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Wednesday, August 27, 2008

Financials Face Massive Credit Hurdle

A quick update on financials in general…

More bad news is pending. Earnings have already started coming out in Canada. They’ve been disappointing. I’m short Canadian financials through the Horizons BetaPro Capped Financials Bear Plus ETF (HFD.TO).

Canadian Imperial Profit Falls on Debt Writedowns (Update1): “Canadian Imperial Bank of Commerce, the country's fifth-largest bank, said third-quarter profit fell 91 percent, missing analysts' estimates, on writedowns tied to the U.S. mortgage market.

Net income for the quarter ended July 31 was C$71 million ($68 million), or 11 cents a share, compared with profit of C$835 million, or C$2.31 a share, a year earlier, the Toronto- based bank said today in a statement. Revenue fell 36 percent to C$1.91 billion.

Canadian Imperial had C$885 million in pretax writedowns linked to the U.S. mortgage market, adding to C$6.66 billion in debt-related costs since the third quarter of 2007. The writedowns and the slowest economic growth in Canada since 1992 will probably lead to the steepest profit decline in five years for Canada's biggest banks.”

This week is a busy week…

“Bank of Nova Scotia, the No. 3 bank by assets, said yesterday that profit fell 1.9 percent to C$$1.01 billion, while Bank of Montreal, the fourth-biggest bank, said profit fell 21 percent to C$521 million.

Royal Bank of Canada, the country's largest bank, Toronto- Dominion Bank, the second-biggest lender, and No. 6-ranked National Bank of Canada report results tomorrow.”

Judging by the Canadian results (remember, these banks didn’t party nearly as hard as those in the U.S.) I expect the results for this quarter in the U.S. to truly suck.

New Credit Hurdle Looms for Banks: “U.S. and European banks, already burdened by losses and concerns about their financial health, face a new challenge: paying off hundreds of billions of dollars of debt coming due.

At issue are so-called floating-rate notes -- securities used heavily by banks in 2006 to borrow money. A big chunk of those notes, which typically mature in two years, will come due over the next year or so, at a time when banks are struggling to raise fresh funds. That's forcing banks to sell assets, compete heavily for deposits and issue expensive new debt.

The crunch will begin next month, when some $95 billion in floating-rate notes mature. J.P. Morgan Chase & Co. analyst Alex Roever estimates that financial institutions will have to pay off at least $787 billion in floating-rate notes and other medium-term obligations before the end of 2009. That's about 43% more than they had to redeem in the previous 16 months.

The problem highlights how the pain of the credit crunch, now entering its second year, won't end soon for banks or the broader economy. The Federal Deposit Insurance Corp. said on Tuesday that its list of "problem" banks at risk of failure had grown to 117 at the end of June, up from 90 at the end of March. FDIC Chairman Sheila Bair said her agency might have to borrow money from the Treasury Department to see it through an expected wave of bank failures. She said the borrowing could be needed to handle short-term cash-flow pressure brought on by reimbursements to depositors after bank failures.

As banks scramble to pay the floating-rate notes, they could see profit margins shrink as wary investors demand higher interest rates for new borrowings. They're also likely to become less willing to make new loans to consumers and companies, aggravating economic downturns in both the U.S. and Europe.”

I don’t expect any rally in U.S. financials to last. Too many things can go wrong. For example, I’ve already heard rumors the Toothfairy vomited after taking a closer look at Lehman’s balance sheet and that the Toothfairy is now trying to walk on that deal…

I’m short U.S. financials through the UltraShort Financials ProsShares ETF (SKF).


Anonymous said...

thanks Ben.

On your XFN, momentum is doing some dancing, but it appears to be oversold. With bad news looming, do you expect a big drop...since it is already oversold? Or do you expect a slow slide into the teens?

Thx for input on SKF. I just read FDIC needs to borrow money to cover all the bank failures.

It reminds me of the big earthquake in SFO. It put many quake insurance underwriters out of biz as they could not cover the policies.

How many more banks & institutions does the fed need to bail out before it goes bankrupt?

Anonymous said...

Canadian banks are trading at more than double the P/B multiple of US banks - granted there haven't been any dramatic increase in bad debts yet, but the housing market is finally starting to slip. If commodity markets continue to weaken, we'll get a real chance to see if the banks are as "conservative" as everybody says.

Anonymous said...

Just read an interesting post over at Mish's Global Economic Trends. Short version: he is debunking conspiracy theories regarding why gold/silver are sliding. The piece that grabbed me is that banks are refusing to lend to continue to fund futures contracts and even retail shops handling coins despite confirmed orders. THAT tidbit (along with LIBOR rates ratcheting up) tells me the banks are getting worse and worse and that we are in for some rough sledding for the rest of the year. I think being short equities is a wise move...and watching gold/silver for a future 'tell' is even better.

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