You are currently browsing the monthly archive for August 2008.
This article at The Globe and Mail provides a good reality check on why one shouldn’t rush into Canadian banks. The most interesting part of the article:
- During the second quarter of 2008, the industry took provisions of 0.4 per cent of loans — still below the cycle average of 0.5 per cent.
- Provisions rose to 0.9 per cent of loans in 2002. In 1992, the recession saw provisions up to 1.7 per cent of loans.
- Canadian banks have only a dollar in earnings for every $50 in loans. Even a modest increase in impaired loans could damage their bottom line.
- “In a flat-to-falling property price environment, it’s unlikely that we’ll be seeing much in the way of revenue growth,”
Most investors see banks as a staple in their investment portfolio. Despite what’s happening in the US, they don’t seem to “get” just how leveraged banking — as a business model — really is.
From current levels, provisions would need to increase over 300% to match those 1992 recession levels. This would crush bank earnings. Sound bad? Things can get a lot worse when it comes to banks and bad loans. Norway’s three largest banks collapsed in 1991 and shareholders lost every penny. In the US, 25% of S&Ls were bust by 1991. How many US names will be gone post this crisis?
Provisions — for those of you who do not know — are banks’ best guess of loan losses on the end-date of the reporting period. That’s why I don’t think Canadian banks low provisions are necessarily a good thing. They’re low simply because the Canadian economy has not turned down in any major way. Taking a provision is kind of like giving a cookie to a dieter who “just wants a taste,” and telling her she can come back later if she really needs another. She may not come back. It’s hard to predict. But deep down you know that if she does come back, she might want more than one.
Are provisions going to rise dramatically? I have no idea. I’m certainly less knowledgeable than those pasty-faced bank analysts who work 12-hour days and fiddle with spreadsheets. The sad thing though is their lack of social life is completely unnecessary. That’s because it doesn’t really matter now accurate their forecasts are. In a deteriorating economy, investors have a tendency to “sell banks now, ask questions later.” Just look at Bear Stearns.
Even if provisons stay low, it’s hard to imagine how Canadian banks can maintain premium valuations in the face of slowing revenue growth. There are two good reasons to be concerned here: Canadian housing is showing price declines for the first time in years; Chinese and Indian stock market indices are down some 40% from their highs. The slump in their stock markets could portend the end of the commodity cycle.
Click here (for a limited time) for a video of a BNN interview with Danielle Park, the portfolio manager behind the blog Juggling Dynamite. I don’t know her track record but the strength of her conviction is refreshing in the midst of the “everything is going to be OK” mindset of many Canadians. She reminds us that we Canadians are not immune to global forces, selling “rocks and trees,” a viewpoint that I also lean towards. Ms. Park thinks we’re lucky if we’re halfway through the current market correction. I also love the fact that even though her investment firm is paid by % of assets, she’s still gutsy enough to tell people that she’s zero equities — with no buys on her metrics.
What’s clickworthy to me in BMO’s results are the sections on bad debts. A key issue for Canadian banks (and any bank for that matter) is credit quality. The Canadian economy is holding up well, but when an economy starts to turn, investors always ultimately look to previous cycles to see how bad things can get. In 1992, on the back of the recession, Canadian banks saw bad debt charges 3x higher than current levels. A repeat of that performance would crush bank earnings.
A detailed PDF of BMO’s results can be seen here. Key points for me on credit quality :
- BMO’s 3Q specific provision charge of $434m represents an annualized 0.9% of loans up from 0.30% in the second quarter.
- Year-to-date, the specific provision is more than 50% higher than BMO’s original full-year 2008 target.
- To be fair, the bulk of provisions appear to be US-driven. Management indicates that $247m of the specific charge is due to two corporate accounts related to US housing.
- BMO says: “Housing markets have cooled from record levels of activity last year, and should continue to moderate as past increases in prices have reduced affordability”
- Management does anticipate that provisions in the 4Q will be lower than in the third quarter.
I had to laugh when I saw that there was also a specific mention of a $27m provision for a customer in the oil & gas sector. I’m curious what this account was doing to lose money?
Oh and Bank of Nova Scotia results? Provisions, while up sharply from the prior year, were still flat at 0.2% of loans quarter-on-quarter.
It’s funny that I had to read in a UK newspaper that US money supply has stopped growing.
Data compiled by Lombard Street Research shows that the M3 ”broad money” aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959.
What that means in plain English is that banks are not lending in the US. And why should we Canadians care?
Sentiment aside, globalization means more than importing our sneakers from China. We should consider the impact that foreign banks’ problems back home will have on their activities in Canada. Because if their ability to lend is impaired, it will spill over directly into our economy.
But foreign banks only make up about 8% of the Canadian banking system, you say. That may be the case, but they have a much greater economic effect, and in recent years had been growing at up to three times the pace of local banks.
Until recently that is. Foreign balance sheets have shrunk 2% between March 2008 and June 2008
See, Oprah was right. We’re all interconnected after all!
This memo to clients from the chairman of Oaktree Asset Management, sums up perfectly why financial markets always overshoot. It’s a little long, my favorite part being:
But is it right to say Prince and Citigroup could have avoided trouble by refusing to go along? Let’s do what some DVDs let you do nowadays: go back and consider an alternative ending. It’s July 2005 instead of July 2007. Presciently, Chuck Prince says, “When the music stops, in terms of liquidity, things will get complicated. We’re not going to get caught in that trap. As of today, we’re adopting a conservative stance toward loans, mortgages, subprime, CDOs and SIVs. The others can dance all they want; we’re sitting this one out.”
What would’ve happened? Rather than lose his job in late 2007, he probably would have lost it sooner. Why? Because from whenever he made that statement until July 2007, Prince would have looked dumb. While other banks were gaining market share, Citi’s share would have been shrinking. And while other banks were borrowing on the cheap to make mortgage-related investments at seemingly attractive spreads, Citi would have been on the sidelines, forgoing easy profits. Shareholders would have been yelling for Prince’s scalp.”
I couldn’t agree more. I get annoyed whenever I hear people complaining that analysts in particular are paid to lie about the stocks they cover — that they stay bullish when they know otherwise. For the most part, nobody “forces” analysts to stay bullish on an overpriced theme. They might know it’s overvalued; they might know it could fall significantly. But the reality is as long as the music keeps playing, they better keep dancing. Otherwise, they’ll be wrong — and they’ll be out.
Good argument on Movesmartly, on a possible reason for the surge in new listings in Toronto:
“Is this short term trend an indication that more sellers are looking to “cash out” at what they perceive to be the peak of Toronto’s real estate market?”
“Perhaps, but part of the increase in new listings may be explained by the many price changes we are seeing in Toronto’s real estate market. When a realtor wants to change the price for their listing at 123 Main Street for example, they can either update the listing for that home with the new price or they can take 123 Main Street off of the market and then upload a new listing for 123 Main Street at the new price. The advantage of the later approach is it resets the Days on Market for the house back to 0 making the listing look newer than it really is. One of the problems with this is that both listings would be counted as new listings because they would have different MLS numbers.”
“It’s not uncommon to see the same house listed up to 4 separate times by the same agent. In this case TREB’s data would show 4 new listings when there should have been just 1.”
I agree that listings may be overstated if this practice among agents has accelerated. But I wouldn’t be jumping for joy just yet. The official statistics show the average time to sell a house is at 35 days versus 32 a year ago. If agents are increasingly de-listing/re-listing homes, then “time on market” is understated.
This translated summary of China’s 2Q monetary report is definitely worth reading for this:
“What’s new? The Central Bank is no longer referring to its monetary policy as tight. The last quarterly report, in May, said the central bank would “place a higher priority on containing price rises and curbing inflation, and implement a tight monetary policy.” This report omits the reference to a tight policy, and says the bank will “make its top macroeconomic priorities maintaining stable and relatively fast economic growth and preventing an excessively fast rise in prices, with curbing inflation put in a prominent position.” The new language is identical to the phrasing other government outlets have been using for the last few weeks, and confirms the policy shift made when the central bank raised lending quotas for the year.
Now just because a government decides to turn on the printing presses does not mean the economy will keep growing (see: Japan in the 90s/the U.S. right now). Still, via infrastucture spending/ state-owned companies, China has more control over its economy than most. Interestingly, China’s stock market did not respond postively to this and fell another 5% on Monday. This bears close watching for us, as Canada’s economic success bears close correlation with China’s continued appetite for global commodities.
PS – this report is particularly interesting in light of this excerpt on Michael Pettis’ latest China posting:
- On a related note I got an interesting email today from one of my former Peking University students. He says (with some editing on my part):
-
“I just talked to a friend in a city in the south. Interestingly, he tried to pay back his mortgage loan last week, and get another 3 year loan again (many entrepreneur there rely heavily on this kind of financing as working capital, sometimes, from informal banks of course). However, he was told that the term of next loan had to be just 1 year instead of the usual 3 yrs, and he has to go through the application process again every year.”
Collapsing property and other assets prices in some cities like Shenzhen seem to have made banks cautious of a probable rise in default risk, and the tightening will hurt these small enterprises further.
I don’t know how widespread this shortening of maturities is, but a common problem in banking is that when risks are perceived to have risen, lenders often respond (rationally, in the case of each individual bank or investor) by readjusting their portfolios in ways that increase overall riskiness in the system.
As it’s the world’s biggest mining company, it’s important for Canadians to pay close attention to what BHP Billiton has to say in its just-released annual results:
- 37.5% return on capital employed — full year attributable profit up 12.4% — final dividend of $0.41 up 51%.
- “The world is confronting supply constraints for energy and mineral resources. While there are enough resources to satisfy the world’s appetite, the industry has not moved quickly enough to meet the growth in demand.”
- “Strong global demand for resources continues to provide cost challenges for the whole industry. This is mainly due to rising prices for inputs such as diesel, coke and explosives, and shortages of skilled labour.”
- “The global economy has remained resilient in the face of significant structural weaknesses in developed economies. The continuing massive industrialisation in China is providing solid support to the global economy.”
- “Emerging market economies have contributed more than their industrial counterparts to global growth since the year 2000.”
- “In particular, China remains a key driver of global commodity consumption through its position as a net importer of raw materials.”
- “We continue to expect that commodity prices will be driven by long-run marginal cost of supply.”
- “The effects of current weaknesses in the developed economies on demand for our commodities should be minimal driven by ongoing strong demand from the emerging economies. Meanwhile, supply side pressures remain high. This has led to overestimation of the supply side response, and thus, price outcomes regularly being underestimated by industry observers. In the short-term, we expect prices to remain high relative to historical levels, albeit with higher volatility.”
Let’s hope they’re right about China’s ability to keep growing. Shanghai’s stock market closed down 5% last night at 2,320. It’s now down 60% from its peak 10 months ago. Hong Kong’s market is down a third.
On China Financial Markets, Michael Pettis discusses some of the worrying data that could illustrate that the over-investment cycle is about to end: Click here for the post:
Total vehicle sales growth in China moderated sharply in July to 4% yoy. According to the China Association of Automobile Manufacturers, sales of commercial vehicles contracted 3% yoy in July (to 177,600 units), the first contraction since January 2006. Passenger vehicles sales managed to maintain 7% yoy growth (to 488,200 units), but this was the first single digit growth since August 2006. The data reflect weakened domestic demand in China.
“China’s stockpile of unsold new vehicles rose about 50 percent in the six months ended June, hitting a four-year high, as automakers expanded production and sales growth slowed.” In the article some commentators brushed off the rise in inventory saying that they were expecting a surge in car buying later in the year. If it doesn’t happen, I suppose we will necessarily see rapidly rising car inventories. Rising inventories is one of the main warning signals we have to watch for as evidence that the over-investment cycle is finally about to end.
This is the sort of data we need to be focusing on. I’m always amazed at the simplistic analysis of Western pundits, who often tell us not to worry because even if China’s growth is slowing, it’s still much faster than the West. Their logic is flawed for one major reason. China’s GDP numbers don’t add up. Speak to any credible economist on the numbers that come out of China and they will tell you the same thing. The official numbers make no sense. So don’t obsess about the actual figures. Focus on other clues.
If you don’t believe me, then explain this:
Recent Comments