Thursday, August 02, 2007

Banks' Losses from US Subprime Expected to be Manageable: DBRS

Reuters, 2 August 2007

U.S. and Canadian banks face limited exposure to subprime mortgage losses and future rating downgrades, bond rating company DBRS said on Thursday.

The U.S. mortgage market has been hit by rising delinquencies and defaults on subprime loans made to risky borrowers, setting off a wave of rating downgrades of related securities in July. Healthy earnings should insulate financial institutions, DBRS analysts said on a conference call.

"There has been a lot of over-reaction in the market," said Alan Reid, a DBRS managing director of U.S. financial institutions in New York. "We do not expect wholesale downgrades of banks with exposure to subprime."

The rating company has re-evaluated its views on some mortgage companies. DBRS on Thursday changed its view on IndyMac Bancorp Inc. , one of the largest independent U.S. mortgage providers, to stable from its previous positive rating trend.

DBRS also revised CIT Group Inc. , the commercial and consumer lender, to stable from positive on July 20. CIT said last month that it is exiting the mortgage business.

U.S. banks, including Citigroup Inc. , Wachovia Corp. and Bank of America Corp. , reported higher-than-expected quarterly earnings last month as their banking activity helped offset a decline in credit quality and concern about bad loans.

"The banks face some risks from subprime but the strength of their earnings will help them to ride that out," said Roger Lister, chief credit officer for U.S. financial institutions at DBRS. "The fundamentals are fairly strong."

Brenda Lum, who covers Canadian banks for DBRS, reiterated remarks made in a report on Wednesday that said Canada's five largest banks also face limited losses from their exposure to U.S. subprime loans.

"There are no credit rating implications for the five largest Canadian banks," Lum said. "There is minimal impact."
Financial Post, Grant Surridge, 1 August 2007

Canadian banks have limited exposure to the U.S. sub-prime mortgage market, according to a report released Wednesday by the Dominion Bond Rating Service.

“Though the big five banks do have exposure to the sector, their exposures do not affect their credit risk profiles sufficiently to impact credit ratings,” said report author Brenda Lum.

The report did not provide details of each bank’s exposure, or of the total exposure of the “big five” banks: Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and Toronto-Dominion Bank.

Canadian banks are exposed through their market making activities, securitization businesses and the financing of players in the U.S. subprime market.

While DBRS expects banks to make some writedowns, it said the magnitudes should be manageable relative to earnings and capital.

The deteriorating sub-prime mortgage market has dominated headlines, with some commentators estimating losses could total $100-billion.

“We felt it was necessary to have a comment out with respect to this particular subject,” said Ms. Lum

Some observers have suggested that even AAA-rated sub-prime debt instruments could see their ratings downgraded. Ms. Lum declined to comment on the implication for Canadian banks.
Investment Executive, James Langton, 1 August 2007

The big five Canadian banks have limited exposure to the subprime mortgage market, and are well positioned to weather the credit quality storm, says DBRS.

The rating agency says that while the subprime market in the United States has come under increasing pressure of late, it has concluded that there are no credit rating implications for the five largest Canadian banks. “Though the Big Five do have exposure to this sector, their exposures do not affect their credit risk profile sufficiently to impact current ratings,” it says.

As participants in the U.S. capital markets, some of the Canadian banks are exposed through their market making activities, securitization businesses and the financing of participants in the U.S. subprime market, DBRS says. As such, DBRS expects some losses, but they are expected to be manageable.

The outlook for the credit risk profile of the Canadian banking industry remains strong, DBRS adds. It anticipates the magnitude of losses and write-downs to be manageable relative to earnings and capital.

DBRS says it expects the Canadian banking industry to absorb the losses and maintain its current credit ratings, as a result of: strong pre-tax earnings, which is the first line of defence to absorb higher losses; and, being well capitalized. Regulatory capital levels are at historically high levels, and earnings are reasonably diversified at all the Big Five banks, it notes.

These factors give DBRS comfort that a significant cushion of earnings and capital are available to support further write-downs, barring any unforeseen negative economic events (i.e., a U.S. recession).

DBRS’s review of information provided by each of the banks indicates that the largest exposures to U.S. subprime mortgages are primarily in the Big Five’s capital markets businesses. “Their exposure, if any, is mainly in their securities books, either in inventory held for trading or investments and in providing liquidity lines to securitization vehicles which may have some exposure to U.S. subprime mortgage lending,” it explains. “There are also modest amounts of exposure in some banking books, such as lending to subprime borrowers or to U.S. subprime mortgage lenders.”

With the deterioration of the ratings of many U.S. subprime RMBS programs, DBRS expects that some of the Big Five may need to write down a portion of the carrying value of RMBS and CDO securities that are exposed to U.S. subprime mortgages. Market conditions are expected to deteriorate further in the near term, resulting in additional losses, it points out.

DBRS expects minimal impact on the Canadian banks from higher default rates in the Canadian subprime mortgage market. The Big Five are not active direct lenders in the subprime market, given their conservative underwriting, the small size of the Canadian market and high administration requirements, as these mortgages are more labour-intensive than prime mortgage loans, it says.

The Canadian subprime market is growing, DBRS allows, but there are fundamental differences between the Canadian and U.S. Markets, it finds. “Given the lack of data on the Canadian subprime market, the only comparable default rates were 2.35% (over 90 days in arrears) in Canadian subprime as of October 31, 2006, compared with U.S. subprime adjustable rate mortgage loans past due, which were 14.03%, and subprime fixed rate mortgage loans past due, which were 9.96% for the month of October 2006,” it suggests.

According to more recent data from the U.S. Mortgage Bankers Association (March 2007), U.S. subprime adjustable rate mortgage loans past due were 16.22% and subprime fixed rate mortgage loans past due were 10.21%.

The better performance of the market in Canada is likely due to: the slow adoption of subprime mortgage products in Canada; more conservative application review; limited underwriting of low quality subprime products within the market; and, a lack of mortgage-interest deductibility, DBRS says. “At the same time, the role of mortgage brokers in the U.S. capital markets combined with low interest rates and house price increases appear to have been the key drivers for rapid growth in the U.S. subprime market,” it adds.
Bloomberg, 1 August 2007

Bank of Montreal and Canadian Imperial Bank of Commerce led Canadian bank stocks lower, adding to their biggest two-month decline in five years, on concern that turmoil in the credit markets will erode earnings.

The Standard & Poor's/TSX Banks Index fell 1.2 percent, the seventh decline in eight days. The index of nine Canadian lenders plunged 7.6 percent in June and July, the steepest drop since the summer of 2002.

Reduced demand for corporate credit may cut underwriting fees for lenders such as Royal Bank of Canada, analysts and investors said. The banks may also be forced to write down the value of their mortgage-backed securities in the U.S. as defaults among subprime borrowers reach a 10-year high.

``This subprime thing has got everybody really nervous,'' said John Kinsey, who helps manage $900 million at Caldwell Securities Ltd. in Toronto, including bank stocks. ``People are saying `what if?', but so far the banks haven't made any disclosures, and nobody's warned about the earnings.''

RBC Capital Markets analyst Andre Philippe-Hardy today lowered his price targets and 2008 earnings estimates for five of the six largest banks, citing concerns about capital markets fees. The Canadian banks are scheduled to report fiscal third- quarter results at the end of this month.

Hardy said investment banking earnings will fall 3 percent on average next year because of slower revenue growth and rising loan losses. That compares with a 15 percent increase in 2006 and an estimated 10 percent gain this year.

``Fixed-income trading, debt and equity underwriting, M&A, bridge financing and asset management could all suffer,'' Hardy wrote in a note to investors today.

Shares of Bank of Montreal, the fourth-biggest lender, fell C$1.45, or 2.2 percent, to C$65.14 at 4:10 p.m. in trading on the Toronto Stock Exchange. Bank of Nova Scotia, the No. 2 bank by assets, fell 65 cents, or 1.3 percent, to C$48.80. Canadian Imperial Bank of Commerce fell 2.2 percent to C$90.47, and has dropped 12 percent since May 31.

Analysts and investors are concerned about the banks' holdings of U.S. subprime loans, which are souring at the fastest pace since 2002, according to the U.S. Mortgage Bankers Association.

Canadian banks have ``limited'' ties to the U.S. housing market by holding mortgage-backed securities, which could lead to writedowns or losses, according to Dominion Bond Rating Service. Among Canadian lenders, Royal Bank, Canadian Imperial, and Bank of Montreal have the largest capital markets businesses in the U.S.

CIBC, the fifth-largest bank, may record a writedown of as much as C$100 million ($94.2 million) in the third quarter to reflect the reduced value of its investments tied to subprime housing, Hardy wrote last month.

``We believe the markdown at CIBC could exceed our previously estimated range given the continued rapid deterioration,'' in asset prices, he wrote today.

The Toronto-based bank has investments in mortgage-backed securities including collateralized debt obligations, which package mortgage bonds into new securities. New York-based newsletter Grant's Interest Rate Observer reported in June that CIBC may have as much as $2.6 billion in such investments.

CIBC said in a July 10 statement its ``unhedged exposure'' is well below that amount. CIBC spokesman Rob McLeod declined to comment today.

Royal Bank said on May 25 it had a ``small net trading loss'' in the second quarter related to weakness in the U.S. subprime market.

The Canadian subprime market, while growing, has a lower default rate than in the U.S., Dominion Bond Rating Service said in a note today. Canada has been slower to adopt subprime mortgages, and borrowers can't deduct mortgage interest payments from their taxes, the ratings agency said.

Another concern among investors is that companies such as CanWest Global Communications Corp. have scrapped high-yield bond sales, forcing banks to take more risk in leveraged buyouts. U.S. banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc. failed to sell $20 billion of loans last week to finance the buyouts of Alliance Boots Plc and Chrysler by Kohlberg Kravis Roberts & Co. and Cerberus Capital Management.

Toronto-Dominion Bank said it will provide C$3.8 billion in financing for the proposed C$34.2 billion takeover of BCE Inc., Canada's largest phone company. Toronto-Dominion plans to distribute the debt and equity to other lenders and investors.

Toronto-Dominion spokesman Simon Townsend declined to elaborate on the bank's financing for BCE.

``People in general are skeptical towards all the banks,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages about $4.2 billion, including bank stocks. ``They're a little uncertain exactly how this whole credit spread widening is going to affect any one of them."