Canada’s banks brace for indirect exposure to Italian debt

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grant robertson — BANKING REPORTER
From Monday's Globe and Mail
Published Sunday, Nov. 13, 2011 7:00PM EST
Last updated Monday, Nov. 14, 2011 6:59AM EST

With Italy teetering on the brink of a default, the question hanging over Canadian banks now is how exposed they are to the latest sovereign debt crisis brewing in Europe.

Canada’s banks have steadfastly maintained that their exposure to Europe’s growing sovereign debt problems is small. And when it comes to Italy, that appears to be the case.

At the end of the last quarter, Toronto-Dominion Bank (TD-T72.40----%) listed its exposure to Italian sovereign debt at a relatively small $197-million, while Royal Bank of Canada (RY-T45.65----%) had the second-largest exposure to Italian bonds at $120-million.

Bank of Montreal (BMO-T57.40----%) lists $131-million worth of exposure to European sovereign debt, but doesn’t break out a specific number for Italy, while Canadian Imperial Bank of Commerce (CM-T71.92----%) and Bank of Nova Scotia (BNS-T51.37----%) say they have no direct exposure to Italian bonds.

But when the banks discuss fourth-quarter earnings with analysts in early December, expect Europe to be a key topic of discussion.

Even though the direct exposure to Italian bonds seems small for the banks, there are hidden worries should Italy default. The risk for Canadian banks is not their direct exposure to Italy, but the unknown problems that could spring up through exposure to counterparty European banks that the Canadian lenders do business with.

Should Italy crumble, the contagion could spread from bank to bank. Not surprisingly, analysts are viewing the disclosure from the banks so far on their limited exposure to Italy with some degree of caution.

“The broader impact … is if you get sovereign default, or if you get a banking crisis. At that stage even if you don’t have any exposure, you inevitably have exposure to somebody that has exposure,” CIBC World Markets analyst Rob Sedran said.

“It’s not because I have bad counterparties, but I may have counterparties that may have bad counterparties.”

Even without direct exposure to an Italian default, concerns over slowing economic growth are a reality for the banks, since the impact can filter down and make an impact on their capital markets and lending divisions.

In the last banking crisis, TD had limited direct exposure to the structured credit crisis in the United States, but the bank’s operations were affected when the U.S. economy crumbled as a result, and lending began to slow.

Analysts are expecting more clarity from the banks on their European exposure in a few weeks. Already, the fourth quarter is being looked at as a bleak one for capital markets earnings, given the upheaval in Europe, which is expected to hit RBC in particular, given its larger exposure to the markets there.

Outside of sovereign debt, Canadian banks list other exposures to Italy, but the risks are harder to determine. RBC and TD, for example, also list small amounts of corporate debt exposure, but it’s not clear whether lending to Italian companies is a potential area of concern, particularly those that are in healthy shape.

Even though Scotiabank carries no exposure to Italian sovereign debt, the bank lists $1.3-billion of exposure to Italy’s banks through its large global precious metals trading and lending business. However, most of the business the bank does in that sector would be backed by collateral, such as gold, so analysts don’t consider it to be a particularly risky exposure in a crisis.

At this stage, fear of the unknown in the event of an Italian default is the biggest concern.

“The Canadian banks have run their books fairly cleanly from a counterparty risk perspective,” Mr. Sedran said. “The indirect risk, however, you cannot isolate, you cannot fence yourself off from.”

George25

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