The Big Short's Steve Eisman doubles down on Canadian bank short call

staying with Canadian banks as we know Steve Eisman made famous in the film the big short by betting billions against the US housing market prior to the financial crisis in 2008 joined us two months ago with his thesis on why he is shorting Canadian banks well he is back with us now for an update following the second quarter reporting season Steve Eisman is a portfolio manager at Neuberger Berman Steve good to be able to catch up with you again today thank you for your time and let me get your review what did you think of the second quarter results I thought that the earnings quality of the Canadian banks was exceptionally poor among the poorest I've seen in many many years so we're gonna go through those details why where does that lead you though in your short conviction I've been adding to positions I mean I would say that when we spoke about two two and a half months ago my conviction level on the idea was about a seven and after looking at the Canadian banks reporting season I'm think I'm like more I'd like a nine and nine out of ten in your connection I'm not right like look right nine out of ten you were seven out of ten I'm not nine out of twenty nine out of ten right got it let's go through the details you see that the earnings quality of the Canadian banks is essentially the poorest you've seen in a very long time what specifically stood out well first of all I think I said on the show about two months ago that the risk in the short was fairly low because I expected very little revenue growth among the Canadian banks and that was pretty much true across the board what I was surprised at was you know it's very hard to predict when a credit cycle begins what's gonna go bad first I think everybody including myself anticipated that housing would go bad first and it turns out that it's not housing that's going bad first its commercial credits that's going bad first and the results in terms of bad credit formation during the corridor were actually exceptionally poor so you know one thing that you look at when you look when you look at changes and credit is how much did impaired loans go up during the quarter and for three of the banks this is to pick on three CIBC Royal Bank of Canada and the growth in impaired loans was actually quite high CIBC for example was up about 24% but that's total impaired loans commercial impaired loans at CIBC were up seventy-seven percent year-over-year which is a quite a large increase and so well you I think there's no question that the word the beginning stages of a credit cycle in Canada how severe that credit cycle will be I don't know yet and I am not predicting by any stretch of the imagination Armageddon my only prediction is that we're getting a normalization and so at this stage in the credit cycle what you should be seeing is increasing levels of reserves that increase faster than impaired loans because essentially what you want to do is build money for a rainy day and you did not see that at all and the Canadian banks in fact what you saw was reserves were basically flat so impaired loans up significantly reserves flat which means that the allowance divided by an impaired loans deteriorate in almost every case for the Canadian banks and that's what I call poor priority quality poor earnings probably right but give us a sense going back to your initial conversation with us the thesis with respect to the the different ways to categorize loans and the Balkans in essentially stage one ninety percent of the the bank's loans are in stage one and and you were concerned that they weren't accurately depicting the potential for credit losses where did that I think were beyond I think we're actually beyond that now because stage one is just loans that are current and you're just making a total guesstimate as to how many of those loans will go bad this what happened this quarter I think is much more important if this is no longer theoretical this is very large increases in actual impaired loans for which you're supposed to be reserving for really reserving for and the Canadian banks are not so we're passed theory now we're an actual fact I mean we've got the chart that you pointed out to me and this is in CIB sees quarterly reports to their shareholders we can bring up this chart which you already indicated that the impaired loans on the commercial side of the business for CIBC are up seventy-seven percent year-over-year so you're saying we're already seeing some of the some of the declines real declines that are actually being impacted on the banks balance sheets yeah I mean look a seventy seven percent increase obviously from very low levels but at a seventy seven percent year-over-year increase and I believe forget to look at my paper for one second a thirty percent increase in commercial impaired loans in just three months is it indicator that there's deterioration like I said it's not calamitous but conservative banking principles should dictate that you should be building your reserves now for a rainy day and I I don't understand why these banks aren't doing that and I don't understand why the bank regulators in Canada are forcing them to do it so what do you think exactly should be the right move by the Canadian bank regulators what what could or should they be doing or what kind of conversations should they be having right now according to you they should be having serious conversations with the banks about what's going on in the deterioration and commercial credit and they should be in my opinion ordering them to increase reserves beyond the growth and impaired loans so that when the losses actually start to show up on the on these type of loans the Canadian banks would then sail seamlessly through it now they'd be having lower levels of earnings and they currently have but on the other side as the credit cycle actually hits their earnings would be higher it's called counter cyclical earnings management now the Canadian banks wants to be don't seem to be doing that but that's what's prudent in my view for bank management's if in fact they started to do this Steve what kind of earnings deterioration would you actually see in terms of earnings growth what would I'm sure you've modeled this out because the stock price has gone up yeah what does it look like so if you do a very simple exercise and take the allowance the mole loss reserves and / the impaired loans what you should be hoping for is for that ratio currently to go up and instead the ratio is going down so with respect to Bank of Montreal raw Bank of Canada at CIBC if we just held the ratio constant versus the first quarter earnings would in the second quarter would have been lower by anywhere from eight to fourteen percent now if they had done with this of what I think they're supposed to do is actually increase the ratio then the earnings would have been down by even more and that's what should be happening and when we spoke last time Steve part of the issue is it's up to the banks in many ways to decide how they want to reserve for for loan losses so there's a timing impact work for you in many ways going short because we talked about this before for anyone who's new joining us there's a cost to borrow and a cost to carry when you have a short position you're a little bit at the mercy of the bank CEOs timing well I'd look at some point you can't play these games forever if you continue to see more deterioration then at some point you know having this allowance / impaired loan ratios deteriorates it's going to start to look ridiculous it's already starting to look silly in my view but we're I think we're on the edge where they're not going to be able to manage earnings anymore like this Steve is there I mean I know you're focused on the comedy specific stories and and and looking at the bank balance sheets and what's going on and how they're reserving etc but my I suppose when you take a look at the commercial loan losses the impaired losses that we just cited we have to kind of wonder a little bit why is that happening what is going on in the Canadian economy that is allowing or causing that to happen if in fact we get some go ahead I think it's like that's a very very difficult question to answer I think look I think the Canadian economy is structurally not as strong as it used to be partially because Canada's we all know is a very commodity oriented economy and oil production cheaper in the United States so the oil industry in Canada from point to point I think is structurally weaker and you're just trying to see this roll through the commercial loan books in Canada just a gradual weakening like I said at the beginning it's not a calamity it's what you're gonna get is a normal credit cycle but as far as I can tell the Canadian bank management is just very ill prepared for that so I'm curious do you ever speak to the Canadian bank management when we've had them on our network your call got a lot of attention across the board with portfolio managers as well as annals let's start with that group first and and the the call was universally dismissed you would say what - those portfolio managers and analysts who own some of these banks that you you're sure it was actually I was this it was dismissed incredibly dismissively in fact I thought the funniest comment of all was one of the bank analysts I think literally the day after we spoke said I really laughed this was very funny he said that that the probability of my being right was so low that it was more likely that the Roth at the Toronto Maple Leafs would win the Stanley Cup and I have to say I have so much more confidence in my theory that I'm feeling pretty good about those Maple Leafs this coming season I understood well they've got they got some time to practice apparently so we'll wait for that but but what would you say to the what but in all seriousness because these portfolio managers as well managed money for four individuals watching are watching our network you you would say what to the individual what I would say is the hardest thing in the world this is one of the lessons of the financial crisis is to have lived through a certain kind of paradigm for a very very long period of time and then to realize that that paradigm is changing and the paradigm that has existed in Canada for almost 30 years is superior credit quality all the time and when you live with that for pretty much your entire career it becomes almost imaginable unimaginable that things could be different and people react very very slowly to that especially when you know credit doesn't implode overnight it takes time sometimes it's it's something that happens in slow motion and when you live in it and it's a particular paradigm it's very hard to change when what what the change of this happening is slow mm-hmm so are you seeing then this will continue to play out almost like a slow bleed we talked about that last time and or the catalyst is is what I mean the catalyst is again you get an increasing formation on the commercial side and then I think at some point and our soul don't know when that is but I think it could be soon you're going to get start to see formation on the residential side and the combination is going to mean that the ability to manage ironing is that the Canadian banks will become impossible so that's interesting Steve because last time when we spoke you weren't so concerned about the Canadian housing market and it's interesting that what we did see in this current quarter that it was the commercial loans that really started to show up deteriorating first and apparently you can't really tell which ones gonna happen first but they happen and now you sounds like you're expecting the the housing market to follow at some point I mean I'm not gonna make a prediction on what quarter I think with any within a year that's gonna happen okay so you're gonna get a combination of a commercial cycle and a residential cycle what was your advice and and and comment towards the Canadian bank CEOs be today well versal we don't talk you don't tell not like it's not like this the Canadian see bank CEOs and I have ever had any real relationship you know they said they think what they think and I think what I think and we'll see who's right but we don't we don't speak together why are they so wrong they've been working hard to diversify their business models to be more international to be focused on wealth management the list goes on why wouldn't that be the right model I'm not saying it's not the right model I like I said I'm not I'm not predicting some calamity and in Canada that's gonna obliterate the bangs I'm not predicting that at all I am simply predicting a normalization of credit losses which the evidence right now is I think pretty overwhelming is happening as we speak and Steve when we take a look at the stock price performance what's your thought in terms of how you've been performing on this call you know the bet the Canadian banks are up they're not a very much certainly not compared to u.s. banks they're better than the European banks generally speaking that's and like I said I think the risk in the trade is fairly low because the Canadian economy is is certainly at the least we could say is that it's sluggish and so revenue growth in the Canadian banks is going to be very tepid weak weak that's going to continue I believe when you look at the timing of this again I go back I go back a little bit to the timing of this in terms of whether or not this when and and if this will play out to the to your call what do you what do you expect in terms of how the bank management's are going to react to really try to protect themselves on this call I mean I think you know given the history they're gonna probably continue to do what they've been doing which is manage the reserves to protect their earnings until the credit deterioration is such that that becomes impossible that's what Bank management's and I'm not picking on Canada that's what Bank management's do all over the world Stephen we spoke last time it seems as though where are these stocks go from this current level it sounded like it was more than 20% you're you're looking for a greater than 20% downside that was one we spoke love to try and you love to try and pin me down a little bit a little bit but here's the question that's what you said last time just reminding our viewers but my question is with what you saw in the second quarter results given the fact that you know our original conversation was about the the loan loss provisions we talked about the the the capital concerns that you had and that prices follow capitals capital ratios decline and now you're bringing up these impaired losses we got new news on that this quarter so my question is are you expecting an even greater decline don't want to answer that question how's that I I have the same thief all I would say is I have the same thesis that I've had I just think that the results of the second quarter give me greater conviction in that thesis that's all I want a second okay and to wrap it up as to where we started you you've been adding to your positions on that greater conviction I've been adding but not tremendously but I'm adding a little bit to the on to the position that would be an accurate thing okay to the positions royal you said this before royal Laurentian and CIBC that's amongst three of the positions that I have I have a few others as well okay did the second quarter cause you to put on some new positions new names no I haven't put any position any I haven't put on any new positions on no new names all right it's not since we spoke okay since last last two months ago great so nothing on the second quarter that caused you to add on another name call let's let's talk next quarter will have a different company we'll have a different conversation okay Steve we'll leave it there I appreciate your time we appreciate time as always

Channel: BNN Bloomberg

Views: 105,082

Rating: 4.8610039 out of 5

Keywords: Steve Eisman, Canadian banks, Big Short, short, finances, Wall Street, Bay Street

Id: OkfpTEVIcM8

Length: 16min 46sec (1006 seconds)

Published: Tue Jun 04 2019