Canadian Bank's Profit Miss Spells Trouble In Banking Sector

From Bloomberg Businessweek:

Bank of Montreal Shares Drop as Profit Misses Estimates

Bank of Montreal lead most Canadian lenders lower after posting fourth-quarter profit that missed analysts’ estimates on a drop in capital markets earnings.
Bank of Montreal fell 2.2 percent to C$81.43 at 12:08 p.m. in Toronto, the biggest intraday decline since Oct. 16 and the worst performance on the eight-company Standard & Poor’s/TSX Commercial Banks Index, which slid 0.9 percent.

A slump in fixed-income trading and higher costs weighed on capital market earnings and countered profit gains in personal and commercial lending in Canada and the U.S., the firm said. Bank of Montreal (BMO) is the country’s fourth-largest lender by assets.
“BMO posted a messy result that had some good, some bad and some ugly,” Meny Grauman, an analyst with Cormark Securities Inc., said in a note to clients. “The ugly was capital markets revenue, particularly fixed-income trading.”

Video link from Bloomberg:

SocGen Misses Q3 Estimates

My view:

Some years ago as we left the depths of the financial crisis behind us, a paper was published by the Federal Reserve Bank of St. Louis regarding consistent threads that linked bank failures.

The first warning sign that occurred much earlier than any other indicator, was a deterioration in earnings.

The paper concludes that deteriorating asset quality is the primary driver of bank stress.

While it is still too early to make definitive statements, it seems that Canadian banks likely have a tremendous number of potentially poor performing assets on their balance sheets. 

Specifically, oilfield related commercial loans, and residential loans in areas of the country where the economy is highly dependent on the oil industry.

In our view, this is the true present danger to the banks and the economy as a whole.  The Canadian economy is much more vulnerable to a popping housing bubble than the American economy due to its petroleum and resource basis.

While the American housing bubble burst in 2006 and deflated until 2011 and since has recovered to some degree, the Canadian economy has yet to experience a housing bubble pop.

Given the high levels of leverage used in Canada to finance houses and condos (19 to 1 leverage ratio is not uncommon) an economic slow down or outright recession would provide the pin to pop the growing bubble.

This scenario leaves banks with tens of billions of deteriorating assets on their balance sheets as the highly leveraged homeowner and oilfield business owner loses the ability to pay.

While it is likely a year or more before we see substantial impact in the housing market and bank asset quality, it reminds us that rapidly expanding booms and the debts associated with them always lead to busts.

The astute investor will carefully watch for additional signs of deterioration over the balance of this 1st quarter and take appropriate action including limiting portfolio exposure to banks and considering safe havens for bank deposits.

Popping bubble courtesy of Flickr: