Financial Update for Feb. 23, 2009

GOLD TOPS $1000 per ounce

· TSX-235.36(Reuters)
· DOW -100.28
· Dollar +.63c to 80.04USD
· Oil -$.54 to $38.94US per barrel.
· Gold +$25.70 to $1,001.80 USD per ounce
· Canadian 5 yr bond yields -.04bps to 2.05
· http://www.financialpost.com/markets/market_data/money-yields-can_us.html

Canadian bank profits down but not out, for now (Reuters) - It's a problem most of the world's bankers would love to have in 2009.

Canadian banks are expected to post weaker quarterly results when they kick off their reporting season on February 25. Yet unlike many U.S. and European lenders -- ravaged by the global financial crisis, forced to beg for government aid and dogged by rumors of nationalization -- Canada's banks are actually expected to turn a profit.

The country's banking system was ranked last year as the world's soundest by the World Economic Forum. Analysts said the Canadian industry's conservative lending practices, which helped it avoid the writedowns and losses seen at firms like Bank of America Corp and UBS AG , should ensure a profitable first quarter.

Some predicting a brighter economy

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Despite the glut of bad news, some experts are seeing early positive signs
Julian Beltrame The Canadian Press

The economic picture across Canada keeps darkening, but at least some economists see a faint ray of light on the horizon.

Conference Board chief economist Glen Hodgson has joined an exclusive club of forecasters who see the Canadian and the U.S. economies approaching a recovery.

"To be sure, these are still early days in the search for recovery -- the bottom has not been reached,'' he cautions in an article. "(But) if you look hard enough, there are some early positive signs that the recession is approaching bottom.''

Hodgson believes the bears are missing the sunshine peeking through the black clouds, particularly in America, where President Barack Obama is moving aggressively to hike government spending, rescue cash-strapped homeowners and shore up the banking sector.

Even before the "exceptional'' government measures have had time to take effect, he said encouraging signs were starting to appear.

U.S. housing sales and prices rose six per cent in December after falling off a cliff for most of 2008, mortgage rates have fallen one percentage point, and the risk factors of financial markets and spreads are down from October.

This analysis is certainly one favoured by only a minority, although it largely tracks that of the Bank of Canada and University of Toronto economists.

These three groups see the economy hitting bottom during the first half of 2009 and starting a slow recovery in the latter half before picking up steam to a near four-per-cent advance in 2010.

Last month, Bank of Canada governor Mark Carney defended his rosy outlook by pointing out that past recoveries from deep recessions in the early 1980s and 1990s have been quicker than he was predicting.

"When recoveries come, they come sharply,'' Carney said at the time, while admitting that economic forecasting is as much art as science.

Hodgson agreed -- he breaks with most economists in seeing the current crisis as not that unusual.

"The trigger for the recession was exceptional, being credit markets, but if you compare the cycle in terms of quarterly impact to the last (few) recessions, it's not that different,'' he explained.

"I'm not an optimist, I'm simply looking for a real-world balance. At some point we are going to hit bottom and have a recovery."

Despite that, some of the news keeps getting worse.

Yesterday, Statistics Canada reported the annual inflation rate edged one-tenth of a point lower to 1.1 per cent in January bringing the rate to the lowest in two years. But measured on a month-to-month basis, prices actually fell 0.3 per cent from December, the fourth straight month in which prices have dropped.

Bank of Montreal economists also see conditions worsening and this week cut their forecast for the Canadian economy in 2009 by half a point to negative two per cent.

Analysis: Can bankers meet the financing needs of corporate Canada?

Eoin Callan, Financial Post

The country's top bankers are deeply sceptical about the ability of markets to meet the financing needs of corporate Canada as economic headwinds push companies' backs against the wall.

Executives warn that pressures will continue to build in the financial system and that banks will increasingly struggle to fill funding gaps left by the retreat of more fickle investors from capital markets.

Solving this impasse will require further action by Ottawa to restore confidence in credit markets and stem the flow of bankruptcies and job losses, according to bankers.

"The number one recommendation I would give to our government, and to others, is we have to get the capital markets growing," said Rick Waugh, chief executive of Bank of Nova Scotia.

"The problem now is the bond market and equity market are largely closed, and of course that puts on pressure [that] comes back to banking system," he said.

Addressing this will require new extraordinary short term interventions to restore confidence as well as structural reforms to make it easier for companies to raise money through credit markets, bankers say.

Yet executives are anxious not to strike an alarmist tone or be seen to criticise Ottawa, lest they provoke a political confrontation or rattle investor confidence.

Bill Downe, chief executive of BMO, acknowledged that in order to bring about a fresh round of action to stimulate markets and the economy, "the government of Canada will need to be pressured to do it".

But he said there was a risk a process like this would conjure up the kind of apocalyptic imagery that was invoked in the United States to get a $800-billion fiscal stimulus and $700-billion bank bail out package passed by Capitol Hill.

"In order to get the political will to get the economic stimulus package in place it was necessary to create a very high level of anxiety about what happens if [it is not passed]" said the executive.
"The impact of the rhetoric that was necessary has probably come back into our own mind set," said Mr. Downe, adding existing measures should be given time to take effect.

Instead of clamouring for immediate action, bankers are taking a long view and using private discussions with Ottawa to advocate more radical state intervention, while lobbyists work behind the scenes.

"I understand that there is a good amount of co-operation and discussion both between our institutions and government, but also internationally," said Nancy Hughes-Anthony, head of the Canadian Bankers' Association.

Bank lobbyists also see an opening to advance their agenda when the Conservative government is forced to report on implementing the recent budget as a condition of the ongoing support of Michael Igantieff, the Liberal leader.

The first of three "accountability" reports is due on March 26, and is adding urgency to bureaucrats' efforts to implement the full $200-billion of "extraordinary" support pledged to the financial sector.

"All of a sudden the blood pressure has gone up," said one bank lobbyist.

The willingness of bank lobbyists to use Mr. Ignatieff's ability to bring down the government as leverage represents a significant change of tack now that the opposition has abandoned plans for a coalition government.

The bank lobby had previously rallied around the Conservatives and recoiled at the unpredictable prospect of a coalition supported by the Bloc Quebecois and New Democratic Party.

But while the political wheels grind in Ottawa, companies across the country are likely to bump up against ceilings on the amount banks will lend and face prohibitive costs to tap public markets.

Standard& Poors identified over-exposure to struggling companies as one of the main risks facing the country's banks, in a recent report.

"The Canadian economy we believe has significant concentration issues because many industries are dominated by a few very large players, a situation that makes it difficult for Canadian banks to avoid excessive loan concentrations," said the otherwise-glowing assessment by the ratings agency.

The head of Scotia said this creates a Catch 22 for banks that want to remain "disciplined" about limiting risk "yet still feel obligated in meeting the needs of our customers."

"There is a dilemma there," he said.

Mr. Waugh said this "has been somewhat addressed in the budget, but is an issue going forward".

He said "the policies and incentives that the government can provide would be very important" in getting "capital markets functioning again".

Not all market participants and observers are as pessimistic about the state of the country's capital markets.

People in the industry who track sales of corporate bonds – and who didn't have a lot to do in the fall of 2008 – tend to get pretty excited about the handful of companies have been able to raise money in debt markets.

Altaf Nanji, a credit analyst at RBC Capital Markets, said the Canadian corporate bond market is "not vibrant, but there are signs of life."

But bankers' concern also relates to the hidden market for corporate credit, the shadow capital market where banks bundle loans to companies too small to go directly to markets, and pass them on to investors in a process called securitisation.

This market has been moribund since credit markets seized in August 2007, leaving banks with tens of billions of outstanding securitised credit to carry and limited ability to sell on new loans.
Research by Michael Gregory, an economist at BMO, suggests this has led to a significant shift from investor-backed financing for companies to direct bank lending through so-called Bankers' Acceptances.

"Will securitisation come back as a vehicle for people to access finance? Yeah, I think it will eventually come back. In what form it will come back is still to be determined," said Lindsay Gordon, chief executive at HSBC, the foreign bank with the biggest footprint in Canada.

It is unclear how much concern this substitution of bank lending for market financing is causing at the Bank of Canada at this juncture.

But warnings from bankers that it will become increasingly unsustainable amid a prolonged recession have been heard in government.

The recent budget included $12-billion for the government to buy securitised credit off banks, but only if backed by auto loans and equipment leases, in a bid to get credit flowing to car buyers.

One of the things bankers are looking for is essentially a much larger and far-reaching version of this program that would use public funds to create more demand for repackaged debt and bonds, essentially making taxpayers a lender of last resort to corporate Canada dur