening the banks. Accordingly, he reduced most of his 1992 earnings estimates for Canadian banks.

He downgraded Canadian Imperial Bank of Commerce to a "hold," leaving only Bank of Montreal and Royal Bank of Canada on Salomon's "buy" list.

But thanks to the industry's strengths, Mr. Leonard and other analysts figure the period of retrenchment could end soon after the current fiscal year.

"We continue to expect improved performance in 1993, as the economy recovers, and believe current stock prices amply discount uncertainties," he wrote. Canadian banks still "enjoy asset diversification that U.S. bankers only dream of," he said.

"The world maybe won't come to an end," added Kevin R. Choquette, analyst in First Boston Corp.'s Toronto office.

Although big bureaucracies hamper decision-making somewhat, the banks remain better capitalized than their U.S. counterparts, at 5.5% of assets or better, Mr. Leonard said. And the six, especially Bank of Montreal remain possible acquirers of U.S. franchises.

Robust Capital Ratios

Royal Bank and Bank of Montreal are especially strong. Using more lenient U.S. regulatory yard sticks, the total capital ratios of these banks would be 10.3% and 10.4%, respectively, compared to 9.5% and 9.1% using the more conservative Canadian measures.

Regulation, although firm, is "more consistent" than it is in the United States.

"The Canadian system is very concentrated, and the U.S. system is very fragmented. That is the major, macro difference," said Mr. Chocoquette. !!!BEGIN TABLE Canada's Top Three Ranked by assets;

dollars in millions Fiscal year ending Percent World

10/31/91 10/31/90 change rank

Royal Bank of Canada $111,376 $98,927 12.6% 44

Canadian Imperial

Bank of Commerce 100,854 89,894 12.2 52

Bank of Montreal 84,562 71,786 17.8 61

Source: American Banker

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