Veritas Predicts BMO and CIBC Will Increase Equity to Construct Firewalls

According to analyst Nigel D’Souza, Bank of Montreal and Canadian Imperial Bank of Commerce may need to raise new equity over the medium term to build capital levels as the bank regulator bolsters its requirements.

In December, the Bank of Montreal issued shares, and there has been speculation that the CIBC may do the same after the Canadian financial watchdog increased the minimum buffers that large banks must maintain to absorb losses.

D'Souza, who works for Toronto-based Veritas Investment Research Corp., said that stock sales are unlikely to happen in the short term. However, he added that an economic slowdown and higher loan losses may eventually force both Canadian lenders to tap the market.

D'Souza believes that BMO is most at risk of higher credit losses because they have a higher proportion of their lending portfolio in cyclically sensitive sectors. He does not believe that a deep recession is likely, but if one were to occur, the bank would be disproportionately affected. Additionally, the bank's recent acquisition of Bank of the West will put strain on its capital levels.

In February, the Office of the Superintendent of Financial Institutions raised the required common equity tier 1 ratio for the country’s largest banks by 50 basis points, to 11% of risk-weighted assets. It also increased the range of the “domestic stability buffer” — setting the stage for possible further increases to capital thresholds.

All large Canadian banks target a capital ratio that is higher than the regulatory minimum. OSFI's new, wider range may force them to carry even larger surpluses over what is required. This could have implications for the banks' profitability and competitiveness.

D'Souza said that the other four large banks - Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia and National Bank of Canada - are all on track to reach a 12.5% CET1 ratio over the next two fiscal years based on their internal capital generation.

According to Mr. Dodig, if the Bank of Montreal and CIBC would like to catch up with other large banks, they will need to raise other capital. He noted that they wouldn't achieve that level until fiscal 2025.

Interest rates in Canada have been rising rapidly, leading to concerns about financial distress among households. High levels of leverage may result in loan defaults during an economic downturn.

National Bank is the least at-risk of the six largest domestic banks because of its concentration in Quebec. According to D'Souza, Quebec has experienced lower credit losses through recessions than other provinces, making National Bank a safer investment.