ROSS LAVER November 26 1990



ROSS LAVER November 26 1990




Like most of Canada’s powerful banking executives, Cedric Ritchie guards his privacy. Quiet but hard-nosed and autocratic, the 63-year-old chairman and chief executive officer of the Bank of Nova Scotia rarely poses for photographs, grants few interviews and almost never appears on television. Most of the time he prefers to let other senior Scotiabank executives speak on the bank’s behalf. Lately, however, the publicityshy Ritchie has shown an uncharacteristic willingness to speak out about the operations of the country’s third-largest chartered bank. His aim, he says, is to quell speculation in financial circles that the bank’s performance is suffering because of its heavy exposure to the slumping U.S. real estate market and high-risk loans used to finance corporate takeovers. “There is a perception by certain analysts on the street that we are overexposed,” Ritchie told Maclean’slast week. He added, “I personally don’t think the market gives us enough credit.” Ritchie has ample reason to be concerned about his bank’s image. Among investors, a financial institution’s strength is usually measured by its capital ratio—in other words, the amount of money it has on hand as a proportion of the money owed to it by borrowers. But perhaps a bank’s most valuable asset is one that does not appear on any balance sheet: the confidence of investors and depositors in its ability to weather the unexpected, and sometimes brutal, consequences of an economic slowdown. And on that score, some of Bay Street’s most influential analysts are voicing concerns.

Although Ritchie himself has a strong track record for rescuing troubled loans, they argue that Scotiabank’s portfolio of high-risk loans leaves it more vulnerable than the other five large Canadian banks to the potentially damaging effects of a deep and prolonged recession. Said Kersi Doodha, a banking specialist with Maison Placements

Canada Inc., a brokerage firm in Toronto: “The value of the collateral which was Ritchie’s cushion in the past is not there. They are skating on thin ice.”

Despite that harsh assessment, Bay Street stock analysts are quick to point out that Scotiabank’s profit and loan picture remains strong by international standards. And no one in the industry is predicting a run on the Bank of Nova Scotia by large commercial depositors, as happened in 1985 to the Continental Bank of Canada, which was later swallowed up by Lloyds Bank Canada. Above all, banking specialists say that Scotiabank’s problems are far less severe than those currently plaguing banks in the United States. Caught off guard by the collapsing real estate market, U.S. banks are writing off an estimated $23 billion a year in mortgages and other loans. The wave of losses has forced widespread layoffs at major commercial banks in New York City, while driving some regional institutions—including Bank of New England and Maryland National—to the brink of collapse.

As the recession tightens its grip across most of North America, the number of problem loans is rising in Canada, too. Currently, about

1.5 per cent of the Big Six banks’ loans are

classified as non-performing—which generally means that the borrower has fallen at least 90 days behind in his payments. Based on estimates of the number of new delinquent loans in 1991, that figure will probably rise next year to 1.7 per cent. But even that is far below the 4.5per-cent rate for non-performing loans during the 1982 recession. At a time when the economy is in a tailspin, Canadian banks have a number of advantages over their counterparts south of the border. Unlike the major U.S. banks, Canadian banks have large retail-branch networks, which generate a steady stream of income and provide a stable source of funds for lending. Most smaller U.S. banks, which can accept deposits, are prevented by federal law from operating in more than one state. That means that when property prices in any one area of the country start to fall, the impact on banks in that region is especially severe. By contrast, Canada’s major banks are spread out across the country. In today’s circumstances, with property values and economic output generally weak in Central and Eastern Canada, but stronger in the West, that is a distinct advantage. Measured against its domestic competitors, however, the Bank of Nova Scotia is clearly facing tough times. The bank’s stock has plunged 37 per cent from its peak in the last year, closing last Friday at $11.38. That com-

pares with an average decline of 26 per cent for the shares of the other large five banks.

Ironically, the problems at Scotiabank are largely a result of the bank’s past successes in penetrating the U.S. market. Currently, U.S. borrowers owe the bank about $14.5 billion. That includes $3.2 billion in real estate loans and $2.5 billion in loans for so-called highly leveraged transactions (HLTs), in which corporations finance takeovers by taking on a large amount of debt. In total, says analyst Doodha, Scotiabank has $11.7 billion tied up in these and other loans that carry an abnormally high level of risk. That compares with Doodha’s estimates of $7.4 billion for the Royal Bank of Canada, $7.1 billion for the Toronto-Dominion Bank, $6.7 billion for the Canadian Imperial Bank of Commerce, $6.5 billion for the Bank of

Montreal and $3.2 billion for the National

Bank. Declares Hugh Brown, an influential bank analyst with Burns Fry Ltd. of Toronto: “Quite simply, we are in an environment where loans with above-average risk are a concern. And Scotiabank has a greater number of those loans than its Canadian peers.”

Like its competitors, Scotiabank declines to disclose the identity of its borrowers or how much each owes—although the information becomes public if a borrower goes into receivership. But one analyst who asked not to be named said that the bank ran into problems when it helped to finance construction of a major new shopping mall outside Cincinnati. The mail’s owner is Atlanta-based L.J. Hooker Co., which also controlled the Bonwit Teller and B. Altman & Co. Ltd. department store

chains before being forced to sell them last spring. In August, 1989, the company sought bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code.

According to Brown, Scotiabank also helped to finance Australian entrepreneur Alan Bond’s $1.5-billion takeover of G. Heileman Brewing Co., of Lacrosse, Wis. Since then, Heileman has had difficulty competing with larger, more efficient brewers in Canada and the United States. Said Brown: “Believe me, it is quite a troubled situation. There may be some chance of loss.” Indeed, Doodha said that the bank has already written off as much as $62 million of the $150 mil-

lion it lent to Bond. But even that amount may be insufficient, he added. “Some banks have written off almost 100 per cent of their loans [to Heileman]. Ritchie has not.” Scotiabank also has several large loans in Canada that appear to be in trouble. Analysts say that debt-laden Campeau Corp. of Toronto owes the bank about $200 million—debt that is secured by mortgages on the bank’s 68-storey headquarters in Toronto, as well as Montreal’s Blue Bonnets racetrack and other properties. In addition, the bank is owed an estimated $300 million by Markham, Ont.-based Magna International Ltd., a financially troubled automotive parts company owned by Frank Stronach, and $29.1 million by Clarus Corp. of Brantford, Ont., a carpet maker that is close to receivership. Scotiabank also had an outstanding

$2.5-million loan to Creeds

Ltd., a high-fashion Toronto clothing store that last week filed for voluntary bankruptcy.

For his part, Brown says that Scotiabank share prices have been driven down partly because of nervousness on the part of U.S. investors. He added: “In the United States, there is a hunt on for the banks. People are scared. They look at the ratios for Scotiabank and get concerned.” One key ratio is the extent to which a bank’s capital base—including cash, bonds and reserves—covers its loans for highrisk HLTs. Scotiabank’s HLT loans are equal to 114 per cent of the bank’s capital, Brown said. That compares with 20 per cent for the Royal Bank and 39 per cent for the Commerce.

As bad as those numbers may appear, Ritchie insists that the bank’s critics are exagger-

ating its problems. “Certainly the law of averages suggests that you’re going to take a certain percentage of loss," he said over a coffee in his plush, sixth-floor office in Toronto's Scotia Plaza. “But we are in the risk business.” Ritchie added that some investors have mistakenly confused the bank’s HLT loans with so-called junk bonds, the high-risk, highyield certificates that were used to finance some large corporate takeovers. “You get ups and downs, but we are very comfortable with our portfolio.”

Indeed, Scotiabank executives frequently complain that their lending practices are misunderstood by outsiders. A case in point, says chief financial officer Robert Chisholm, is the bank’s $3.8 billion in loans to developing countries—known in bankers’ jargon as LDCs— two-thirds of which have already been written off. “People are saying that every LDC is a dog,” Chisholm added. “They aren’t. It’s true that not every one is a gem, but it’s not nearly as negative as people say.” As for the bank’s U.S. real estate exposure, Chisholm says: “Obviously, we are not walking on water here. We

are concerned that the market is fragile. But we’ve been careful to spread our portfolio over many cities.”

Beyond trying to calm jittery investors, Ritchie says that he has no plans to alter the bank’s operations. Among other things, he says, Scotiabank will open another 50 or 60 branches this year, bringing its cross-country total to more than 1,200. It will also double the number of its automated banking machines to 880.

But despite the fact that Ritchie is within two years of the normal retirement age, he declines comment on the identity of his likely successor.

Some analysts speculate that the bank’s succession plans were disrupted earlier this month when vice-chairman Lynton (Red) Wilson, 50, left to become president and chief operating officer of telecommunications and financial services giant BCE Inc. “We’re trying to run a business here, not to psychoanalyse what other people are writing about us,” Ritchie says. Clearly, though, the criticism from the outside has struck a nerve.