Friday, July 18, 2008

Merrill Lynch Economists Prognosticate the Direction of S&P/TSX Financials Index

Reuters, Lynne Olver, 18 July 2008

The huge recovery posted by Canadian financial stocks this week is actually a bad sign for the sector, as bear markets bring big bounces, Merrill Lynch economists said on Friday.

The S&P/TSX Financials index, composed of 28 bank, insurance company and asset management stocks, fell sharply on Monday and again Tuesday, with the country's largest banks hitting 52-week lows on Tuesday.

But on Wednesday, the financials index bounced up a "shocking" 5.5 percent, followed by a 3.2 percent climb on Thursday, Merrill economists David Wolf and Carolyn Kwan said in a weekly research note.

On Friday, the index gained an additional 1 percent.

Before this week, there had been only five days since 1988 when the S&P/TSX financials index was up more than 5 percent -- and four of them came during the financial crisis of 1998, Wolf and Kwan noted. The other was during the "Enron-inspired credit swoon late in 2002."

"Overall, we remain of the view that there are further declines in store for the Canadian financials," the economists stated.

As for daily bounces of just 3 percent in the financials index, none came between 2003 and 2006, a period in which the index more than doubled.

"We've already had seven such 3 percent up days in 2008, on track to break the previous record high of 10 in 1998," the Merrill note said.

While the problems facing Canadian financial stocks have not been as grave as those pressuring U.S. banks, "the market action of recent weeks has reminded us of how interlinked the sector is globally, and the domestic banks have their own challenges on the way, in the form of a slowing Canadian consumer and a weaker Canadian housing market."

Illustrating the volatility this week, investors who managed to buy Canadian bank stocks right at their 52-week lows would have reaped substantial gains in just a few sessions.

For example, Canadian Imperial Bank of Commerce hit a low of C$48.70 a share on Tuesday, and closed on Friday at C$57.76, for a gain of nearly 19 percent.

Bank of Montreal rallied 22 percent from its Tuesday low of C$37.60 to its close this week at C$45.96.

Royal Bank of Canada bounced 13 percent from its Tuesday low to Friday's close of C$44.70.

Bank of Nova Scotia rallied 14 percent from its Tuesday low, while Toronto-Dominion Bank climbed 10 percent.

Despite the recent swings, the Big Five bank stocks remain down from 2007 year-end levels, with year-to-date losses ranging from nearly 5 percent to more than 18 percent.
Reuters, Lynne Olver, 15 July 2008

Fears about the state of the U.S. financial system and the outlook for the U.S. economy battered Canadian bank stocks for a second day on Tuesday, with most share prices at or near 52-week lows.

In the case of Canadian Imperial Bank of Commerce, its stock plumbed five-year lows.

One analyst said CIBC, Canada's fifth-largest bank, could take as much as $1.9 billion in additional credit market-related writedowns in the current quarter.

The broad themes dragging down the Canadian sector were worries about the U.S. financial system and the broader U.S. economy, tumbling U.S. bank stocks, and signs of deteriorating loans at some U.S. regional banks.

"The situation in the U.S. is at the heart of what's happening now, first because of the credit crunch but secondly the increasing concern that this is going to translate into a U.S. recession, with Canadian banks and Canada not being immune," said Michael Goldberg, an analyst at Desjardins Securities in Toronto.

"I've been saying that (Canadian bank stocks are) all undervalued, but they could get more undervalued before the situation improves."

Federal Reserve Chairman Ben Bernanke warned on Tuesday that a weakening housing market, tighter credit and rising oil prices threaten U.S. economic growth, while inflation risks have become more intense.

Many financial markets and institutions remain under "considerable stress," Bernanke told the Senate Banking Committee.

His comments seemed to ruffle investors already anxious about the U.S. financial sector after Friday's seizure by regulators of IndyMac Bancorp Inc, the weekend pledge of U.S. government support for mortgage finance companies Fannie Mae and Freddie Mac, and this week's plunge in U.S. bank shares.

On the Toronto Stock Exchange on Tuesday afternoon, Toronto-Dominion Bank was off 4.1% at $53.45, after falling as low as $53.05; Bank of Montreal was down 1.1% at $39.65 a share, after trading as low as $37.60; while Canadian Imperial Bank of Commerce was down 3.0% at $49.62, after touching $48.70 in morning trade -- a level last seen in May 2003.
The Globe and Mail, Tara Perkins, 15 July 2008

Jittery investors dragged Canadian bank stocks down yesterday, dealing the biggest punishment to those with the greatest exposure to the United States, where continued mortgage woes are raising fears about the health of regional banks.

The market is on the edge of its seat after IndyMac Bancorp Inc. collapsed last week in the second-largest bank failure in U.S. history.

"I think the market is really recognizing the deterioration that's happening in the credit environment," said Edward Jones analyst Craig Fehr. "It's a classic case of what we've been seeing now for some time, indiscriminate selling. The market just doesn't want to own anything that's exposed to this credit risk."

National Bank Financial analyst Robert Sedran said it seems "the Canadians are taking direction from the U.S. banks right now, and that direction is not a good one. We believe the fundamentals behind the Canadian banks are better, but that matters little right now."

Among Canada's big banks, Bank of Montreal and Toronto-Dominion Bank have the highest gross loan exposure to U.S. borrowers, Blackmont Capital analyst Brad Smith said in a note to clients. BMO's exposure is $51-billion, or 25 per cent of its consolidated loans outstanding, while TD's is $46-billion, or 23 per cent, he said.

Investors appeared to be taking this U.S. vulnerability into account, with Toronto-Dominion the biggest loser of the Big Five yesterday, dropping by 5.1 per cent to $55.74. It was the stock's lowest close since November, 2005,with 6.87 million, or 2.3 times the average daily trading volume of shares, changing hands.

Bank of Montreal shares also lost a lot of ground yesterday, falling by 4.2 per cent to $40.09 on higher-than-average trading volume. This was the stock's lowest close since March 17.

The other banks, however, held up just slightly better, and all had heavier-than-normal trading activity.

Bank of Nova Scotia sank by 3.6 per cent to $43.82, its lowest point since March 19. Royal Bank of Canada shed 3.4 per cent to $41.03, touching its lowest close since October, 2005. Canadian Imperial Bank of Commerce lost the least amount of ground on a percentage basis, down just over 2 per cent. However, it's end-of-session price of $51.15 was the stock's lowest close since June, 2003.

"Despite its well-established U.S. retail banking and wealth operations, Royal Bank of Canada has only modest loan exposure at $25-billion, or 10 per cent of consolidated loans outstanding," Mr. Smith wrote. Scotiabank and CIBC have the lowest exposures, at 6 per cent and 3 per cent, although CIBC actually has the highest relative exposure to U.S. credit if its large credit derivative portfolio is included.

Mr. Smith believes that both BMO and TD could see their 2009 earnings chopped by roughly 7 per cent as a result of U.S. personal and commercial banking loan exposures. However, he noted that "estimating the potential impact on earnings from identified credit exposures is fraught with hazard as ultimate losses reflect a combination of factors, including macroeconomic conditions and company-specific credit underwriting processes."

Genuity Capital Markets analyst Mario Mendonca said the issue with TD's shares appears to be weakness in the loan books of two northeastern U.S. regional banks. M&T Bank saw credit losses spike, while Webster warned of higher credit losses, Mr. Mendonca said. (TD Banknorth Inc. is based in Portland, Me.) "This has the market wondering if in fact TD's Northeast exposure is really that much better than other parts of the U.S.," he said.

Shane Jones, managing director of Canadian Equities at Scotia Cassels Investment Counsel Ltd., said some of the bank weakness might stem from hedge funds that are selling.

Yesterday's share price declines were a continuation of weakness that has plagued the sector recently, with Canadian banks stocks having fallen about 5 per cent last week, Mr. Smith said in his note.