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'When will this turmoil end?' Banks wish they knew

'A key part of the solution to the problem lies where the crisis began - in the U.S. housing market,' says Ed Clark, Toronto-Dominion Bank chief executive

Todd Korol/Reuters

BANKING

'When will this turmoil end?' Banks wish they knew

Most Canadian banks are doing away with their annual profit targets because 2009 is just too unpredictable

By Tara Perkins

The global banking sector is limping into 2009 a bruised and battered mess, and the scars won't be healed by next December. Dramatic events of recent months, from September's rapid collapse of Lehman Brothers Holdings Inc. to governments' decisions to buy equity stakes in banks, were widely unforeseen. In a short time the titans of banking were driven to the edge and the crisis has left many pummelled industry executives in a state close to shock. Even after the bandages come off, the effects will linger for more than a decade.

"Global banks are currently operating in one of the most challenging environments since the Great Depression," analysts at UBS Investment Research said in a report.

Canada's banks are recognized as being among the most stable in the world, but, as Finance Minister Jim Flaherty repeatedly notes, this country is not an island. The big Canadian banks saw their collective earnings drop by more than one-third in 2008, to $12.15-billion, and most have decided to do away with their annual profit targets because 2009 is just too unpredictable.

"When will this turmoil end? The truth is no one knows," Toronto-Dominion Bank chief executive Ed Clark said in a recent conference call with analysts. "A key part of the solution to the problem lies where the crisis began - in the U.S. housing market. We need price stability in that market and the start of a recovery there before we can begin to see any light at the end of the tunnel. Unfortunately, this may take some time."

Banks and brokers around the world have taken nearly $720-billion (U.S.) in credit losses and writedowns since the U.S. subprime mortgage market collapsed, according to Bloomberg data. Canadian banks account for roughly $16-billion (Canadian) of that, a relatively small proportion.

For the big Canadian banks, the final quarter of the year was "one of the worst the group has reported in a very long time," TD Securities analyst Jason Bilodeau said. He now expects 2008 and 2009 to be among the two worst years of earnings development the industry has reported since the 1960s - which is as far back as his data dates.

Writedowns should subside in 2009, thanks in part to recent changes in accounting rules. But trouble will begin to run deeper as bad loans rise. Basic banking practices will come back to the fore as banks contend with a rising number of customers who have trouble paying their debts.

"We expect all Canadian banks will face higher loan losses going forward on credit cards and other forms of unsecured loans as well as commercial losses," CIBC World Markets analyst Darko Mihelic said.

Expenses for bad loans are the single largest risk factor for bank earnings globally in 2009, UBS analysts said.

But simmering under the banks' financial reports, larger changes will be afoot. One of the questions banks will have to wrestle with is how much lending to do in this environment. Too much would be risky, because stretched consumers are at the heart of this financial crisis. Too little could do further damage to the economy.

TD is continuing to lend, Mr. Clark said, but that does not mean "that credit growth will not slow in 2009 as businesses become more cautious about their expansions."

Many companies will try to rein in spending, a sign of one of the biggest trends to affect the banking sector - deleveraging, or the reduction of debt. It will take place among banks, companies and consumers.

"I think the financial services companies are going to be deleveraging in a fairly big way, and I think we're at the front end of that, not the middle and not the back end," said Mike Lagopoulos, chief executive officer of RBC Wealth Management's international division. "What are the carry-on implications for business and the economy? Less credit, and more expensive credit."

The price of loans on banking products ranging from corporate credit lines to mortgages is expected to rise in 2009, partially because the banks themselves now have to pay more to obtain funds. But there will also be changes on the demand side of the equation, as companies and consumers try to tackle their growing addiction to debt.

"The importance of savings will be of higher focus in 2009," said Peter Aceto, chief executive of ING Direct Canada.

"There has been such a massive privatization of wealth, and we've just had a massive socialization of losses," said Mr. Lagopoulos. "What is the chain reaction to that? As part of the socialization of losses, are we now into a new age of saving? We [saw] the overleveraging of society and the over-indebtedness of society. Are people going to now see that that's blown up in their face and say, 'I'm absolutely going to have to live within my means'?"

Heading out of 2009, one of the key factors to watch will be the regulatory backlash to the crisis, as policy-makers crack down on the industry. "This is a process that is likely to be lengthy, but one that we think could reshape the financial regulatory landscape over the next decade," said the UBS report.

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