Financial Update May 25, 2009

 TSX+43.83
 DOW -14.81
 Dollar +1.39c to 89.26USD
 Oil +$.62 to $61.67US per barrel
 Gold +$7.70 to $958.50USD per ounce
 Canadian 5 yr bond yields +.01bps to 2.27
 http://www.financialpost.com/markets/market-data/money-yields-can_us.html?tmp=yields-can_us

The yield, rate of return on your bond, can be read through a yield curve, which is the pattern of yields on bonds. This increase in bond yield is something to watch. If the bond yield continues to go up, the spread will continue to shrink and this could be a trigger for interest rates to rise


Bear Market
A market in which stock prices are falling. The rule of thumb seems to be at least 20%. However, a lot depends on how long the drop lasts. The quicker the rebound, the less likely that investor psychology will turn from optimism to the pessimism that usually accompanies a bear market.

Bull Market
A market in which stock prices are rising for a length of time. Prices need not rise continuously. There can be days, weeks and even months in which prices fall. What matters is the long-term trend. When it comes to people, bullish describes one who is optimistic

Interesting article below on credit and interest rate costs
Banks walk tightrope while hoping to cushion profit fall
Bulls believe earnings season will signal turning point for industry, but the bears are still urging caution

RITA TRICHUR
BUSINESS REPORTER TORONTO STAR

Swollen loan losses, soaring writedowns and slumping profits – it's enough to make even seasoned bank shareholders run for cover.

But with Canadian bank stocks on a rebound since March, wary investors are wondering whether it would be wise to hang on for the long-term or head for the exits while the getting is still good. Analysts appear divided on the hold `em or fold `em debate, but surmise that next week's round of second-quarter earnings should provide some sense of direction.

Banks, meanwhile, are facing a delicate balancing act for the remainder of fiscal 2009. In order to stay profitable, they have to keep loans flowing, while boosting some rates because the recession is rife with risk. At the same time, they must sop up climbing credit losses and maintain plump capital cushions – all without jeopardizing the sanctity of their dividends.

While acknowledging that the economic outlook remains murky, bank bulls argue this earnings season marks a turning point for the industry. For the first time in about 18 months, those much-maligned capital markets-related writedowns are not expected to eclipse the earnings parade.

The running tally of those charges hit $20.24 billion for the "Big Six" at the end of January. While more writedowns are anticipated for the February-to-April quarter, some analysts suggest this batch of reports could signal those charges are on the wane. With capital markets on the mend, many are also betting that results from the banks' trading businesses could even surpass expectations.

Another plus, rebounding stock prices have taken the banks' dividend yields out of the danger zone, which has dampened speculation of cuts to those sacred payouts. In fact, Michael Goldberg of Desjardins Securities is actually expecting "minimal dividend growth" for the second half of fiscal '09.

Those in the bear camp, however, are advising investors to be extremely cautious because bank stocks remain fraught with risks. In short, "the economy still sucks," observed John Aiken of Dundee Capital Markets in a research note to clients. He has a majority of "sell" ratings on Canadian banks, most because they are bracing for more bad loans as the economy sheds jobs and consumer bankruptcies soar.

Provisions for credit losses, the money banks set aside to cover bad loans, have been rising in recent quarters. Craig Fehr, an analyst with Edward Jones, predicts credit conditions will worsen for the rest of this year.

"We are seeing some of the pressures that have existed for the last year or so, largely on the capital markets side, are starting to subside. And we're exchanging that a bit for the pressures that are coming from good old-fashioned credit deterioration – higher loan losses," Fehr said in an interview.

"I think that we are going to see pretty substantial year-over-year increases in provisions across the board – for all the banks. We're talking about 50 to 100 per cent increases in provisions year over year."

The key trouble spots are likely defaults in credit-card lending, while commercial mortgages are also expected to show increasing signs of stress. The Canadian Imperial Bank of Commerce administers Canada's largest credit-card portfolio. It began curbing lending during the second half of fiscal 2008 but remains at risk of more losses, Fehr said.

Toronto-Dominion Bank, meanwhile, has large exposures to the hard-hit U.S. commercial real-estate sector and the sputtering Ontario economy, suggesting its "results might disappoint," said André-Philippe Hardy of RBC Capital Markets. His research also proposes that results from the Bank of Nova Scotia could miss expectations because it "is also exposed to rising credit losses in Latin America and the Caribbean."

While all banks are expected to pad their provisions, it appears to be "less of a negative" for Bank of Montreal, while National Bank of Canada is "least exposed to deteriorating credit quality near term" because of its regional concentration in Quebec, Hardy said.

Royal Bank of Canada, meanwhile, is facing its own challenges south of the border. Last month, RBC pre-announced an $850 million (U.S.) goodwill impairment charge for its international banking business. "The impairment charge is the result of the prolonged economic difficulties in the U.S., in particular the deterioration of the U.S. housing market, and the decline in market value of U.S. banks," noted Scotia Capital's Kevin Choquette.

Despite those economic hurdles, some analysts contend the Canadian banks' penchant for being "boring" retail lenders is standing them in good stead for longer-term profit growth.

While the banks' net interest margins – the difference between the money they make on interest and their own interest expenses – are being squeezed because of historically low interest rates, that pressure is expected to ease going forward for a number of reasons.

First, banks have taken action to hike their rates on popular consumer loans such as personal lines of credit and float-rate mortgages. "Banks have repriced some of their mortgages and we believe banks are now charging a premium of about 75 to 100 basis points over prime on a five-year variable mortgage versus a discount of 75 to 100 basis points before the crisis," Hardy said.

Moreover, the banks' key short-term funding costs have fallen in recent months. Medium-term funding is also down from crisis levels, while longer-term funding remains elevated. Banks are also benefiting from a surge of new deposits as their customers hoard cash.

Fehr said those various factors have created a wider spread between short-term and longer-term interest rates, which suggests that banks are poised to reap profits from interest income in the not-too-distant future. That's because banks tend to borrow "cheap" short-term funds to make longer-term loans that feature higher interest rates, he said.

"As we reprice on the long end and keep the short end very cheap, that spread will increase for the banks. And it will actually be a very strong driver of profits for them going forward," Fehr said.

"There's no doubt in my mind that (loan) volumes will slow relative to peak years. The idea here is that the profitability of each loan they make now has the potential to be higher. So, net interest margins, in my mind, will probably increase as we move throughout the year."

Retail sales rise for third-straight month

THE CANADIAN PRESS

OTTAWA–Retail sales increased for the third straight month in March in a further evidence of a stabilizing Canadian economy or at least a slowing of the torrid pace of decline experienced early this year.

And economists say the data, one of the last major pieces of information left that make up the first quarter gross national product reading, suggests the first three months of 2009 might not be as bad as some feared.

"I think we've put to bed the notion that the first quarter hit could be as large as nine or 10 per cent (contraction), which was some of the scare talk earlier in the year," said Derek Holt, vice-president of economics with Scotia Capital.

"Now we're only looking at about 6.5 per cent contraction."

That would still be the biggest quarterly decline in GDP since records began being kept in 1961, beating the 5.9 per cent fall-off in the early 1990s.

The actual retail sales pickup of 0.3 per cent in March, to $33.9 billion, was smaller than some economists had hoped. But it also obscures the better 0.7 per cent increase in the volume of sales.

That suggests Canadian were buying again, but partly because they were taking advantage of bargains, particularly large rebates at car dealerships.

Bank of Montreal economist Douglas Porter said after the sizable decline in retail sales last fall and over the holiday season, the modest bounce-back is at least partly pent-up demand and likely does not signal a major and lasting change of sentiment among consumers.

"It's nice to see three modest gains in the row, but we have to take into context that they took an absolutely massive step backward last year. We're only just beginning to recover," he said.

Statistics Canada noted the three consecutive months of gains in retail sales have not completely offset the sharp declines reported in November and December.

The agency says March's retail sales were 6.3 per cent lower than their peak in September 2008, and the volume of sales were down 2.6 per cent.

The main contributor to the rise was a six per cent volume increase in new vehicles, while the automotive sector as a whole increased by 0.5 per cent.

Holt cautioned that the new figures already show the gain in March auto sales won't be repeated when the April numbers are released next month, as "we already the volume of new vehicle sales was flat in April over March."

As well, higher food prices boosted sales at food-and-beverage stores, which rose 0.9 per cent, their third straight increase.

The largest drop in the four sectors that registered sales declines came at miscellaneous retailers where sales fell 0.7 per cent. The sector includes sporting goods stores and office supply stores.

Sales increased in seven provinces in March, led by a third straight month of rising sales in Quebec, at two per cent, and Ontario, at 0.6.

The largest sales decline in March was a 1.8 per cent drop in Alberta, coming on the heels of a 1.5 per cent decrease in February.