Last fall it appeared as if the entire financial sector was imploding. Many of the icons of American finance either failed or had to be thrown a government lifeline just to keep from failing. The names all are familiar to us: Citigroup, Bear Stearns, Lehman Brothers, Washington Mutual, National City Corp., American International Group, Merrill Lynch, Wachovia.
Conspicuous by their absence are the large Canadian Banks such as Bank of Nova Scotia, Royal Bank of Canada, and Toronto Dominion Bank. Isn't Canada's economy tied closely to our own? How is it they were able to escape the carnage largely unscathed? Furthermore, Canada does not have a Troubled Asset Relief Program in place to save its institutions from their own excesses. Neither does Canada have an equivalent to a Federal National Mortgage Association or a Federal Home Loan Mortgage Corporation to assist their banks in providing easy credit to unqualified borrowers. What Canada does have according to The Financial Times is ..."stricter regulation and a conservative culture that depends heavily on a vast and stable retail branch network, and a clubby working relationship that has enabled Canada's banks to remain the strongest among the G7 group of nations." The Times continues to point out that in Canada, when a borrower needs money from a bank, they will lend you no more than 75% of the value of your house. There was no need for Credit Default Swaps or other highly leveraged financial derivative instruments here.
Although the stock market has recovered sharply, up 43% since the March 9 interim low, the situation in the financial sector is as murky and cloudy as it was when the year began. The best solution for the troubled American financial icons that survive today only by virtue of their taxpayer lifelines may well be to sell the valuable parts and use the proceeds to cover their losses. The restructuring of General Motors and Chrysler into entities that can survive on their own, with government assistance of course, nearly devolved into the very bankruptcy proceedings that government officials hoped to avoid. Likewise, simply supporting troubled financial institutions with capital infusions and loan guarantees hoping that they will slowly recover and earn their way to solvency is wrought with uncertainty and may well fail in the end. Is there some political maneuvering going on here hoping that all will be well in time for the 2010 elections? Only the naive would think otherwise.
What about giving judges the power to rewrite mortgages? Shouldn't this help stem the tide of foreclosures? Perhaps so however, this will only be offset by rising defaults as long as the unemployment rate continues to rise as anticipated even after the recession is declared officially over.
Diversified Banks - Industry Outlook 2009-2010
Our outlook for the banking industry is decidedly mixed. None of the largest American banks rates as conservative an investment as it used to. If they were, there would have been no need to slash their dividend payouts as they all have done. Although the worst of the financial storm may have passed, the upshot of this very long recession is continued loan deterioration and the consequent increases in provisions for loan losses. Elevated unemployment will continue to pressure credit card loans, commercial loans, and even prime mortgages. No relief is in sight until sometime in 2010 at the earliest. Tighter lending standards will constrain loan growth this year and next. Shareholders at those banks that need additional capital according to the government stress tests will face earnings dilution.
Longer term, our outlook is more sanguine. Large diversified banks with solid capital levels have been able to gain market share from weaker competitors. As the economy begins to improve and charge-offs begin to ebb lower, earnings will rise substantially. Those banks with diversified revenue sources both geographically and by product category should fare the best.
Although winter comes earlier to, and lasts longer in our oft-neglected northern neighbors, they have weathered the recent storms much better we have and are well positioned for continued conservative growth.
Kenneth N. Green is Senior Vice President and Director of Investments for Marc J. Lane & Company and Marc J. Lane Investment Management, Inc., the investment affiliates of Marc J. Lane Wealth Group(TM). Mr. Green is a graduate of the University of Michigan (M.B.A.) and the University of Illinois at Urbana (B.S.). Mr. Green is also a Certified Public Accountant.
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