Canadian Financials Landscape

Financial institutions are an extremely important component of corporate Canada. Financial institutions make up 20% of 25% of the market capitalization of the TSX. This does not consider the non-public entities that are active in the capital markets, with major issuers of debt including pension funds and government finance authorities.

Financials encompass banks (commercial and investment banks), insurance, asset managers, captive finance arms, leasing companies and credit unions (in Canada, only Desjardins is a significant player, with VanCity an extremely distant second).

Globally, financial institutions coverage for investment banking is large and sophisticated – however, in Canada the financial services industry is extremely concentrated across banking and insurance – with both banks and insurers also having a very strong share of wealth/asset management businesses. Banks are also involved in insurance and insurers are involved in lending.

Although banks have restrictions in marketing their insurance offerings via the Bank Act, the nature of the business is fundamentally the same as with insurers – currently BMO, RBC and TD have substantial insurance operations, although RBC Insurance is the largest by some measure.

Big 5 banks (RBC, TD, BNS, BMO, CIBC) dominate lending (especially mortgage lending), with Canadian Western Bank having some regional presence in the West and Desjardins (a credit union), National Bank and Laurentian having some share in the East.

Life insurance is dominated by a Big 3 in Great-West Life (controlled by Power Financial [TSE:PWF] , which is in turn controlled by the Desmarais family’s Power Corporation – although they take on a hands-off approach), Manulife [TSE:MFC] and Sun Life Financial. Property & Casualty insurance is more fragmented, with prominent Canadian domiciled names including Intact Financial [TSE:IFC] and Fairfax Financial [TSE:FFH].

What is a Typical Financial Institution?

A very simplified way of looking at banks and insurers is to consider them to be intermediaries or middlemen in terms of risk pooling to mitigate loss. When an entity deposits money at a bank, the deposit earns interest in a savings account. When an entity borrows money from the bank, interest must be paid on the loan. Why can the bank not be cut out of this relationship?

The amount deposited and the amount borrowed are rarely the same, nor do entities want to have the exposure to default by the borrower. Also, the timing of when the borrower wants to repay or when the lender wants to withdraw will differ.

With a bank, all of these factors are pooled together – if the average borrower defaults 1% of the time, spread over thousands of borrowers the bank will still get 99% of the principal back from every loan (before considering collateral). A bank makes money by capturing the spread between what it pays its lenders (depositors) and what it collects from its borrowers.

Financial Institutions Group – FIG Investment Banking

The Financial Institutions Group is one of the largest and most prestigious groups in investment banking globally, but not in Canada. Globally, the business done is some of the most sophisticated and lucrative, as financial institutions have a very good understanding of capital, require large amounts of capital raises and will take views on capital because capital is an inherent part of their business (as opposed to a normal corporate such as an oil and gas company where the oil and gas assets are the operating assets).

In the US, financial institutions is an extremely fragmented sector and the Big 4 banks (JP Morgan Chase, Bank of America, Wells Fargo and Citi) do not bank a majority of the population. As investment banks themselves are financial institutions that look to acquire, sometimes the corporate development function (internal mergers & acquisitions division) and the financial institutions investment banking group are fused or at least work very closely together – a large advantage for major banks and an easy way to give themselves league table credit.

Competition is fierce and there are banking options from credit unions, regional banks, thrifts, alternative lenders, fintech (Venmo, Alipay, Lending Club) and other financials.

Given that the product is undifferentiated and have a lot of redundant costs (head office, IT), banking in the USA is always a good option for consolidation via mergers & acquisitions.

Banks will also issue large amounts of debt, equity and preferred shares, as well as hybrid instruments that have debt and equity components. These can become very esoteric, ranging from contingent capital convertibles (CoCos) to mandatory convertible preferred shares. Capital ratios are key measures for banks and as such, capital issued will have flexible measures to ensure banks are in line.

Debt is not limited to bonds, but companies such as State Street will regularly purchase shares of corporate loans and give investment banks a lot of asset-liability management business. Mortgages and other loans are frequently securitized and sold by banks to institutional investors looking for yield while freeing up capital for investment or distributions by smaller financials.

Likewise, both Life Insurance and P&C are also extremely fragmented, with giants such as MetLife or Travelers holding a far smaller market share compared to the Canadians in their home market.

Financials engage in trading on a very regular basis and in addition to hedging may use derivatives as speculative instruments. While it is extremely rare for a corporate to use exotic options such as barriers, financials will take views often if they feel that they can reasonable shave off basis points in lending.

Financial Institutions Group in Canada

In Canada, financials are extremely concentrated due to the protectionist and heavily regulated nature of the market. The Big 5 banks dominate all lending and deposits and cross-sell insurance and mutual funds. The Big 5 banks indirectly are the largest asset managers in Canada as well.

Similarly, for insurers, the Canadian Big 3 (Manulife, Sun Life, and Power Financial via Great-West Life) dominate the life insurance market while P&C continues to become more concentrated led by Intact Financial.

As such, there is almost no investment banking business from banks as the investment banking arm of any bank will handle the majority of any bond issuance or preferred share raise while naming themselves bookrunner for league table credit.

Also, Big 5 Canadian banks do not like to issue common equity as their investor base is primarily yield seeking retail investors who do not want to see any sort of dilution. The smaller banks and credit unions are far too small to offer business comparable to industries such as mining and energy, but will tend to generate some capital markets business with Big 5 banks (swaps, securitization).

The insurers offer limited capital markets business as there are only three big clients with strong internal corporate development (corporate finance) teams. Also, given their size, they often are clients of Bulge Bracket banks in New York as well. However, from time to time they require M&A advisory and also are large debt and preferred share issuers.

The pension funds such as the Canadian Pension Plan Investment Board and the Ontario Teachers Pension Plan are massive financial institutions in Canada and a huge source of capital markets trading revenue as well as DCM. However, they do not issue equity and are in good position to demand very tight pricing from the banks. Any portfolio investments in private equity or infrastructure are covered not by the Financial Institutions Group, but a Financial Sponsors or respective industry group as well as the mergers and acquisitions team.

Canadian Asset Management Industry

Canadians are less sophisticated with their approach to asset management vs retail US investors and will tend to purchase mutual funds – this market is dominated by the Big 5 banks, all who have large wealth management operations.

Generally, having a chequing account with TD usually means that once assets are large enough, an individual will speak with the Financial Services Representative and purchase a TD Balanced Fund. Higher net worth customers will be given access to more personalized wealth management options (which are rarely better until they are at the ultra high net worth segment – which may be more of a function of the UHNW customer having a better understanding of investing).

Beyond the banks, lifecos (Sun Life and Manulife) sell a basket of mutual funds, usually through third-party contractors. These funds may be tied into their other insurance products including policies and annuities. Investors Group is owned indirectly by Power Financial.

A number of independent asset managers exist in Canada – including Mawer, AGF Investments, and CI Financial that serve retail clients. A large number of firms serve high net worth individuals, including Gluskin Sheff and various hedge funds operating in Canada.

Demographic changes (Millenials) have resulted in increased scrutiny of holdings and a shift towards index (S&P, TSX, NASDAQ) and sector (technology, banks) ETFs – there is less home bias for Millennial investors and a desire to know which firms have a record of alpha generation. Due to this, Blackrock, Vanguard, Invesco and Fidelity have done well and are likely to grow their footprint in Canada.

Asset Managers in Canada

• 1832 asset management
• AGF
• Black Creek Investment Management
• BMO Global Asset Management
• CM Investment Management
• CI Financial
• Canadian Pension Plan
• Edgepoint Wealth Management
• Fiera Capital
• Gluskin Sheff
• Guardian Capital
• HGC Investment Management
• iA Clarington
• Jarislowsky Fraser
• Mackenzie Investments
• Manulife Asset Management
• Mawer Investment Management
• OMERS
• Polar Asset Management Partners
• RBC Global Asset Management
• TD Asset Management
• Dynamic Funds

Asset Managers in Vancouver

• BCIMC
• CCL
• Deans Knight
• Leith Wheeler
• PH&N