CommunityLend blog

The Canadian government continues to pressure banks  to ensure they keep consumer lending going.  The negative headlines from the US relative to credit certainly flow over into Canada and levels of Canadian consumer confidence.

Canadians voice concerns over access to credit, Flaherty says | Globe and Mail

TORONTO — Finance Minister Jim Flaherty says consumers across the country are worried about access to credit.

“We are hearing across Canada concerns about access to credit,” Mr. Flaherty said Tuesday. “It is a major issue going into 2009.”

The finance minister said in Toronto he will be talking to the country’s major banks and working to ensure there is affordable and accessible lending.

In a coordinated move the Governor of the Bank of Canada (Carney) and the Federal Finance Minister (Flaherty) have come out using identical wording “It is not clear to me that they need additional capital buffers,” and insist that the banks turn lending back on, particularly for businesses who are having difficult finding access to lending from the Banks.

Flahery warns Banks on lending | Globe and Mail

“It is not clear to me that they need additional capital buffers,” he said of the banks during a meeting with the editorial board of The Globe and Mail. “What is clear to me is that there is unfilled demand for credit for worthy investments, and I’m sure that our banks will see these opportunities in the fullness of time.”

The federal government is buying $75-billion of mortgage securities from banks to help them expand their balance sheets and pledged to backstop their sales of wholesale debt. The central bank is offering billions more through short-term loans to financial institutions hurt by the credit crisis.

Mr. Flaherty made clear he doesn’t think the banks are showing enough gratitude.

and yesterday:

Carney to banks: Lend, don’t hoard | Globe and Mail

TORONTO — Mark Carney is pointing a finger at the country’s big banks for hoarding capital against a rainy day instead of doling out more loans, a choice the Governor of the Bank of Canada says is damaging the economy.

…

Worries about companies’ struggles to get loans emerged as one of the biggest risks to the economy at a meeting between Finance Minister Jim Flaherty and his provincial counterparts yesterday in Saskatoon.

This introduces a dilemna for the Governent that was well stated by the famous economist J.M. Keynes nearly 90 years ago.

The Paradox of Thrift | Economics Professor

Paradox of thrift was revised by English economist John Maynard Keynes (1883-1946) in the 1930s, who asserted that thrift is virtuous only up to a point. If an individual increases the proportion of income he saves, his reduced expenditure on goods will lower total demand in the economy.

Simply put, when peoples confidence is unsettled their natural reaction is to batten down the hatches,  save, pay off debts and prepare for the future.  In turn this reduces the size of the economy and reduces value for everyone.  It becomes a vicious spiral.   It is interesting that the communication effort to Banks is focussed on helping businesses, presumably because business confidence is a necessary precursor to consumer confidence returning.

GDP is made up of spending by 1. Business, 2. Consumer, and 3. Government plus 4. net exports.  The thinnking of the government is that with confidence for 2. being in the ditch, they must do all they can to avert 1. (business) confidence dropping so much.

All this coming at the time when banks consider they need to re-capitalise in order to save for future loan losses including the likes of the Maddoff affair coming out of the woodwork, and they are betting there has to be more to come.

The Canadian banks choose to rebel against the Government of Canada direction to reduce interest rates.  The Central Bank dropped rates by a half percentage point indicating concern about the economy and in an attempt to ease credit.  However the Canadian Banks are choosing to keep 50% of the drop for themselves.  Story at the Globe and Mail.

Banks trim prime but lag BoC cut | Globe and Mail

OTTAWA — Major Canadian banks said they would lower their prime rates by just a quarter of a percentage point, refusing to pass along all of the Bank of Canada’s half-point decline.

The rebellious move is a departure from the past, when the big banks have fully matched central bank rate cuts, despite complaints they couldn’t really afford it.

The mainstream press do a good job of presenting quick quotes, and implying all kinds of dread and panic.  Its worth looking beyond the headline and some facts at the differences between the US situation and Canada.

Future of Canada’s economy comes into question as TSX ends week of panic | Canadian Press

The theme of the article is broadly the spillover effect of a slowing US economy, reduction in credit availability, and reduction in consumer spending.

It is certainly not our place to make predictions or make economic commentary, but some facts might be useful.  Then we can each decide the reason or cause for any panic reflected in the TSX.

Some basic facts in the diagram below, compiled courtesy of Google Finance.  In order to highlight the relative effects of banking in each country’s stock market.  We have US on the left, Canada on the right. 

The US Dow is down 26% and roughly the same in Canada at 27%. 

However when we look at financial services, a component of the Dow index, the American index is down 52%.  This suggests that the Dow banking sector is worried.   The sentiment of the market is that the US is in a flat out banking crisis.

In Canada it appears to be the opposite - what exactly are we panicking about in Canada?  Clearly not banking, because relatively speaking the Canadian banks are holding the Canadian stock market higher, with the TSX is apparently being dragged down by other factors.  We may well have cause for panic, but it doesn’t appear to be reflected in market sentiment for Canadian financial services.

Today will be a bloodbath on the markets, following Sunday when we saw the end of Lehman Brothers, Merrill Lynch, and a deepening crisis for AIG Insurance.

Wall Street shaken by Lehman failure, Merrill sale | Globe and Mail

NEW YORK — — Global markets plummeted on Monday after investment bank Lehman Brothers Holdings Inc. [LEH-N] filed for bankruptcy protection, rival Merrill Lynch [MER-N]agreed to be taken over and the Federal Reserve threw a life line to the battered financial industry.

As a deepening crisis took new, bigger victims, the U.S. Federal Reserve said for the first time it would accept stocks in exchange for cash loans and 10 of the world’s top banks agreed to establish a $70-billion (U.S.) emergency fund, with any one of them able to tap up to a third of that.

On a black Sunday for Wall Street, frantic attempts to find a rescuer for Lehman failed, and troubled insurer American International Group [AIG-N]asked the Fed for a lifeline, according to news reports.

But the larger question remains - what does this all mean for Banks and financial institutions.  The day to day Banks that we all see are enormous holding companies comprising banking, brokerage, mutual funds, and investment banking.  Then there are the specialised investment banks such as Merrill and Lehmans,  So the obvious school of thought is that the big bank  holding companies will simply take over the investment banks.  Bank of America is paying 48 billion for Merrill.

Banking models | The Financial Times

Is it the end for standalone broker-dealers? Many believe the fading of the light at Bear Stearns, Lehman Brothers and Merrill Lynch proves that the independent investment banking model is dead. Even the mighty Goldman Sachs and Morgan Stanley are under pressure to explain how they will survive on their own. The new mantra is that investment banks only have a future within large financial institutions.

That view is wrong. Indeed, until recently, investors argued the complete opposite. Universal banks such as HSBC and UBS, for example, have long been accused of being too diverse, with their share prices underperforming the broader sector as a result. Common complaints were that global banks lacked focus, or scale in particular businesses. And the revenue benefits from running, say, a wealth management division next to investment banking, were also tricky to identify.

However as the FT points out the complaint on the banks is that they are already too widely spread and have become unwieldy.  The notion that the average persons bank account funds should be held and managed to support risky investment banking, for example is not something that everyone agrees with.  When the investment banking arm loses money, whose fees are raised to compensate?

Banks are also becoming even closer to the central banks, particularly in the US, with the latest episode yesterday resulting in the Federal Government providing $70 billion in support.

The credit crisis has laid bare the banking model, and the relationship between the banks, the investment banks, and the government.  It will be fascinating to watch how the crisis is managed over the next months and years.  Yesterdays events appeared US specific, but Barclays Bank from UK were also involved.  This is a global crisis, and Canada is not immune - the reverberations will hit us at some point.

This additional quote from Nixon of RBC pretty much answers the question in our last post. 

Credit crunch fallout will cast a long shadow

“The days of cheap money are over,” said Gord Nixon, Royal Bank’s chief executive officer. If anyone would know, he would.

…

That means the banks’ own cost of money is likely to stay high. The credit crunch was a useful reminder to bankers of the value of a large, stable base of retail deposits. The institutions that failed - Northern Rock and Bear Stearns - didn’t have it. Everyone else wants it and they’re going to have to pay for it. That could work to savers’ advantage, but for borrowers, it’s nothing but grim news. The banks will pass on their elevated funding costs to the customers.

Irrespective of the way that the capital markets react to this week’s earnings announcements from most of Canada’s largest banks, the core message from each of their announcements will be clear – banking in Canada continues to be a highly profitable business, this, despite the significant issues around sub-prime investment exposure and a worsening economy.

Looking specifically at the BMO and Scotiabank announcements of Tuesday August 26^th highlights this message.

While BMO did report a third quarter profit that missed analyst projections, they also reported one of their best quarters ever on the domestic core banking.  According to today’s Globe and Mail reporting on the announcement, “Profit in the core Canadian consumer banking division, which comprises the largest portion of the company, fell 3.2 per cent from a year ago to $343-million. But the bank said the results in this unit represented “one of our best-ever quarters,” as the profit was up more than 3 per cent from the prior quarter. Expenses were up nearly 7 per cent from a year ago as the bank opened and expanded branches.  

The Scotiabank announcement contained similar news.  Again from the Globe and Mail reporting on the announcement, “Highlights in Scotiabank’s results included a record quarter from its domestic retail banking unit, an area that chief executive officer Rick Waugh has targeted for growth. Net income for the division rose 16 per cent, year over year, to $456-million.”

So what does this mean for the promise of social lending in Canada?

The fundamental premise of social lending is to connect Canadian lenders with Canadian borrowers in a safe and secure lending platform where they can set their own rates and receive the resulting benefits excluding the middleman. 

Even in today’s turbulent financial markets, Canadian banks are proving that this core business of banking in Canada is a strong and profitable business indeed.

Michael