Bay Street is likely to suffer less than Wall Street as global
economic conditions worsen and international banks continue to grapple
with bad loans and toxic assets, according to UBS. Researchers at the
Swiss bank “expect Canadian banks to continue to outperform their
global peers given superior asset quality, capital, liquidity, and
return on equity.”

While shares in U.S. and Canadian banks both
hit historical lows in January, UBS points out that Bay Street banks
have suffered a 38% fall while Wall Street bank stocks have fallen 66%.

Researchers
at the investment bank say they “remain negative on the outlook for
global banks due to a weaker economy,” but see less risk lurking in the
books of Canadian banks.

“Exposure to high risk toxic assets is fundamentally lower in Canada,” according to the UBS team.

The
researchers also point to several other key metrics that indicate a
healthier banking system, including more stringent underwriting
standards for home loans. The bank points out that Canadian banks are
less leveraged than international peers, with a “a low loan-to-deposit
ratio of 78% versus 83% in the U.S., 96% in the U.K.”.

In
particular, the bank argues investors should not use the same
conservative metrics to evaluate the riskiness of Canadian banks that
are in vogue for measuring U.S. banks. U.S. investors have been
increasingly ignoring measures of banks’ capital reserves that are
based on elaborate systems of risk-weighting arrived at by executives
and regulators.

Instead, they have been stripping balance sheets
down to so-called tangible common equity, because “all assets have
become more risky in this environment”, making “risk weightings less
reliable, according to UBS.

Using this risk-averse metric,
Canadian banks look significantly less well capitalised. But UBS argues
this is misleading. It points to a number of conditions in Canada that,
including strong earnings flows.

“We think that earnings are the
most important cushion for credit losses,” the researchers say, adding:
“therefore their implicit pro forma capital levels are higher than
their US peers regardless of what number is used.”