CommunityLend blog

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

Probably overdue efforts to bring credibility back to banking which has been tarnished by an ‘investment banking’ culture lately.

reportonbusiness.com: Be careful, and other new guidelines

Yet many of these proposed guidelines, outlined in a report Thursday by the Institute of International Finance, may strike investors as self-evident – a sign of just how far the banking system strayed from basic principles of monitoring and controlling risk.

The Canadian economy is reported by Ivey to be continuing with rapid expansion. What the article fails to note explicitly, is whether the level of expansion noted is inflationary.

reportonbusiness.com: Ivey index suggests economy still solid

The index is not adjusted for inflation or seasonal factors, and University of Western Ontario professor Michiel Leenders, director of the index, noted that the price subindex stood at 84.1 in June — the highest since its inception.

Good review of the current investment climate and fundamentals in Canada, and relate to the similarities, yet major differences to the situation in 1974.

reportonbusiness.com: The danger zones of 2008

“The charts did not predict a major crash [in 1974],” recalls Mr. Tynkaluk, who has managed money for Leon Frazer & Associates in Toronto for more than five decades. “But all of a sudden, it happened.”

There is much talk about the push towards regulation in social lending. However this headline about Citi introduces a different point, and highlights a positive aspect of social lending that is directly tied to web 2.0 companies.

FT.com / Companies / Financial services – Citigroup’s Pandit vows major cost cuts

Vikram Pandit, Citigroup’s chief executive, has vowed to slash the beleaguered financial group’s cost base by up to 20 per cent, deepening fears that Wall Street and the City of London are about to be hit by tens of thousands of additional job losses.

The NYSE jumped for joy on this announcement .. why? The underlying assumption is that Citi can carry on with the current revenue streams, yet reduce their costs by 20%, so the benefit flows straight to the bottom line. Some might suggest there must be a chunk of fat in any company that can do that! Yet this occurs all the time, and is likely what will break the markets into positive territory as most other Banks’ make similar announcements. It is potentially just a matter of time before we see that in Canada.

The web 2.0 difference:
we are not so naive to believe that business realities will not hit us too over time. However what makes us somewhat different at CommunityLend, is that we always try to bring web 2.0 thinking to our financial services model. Web 2.0 meets reality. The advantage of a model that is purely web based is the opportunity to re-think everything in terms of customer activity and support. The promise is a better model for customers and for companies; a viable long term solution that works the way customers expect … a true win – win.

Lots of unsaid commentary going on with the Bank of Canada’s move today to inject $2Bn liquidity into the Canadian Banking system. In effect the move removes risk from Canadian Banks balance sheets, and takes risk on to the central Bank. The amount is not large in money market terms but it does send signals that the Central Bank is watching carefully.

reportonbusiness.com: Central bank injects $2-billion into market

The announcement has the effect of injecting liquidity into the 28-day market, with the central bank soaking up securities that banks and primary dealers are having trouble with these days, and replacing those troubled securities with top-notch t-bills.