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One good bank and six months of trouble for the rest

Daily Buy-Sell Adviser
0 Comments|August 21, 2008

When will the good old Canadian banks be solid investments again?

The markets can’t really recover until the financial mess is fixed, says this Canadian advisory, but one steady bank is worth a look right now. 

People in the media love marking anniversaries. So here’s one. It’s August—and that means it’s been a year since the sub-prime mortgage crisis struck and financial stocks started going into the toilet. 

Great, eh? Maybe there should be a commemorative plaque or something.    

In fact, the real question this raises for investors is how long it will be before this financial mess is cleaned up? (Yesterday’s mugging of financial stocks on Bay Street and Wall Street was not an encouraging sign.) 

Or, to put it another way, when will our good old Canadian banks be solid investments again?  

For a few answers, we turn to Investor’s Digest of Canada. In the latest issue, Mr. Grant Campbell gives us an update on the clean-up in the financial markets. 

But he also has one Canadian bank that is a good investment right now and has been all along. We’ll start there. 

80 consecutive profitable quarters 

If you are going to hold one financial company, says Mr. Campbell, “look only at a strong regional company that has limited exposure to the U.S. and international lending markets.” 

That bank would be Canadian Western Bank (TSX: T.CWB, Stock Forum), which, as its name suggests, does most of its business west of the Ontario/Manitoba border. The strong economic fundamentals of the region, particularly in Alberta and B.C., give the bank plenty of room to grow. 

In June, the bank recorded impressive second quarter results that marked its 80th consecutive profitable quarter.  

Income for the first six months increased by 51% over the same period a year ago (unheard of for most financial institutions these days), while net income was 14% higher. 

The bank raised the quarterly dividend by one cent a share to 11 cents, and the yield stands at 1.9%. 

The bank reported growth at 21%, adds Mr. Campbell, “and has no exposure to asset-backed corporate paper, collateralized debt obligations, or monoline insurers.” 

Canadian Western Bank has maintained a conservative strategy that has allowed it to avoid many of the problems plaguing other financial firms that jumped into uncharted territory. Indeed, it is ready to use some of the cash it has built up to make acquisitions while others cut their losses. 

A devastating decline 

The story for the rest of the financial community is not so bright. The level of uncertainty for investors, Mr. Campbell reckons, is not going to change anytime soon.  

It is by now a well-known fact that early estimates of the size of the sub-prime mortgage problem were woefully inadequate. This shortfall “would be funny if it weren’t so painful,” says the analyst. 

The latest addition to the catastrophe has been the saga of America’s two government-sponsored mortgage giants, Fannie Mae (NYSE: FNM, Stock Forum) and Freddie Mac (NYSE: FRE, Stock Forum). There’s been lots of talk about Washington’s pending bailout of the two, but the problem is even bigger than many imagine, the analyst says. 

Freddie and Fannie both serve the secondary mortgage market, and own nearly half of the investments in this category, to the tune of some US$6 trillion. 

“It is not surprising that there is increasing concern that if Fannie Mae and Freddie Mac cannot continue to serve this market that the American real estate market could go into a dramatic, lasting, and devastating decline,” says Mr. Campbell. Thus far, they have enough capital to carry on and are not on the verge of default. 

But who ever thought it would come to this? 

Lack of loose lending 

U.S. Treasury secretary Henry Paulson has been working on a bill that would allow the Treasury to provide capital to Fannie or Freddie as a temporary stopgap. The grand total of the bailout could amount to some $25 billion.  

As the likelihood of emergency measures grows, the shares of both firms have plummeted. It will be a long time before the shares retain their previous levels, if ever. Things aren’t quite as bad in Canada. 

Because Canada has no real equivalent to Fannie Mae and Freddie Mac, the financial industry here has been able to maintain a relatively conservative stance on mortgage lending, says Mr. Campbell. 

“Canadian lenders did not offer as many variations and wide-ranging terms, such as zero-down, interest-only, 40-year mortgages, which became quite common in the U.S.,” he says. Along with a robust real estate sector, this lack of loose lending has kept the Canadian financial services sector free from the deep woes that struck the American industry. 

So is this the time for investors to move their money back into financial stocks? Not quite, says this analyst. 

Another six to nine months 

The Canadian economy has been slowing down, and that brings the risk of a decline in the real estate sector, says the analyst.  

“It will likely be another six to nine months before the fallout from a slowing economy and higher inflation has had a chance to impact in any meaningful way the financial services sector,” Mr. Campbell concludes. “Over that time frame, the health of the U.S. real estate markets will be more fully understood as well.” 

So if you don’t want your portfolio to be completely devoid of financial stocks, the analyst tells his readers in Investor’s Digest of Canada, choose one that’s doing well now, like Canadian Western Bank. 

Canada’s big banks and financial firms will recover, but if you want to get in while their prices return to where they should be, he reckons you’ve got at least six months to act. 

In short, be patient and make sure things don’t get worse before they get better.   


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