Although being at the top of the heap among global financial services companies may not be a feat worth trumpeting in the midst of a global credit crisis, it is definitely reassuring for clients holding Canadian bank stocks.

The strength of Canada’s banks in the current economic environment is reflective of this country’s banking structure: a small number of large banks rather than a proliferation of small banks, as is the case in the U.S., where there are 8,400 banks.

The Canadian industry’s relative strength also reflects the conservative, risk-averse nature of Canadians. Neither Canadian banks nor individual Canadians have embraced the use of home equity as a source of everyday cash, a widespread practice in the U.S. and partially responsible for the credit crunch. In addition, Canadian banks didn’t lower their lending standards the way their U.S. peers did.

With only six national banks, the sector is essentially an oligo-poly, with the Big Five able to influence, if not set prices for banking products and debt instruments.

Certainly, Canadian banks’ margins are much better than those of their counterparts in U.S. and much of the world. This means Canadian banks can make a profit through basic banking activities, such as deposit-taking and lending. Elsewhere, intense competition has led to thin margins. That, in turn, has encouraged those banks to take on risky lines of business in a drive to produce strong earnings growth.

In the U.S., retail banks took on subprime and other risky mortgages, while bigger banks and investment banks used very high leverage — as much as 35 times — in their capital markets operations to boost earnings. So, when the credit crunch hit, they were in deep trouble.

Canadian banks haven’t escaped the credit crunch entirely. CIBC has been hit hard. Its losses from structured products could reach $9 billion, according to a Oct. 6 report from Toronto-based Catalyst Equity Research. Relative to CIBC’s size, that puts the bank’s losses near the top of the heap globally.

Another factor is that Canadian banks have much better capital ratios than their counterparts around the world, says John Hadwen, portfolio manager with Signature Global Investors, a division of CI Investments Inc. in Toronto. Their Tier 1 capital ratios — the ratio of a bank’s core equity capital to its risk-weighted assets — are 9:1 to 10:1, whereas ratios for big global diversified banks are only around 8:1.

Reports from Catalyst, Dundee Securities Corp. and Genuity Capital Markets, all of Toronto, have rated both Royal Bank of Canada and TD Bank Financial Group as “buys.” Toronto-based RBC Capital Markets, a subsidiary of Royal Bank, has a “hold” rating on both banks.

Bank of Nova Scotia has attracted the greatest diversity of opinion. The Catalyst report considers it a “buy”; Genuity and Dundee reports view it as a “hold”; the RBC Capital Markets report says it will “underperform” the sector.

Meanwhile, both the Catalyst and Genuity reports rate Bank of Montreal a “hold” rating, whereas the RBC Capital Markets report rates it a “sector perform” and the Dundee report rates it a “sell.”

Among the analyst reports, Catalyst’s is the most optimistic for the sector, with 12-month price targets for the Big Five’s shares that are 28%-55% higher than the level at which they closed on Oct. 10. The Genuity report sees increases of 23%-43%; Dundee, 23%-36%; and RBC Capital Markets, only 12%-25%.

The RBC Capital Markets Oct. 7 report suggests that it’s probably better to wait until there’s a clearer indication that the global crisis is being resolved before investing in the Big Five: “We would not rush to buy financial services stocks in spite of attractive valuations. The macro environment continues to worsen, with faster deterioration being witnessed in certain areas [such as] equity markets, funding costs and access to liquidity.”

The report also maintains that valuations aren’t “that low compared to prior troughs.”

Although the RBC Capital Markets report doesn’t expect any of the banks to outperform the S&P/TSX financial services subindex, it nevertheless suggests owning shares in Scotiabank, Royal Bank and TD because these three “have attractive franchises and are well positioned to make acquisitions.”

In particular, these banks could find good acquisition targets in the U.S. in the aftermath of the credit crisis.

Here’s a closer look at Canada’s Big Five banks:

@page_break@> Bank Of Montreal. BMO is most analysts’ least favourite stock because of the bank’s exposure to both the U.S. economy and to structured investment vehicles (SIVs).

The Dundee report, which came out on Aug. 27, notes that BMO, like other banks, is “gradually withdrawing from areas that produce volatility and do not reflect adequate risk/reward profiles when viewed over a full cycle.”

That said, the report adds: “BMO continues to struggle with its remaining capital market exposures and, while not critical, when coupled with the increasingly challenging credit environment, does provide for higher risks than investors typically associate with the bank.”

The Dundee report holds up “little hope that credit issues will diminish in the coming months.”

Through BMO’s subsidiary, Chicago-based Harris Bank, the Canadian parent bank has proportionately more exposure to the U.S. than the other big Canadian banks. This is already showing up in increases in loan-loss provisions, which totalled $865 million in the nine months ended July 31, vs $202 million for the same period a year earlier.

Some of this was the result of the transfer to BMO’s balance sheet of $395 million in U.S. residential real estate loan assets from the bank’s U.S. asset-backed commercial paper conduit, Fairway Finance Co. LLC. The Genuity report notes that Fairway still has $1.2 billion in assets, which BMO may also have to bring onto its balance sheet, requiring further loan-loss provisions.

Genuity’s report is also concerned about BMO’s exposure to Canadian APEX Trust and British SIVs.

The Catalyst report notes that SIVs account for about $10 billion of BMO’s assets and, as a result, it could also see more charges related to these.

BMO reported net income, excluding unusual or non-recurring items, of $1.4 billion in the nine months ended July 31, down from $1.7 billion a year earlier. Revenue in the nine months was $7.4 billion vs $7.1 billion a year earlier. Its efficiency ratio in the nine months — non-interest expenses as a percentage of total revenue — was 68.6%, vs 66.8% in the same period a year earlier.

As of July 31, BMO’s 12-month trailing return on equity was 12.3%, vs 16.4% a year earlier. Total balance sheet assets were $375 billion; common shareholders’ equity of $15. 2 billion was slightly higher than in the previous quarter. BMO has subordinated debt of $4.2 billion; its Tier 1 capital ratio was 9.9%.

The bank’s dividend per share is an annualized $2.80 at quarter-end, resulting in a dividend yield of 7.5% as of Oct. 10.

The Catalyst report doesn’t expect a dividend increase in the next year.

BMO common shares closed at $37.40 a share on Oct. 10, down by 47% from a high of $70.43 in July 2007.

The Catalyst report suggests the share price could rise to $50 in the next year; Dundee, $47; Genuity, $46; and RBC Capital Markets, $42.

BMO has 504.4 million outstanding shares, which are widely held.

> Bank Of Nova Scotia. Although Scotiabank occasionally flirts with the idea of going into the U.S., it has not embraced that strategy. Rather, it has stuck to its strategy of growing in the Caribbean, Latin America and other emerging countries. This has served the bank well as it has no direct exposure to the slowdown/recession in the U.S.

Scotiabank has the lowest efficiency ratio among the Big Five banks, at 54.8% for the nine months vs 53.1% a year earlier.

Scotiabank reported net income of $2.8 billion for the nine months, vs $3.1 billion for the same period a year earlier. Its revenue was stable at $9.7 billion. Loan-loss provisions were $423 million in the nine months, vs $175 million a year earlier.

Scotiabank’s 12-month trailing ROE was 19% as of July 31, vs 22.6% a year earlier. Total balance sheet assets were $462.4 billion and subordinated debentures totalled $3.5 billion. Shareholders’ equity was $18.8 billion as of July 31, and its Tier 1 capital ratio was 9.8%.

Scotiabank’s dividend has increased twice in the past year, to an annualized rate of $1.96 a share as of July 31, from $1.88 a share in January and from $1.80 the prior quarter. This presents a dividend yield of 4.9%.

The Catalyst report expects a 5%-7% increase in the dividend over the next 12 months.

In October, Scotiabank announced that it is buying Sun Life Financial Inc.’s 37% stake in CI Financial Income Fund. Catalyst analysts are enthusiastic about this, saying in their report that “a solid asset-management strategy is developing.” Catalyst analysts think this transaction will increase Scotiabank’s wealth-management earnings to around 15% from the current 4%.

Scotiabank also bought E*Trade Canada Securities Corp. , which has doubled the bank’s discount brokerage business. That followed the purchase in September 2007 of Dundee Bank, which provides generic products to the independent advisor network, as well as an 18% stake in DundeeWealth Inc.

The Genuity report considers Scotiabank to be the lowest risk among Canada’s Big Five banks. The report notes Scotiabank’s capital strength, minor exposure to U.S. retail loans and little exposure to SIVs, non-bank ABCP, subprime mortgages, monolines, auction-rate securities and other structured products. Nevertheless, the Genuity report says, the bank will have to raise its loan-loss provisions.

The Dundee report warns that Scotiabank’s loan-loss provisions could be higher than expected because of its indirect exposure to the U.S. through its Caribbean and Latin American holdings.

Scotiabank has 990 million widely held shares outstanding. Its shares closed at $39.98 on Oct. 10. Genuity analysts aren’t sure Scotiabank’s shares deserve a 20% premium over its peers.

Although Scotiabank’s share price is down the least among the Big Five, it still fell by 23.8% from its high of $52.48 in July 2007.

The 12-month price targets from analysts cover a range: $57 (Catalyst), $50 (Genuity), $49 (Dundee) and $46 (RBC Capital Markets).

> CIBC. Although the Catalyst report is the only one with a “sell” rating on CIBC’s stock, none of the other reports suggest buying it — even though the 380.7 million widely held shares closed at $49.10 a share on Oct. 10 — 50.5% lower than their July 2007 high of $99.23.

The Genuity report provides the highest 12-month share price target, $70 a share; Dundee, $64; Catalyst, $63; and RBC Capital Markets, $60.

In the nine months ended July 31, CIBC took $4.5 billion in losses related to the structured credit business. This produced a net loss of more than $2.4 billion in the nine months. The bank also reported net losses of $1.5 billion and $1.1 billion in the first and second quarters, respectively, and net income of only $78 million in the third quarter.

Loan-loss provisions were $551 million in the nine-month period, vs $471 million in the same period a year earlier.

The structured credit charges came off both revenue and net income, reducing revenue to just $1.7 billion in the nine months, vs $9.3 billion in the same period the previous year. This also distorts the efficiency ratio, which spiked to a whopping 310.8% for the nine months, vs 61.7% in the year-prior period.

CIBC’s Tier 1 capital ratio was 9.8% as of July 31, assets were $329 billion, common shareholder equity was $10.8 billion and the bank’s 12-month trailing ROE was negative.

In early October, New York-based Cerberus Capital Management LP agreed to invest more than US$1 billion in CIBC’s U.S. residential market portfolio. Although an Oct. 6 Catalyst report considers this move positive, it still recommends selling the stock, adding that the risks at CIBC are much higher than for the other big Canadian banks. An Aug. 28 Catalyst report also notes that underlying earnings for CIBC were weak across the board in the third quarter, particularly in its retail banking division and in CIBC World Markets Inc.

However, the Genuity report notes, CIBC can take $4 billion in pretax charges over the six months ending Jan. 31 and still maintain a 9% Tier 1 capital ratio. That report suggests the stock should continue to trade at a significant discount because the Genuity research team “doesn’t see how CIBC can grow revenue and earnings at a level approaching its peers.”

The Dundee report notes CIBC’s low credit risk profile is changing due to weakness in its credit card and international mortgage portfolios. The report also notes that CIBC remains “subject to headline risk, with widening credit spreads and incremental monoline counterparty difficulties likely to raise speculation of continued writedowns.”

CIBC pays an annualized dividend of $3.48 a share, which represents a dividend yield of 7.1% as of Oct. 10.

> Royal Bank Of Canada. Royal Bank’s 1.3 billion widely held outstanding shares closed at $41 a share on Oct. 10, down by 29.9% from a high of $58.45 a share in July 2007. Its 12-month price targets range from a high of $60 a share (Catalyst) to $55 a share (Genuity), $54 (Dundee) and $49 (RBC Capital Markets).

“Royal Bank continues to remain one of our top choices in the Canadian banking sector as it appears intent on expanding its wealth-management business both inside and outside Canada, a strategy we highly endorse,” states an Aug. 29 Catalyst report, which adds that Royal Bank “has clearly demonstrated that it can generate exceptional returns” and notes the “exceptional” 19% growth in domestic banking earnings in the third quarter year-over-year.

Genuity’s Aug. 29 report upgraded Royal Bank to a “buy,” stating that “positives include the very strong domestic retail results, continued momentum in trading and capital markets generally, the low probability that the bank will acquire a troubled U.S. broker or bank, and the fact that future charges should not be particularly meaningful.”

Royal Bank’s third-quarter results “make a strong case that it could regain the premium multiple valuations for the group,” Dundee’s Aug. 29 report notes. That report points out that the bank “was able to earn through lingering negatives such as higher U.S. real estate exposure and continued capital markets writedowns” and notes that trading revenue has declined as a percentage of total revenue.

Royal Bank reported net income of $3.4 billion in the nine months to July 31, down from $4.2 billion in the same period a year earlier. Revenue was $16.5 billion in the nine months, slightly lower than $16.8 billion in the comparable year-earlier period.

Royal Bank’s efficiency ratio was 66.2% for the nine months vs 63.8%, a year earlier. Loan-loss provisions were $976 million, up from $528 million a year earlier.

Royal Bank’s 12-month trailing ROE was 17.9% as of July 31, and its Tier 1 capital ratio was 9.5%. Balance sheet assets were $636.8 billion, subordinated debentures were $7.9 billion and common shareholders’ equity was $26.5 billion.

Royal Bank pays an annualized dividend of $2 a share, translating into a dividend yield of 4.9% as of Oct. 10.

> Td Bank Financial Group. TD was not exposed to the subprime mortgage mess and didn’t have to take any charges as a result. TD reported net income of $2.9 billion in the nine months ended July 31, little changed from a year earlier. Its nine-month revenue was $11.4 billion, vs $11.1 billion a year earlier.

TD’s efficiency ratio was 58.6% in the nine months vs 56.6%, almost as low as Scotiabank’s. And TD was the one bank among the Big Five whose provision for credit losses were down, to $517 million in the nine months vs $700 million.

TD’s 12-month trailing ROE was 15.1% as of July 31. Balance sheet assets were $508.8 billion, subordinated debt was $13.5 billion, common shareholders’ equity was $29.7 billion and its Tier 1 capital ratio was 9.5%.

TD has 807.3 million common shares outstanding. Its share price closed at $52.14 on Oct. 10, down 29.3% from a July 2008 high of $73.75.

Like Scotiabank, TD has raised its dividend twice in the past year, to an annualized rate of $2.44 a share in October from $2.36 a share in April and $2.28 the prior quarter. That translates into a 4.7% dividend yield as of Oct. 10.

The Catalyst, Genuity and Dun-dee reports all have “buy” ratings on the stock, with 12-month price targets of $81, $73 and $71, respectively. The RBC Capital Markets report rates TD a “hold,” with a 12-month price target of $65.

Third-quarter operating results for TD exceeded expectations, according to the Catalyst Aug. 29 report, which notes that TD has good asset quality and risk management. “We continue to view TD as just plain superior to its peers,” says the report, which adds that the stock deserves a modest premium over Royal Bank’s and Scotiabank’s because of TD’s risk level and solid earnings performance from its personal banking operations.

The Genuity report prefers TD over its peers because it has “very strong domestic retail business, which should show better operating leverage in the near term, its lower risk capital markets business and relative valuation.”

Although TD had to correct “incorrectly priced financial instruments” in the third quarter, Dundee’s Aug. 29 report says, analysts are “willing to look past [this]. With arguably the lowest likelihood of significant writedowns on the horizon, we believe that TD retains a very low-risk profile.”

TD had some difficulties in the U.S. retail market early on, but earnings from TD Banknorth, which operates in the U.S. Northeast, improved significantly in the second half of fiscal 2007. Commerce Bancorp Inc., which is in Washington, D.C., and Florida, as well as the U.S. Northeast, was acquired on March 31. IE