Posted by: Daryl & Wendy Ashby | February 28, 2010

Credit Provisions

A year after the worst financial meltdown in more than 60 years and in the wake of an equally historic recovery, analysts are closely watching the pile of cash set aside by the big banks to cover future bad loans known as provisions for credit losses.

The reason is simple: If the provisions get smaller, it’s a sign that the economy is truly on the mend just as most economists predicted. If, on the other hand, the money pile gets bigger, that would suggest the banks are preparing for a less positive future.

We get our first peek of the year at what the industry is expecting when Canadian Imperial Bank of Commerce reports its first-quarter results this morning, kicking off earnings season for the big banks.

Analysts generally believe the worst is over or soon will be with provisioning declining in 2010 against the backdrop of a strengthening economy.

Jim Bantis, an analyst at Credit Suisse, scaled back his forecast for 2010 credit-loss provisions at the Big Six from $12-billion to $10.6-billion because of recent stability in credit card losses and the absence of large corporate loan losses.

John Aiken, an analyst at Barclays Capital, is similarly optimistic. “All signs point to improving credit quality and lower provisions,” he said in a research note.

Brad Smith, an analyst at CI Capital Markets, takes a more bearish view, pointing to continued deterioration in credit conditions in the United States in the past three months of 2009. “With limited improvement evident in recent domestic employment and bankruptcy data, scope for adoption of a more optimistic view of domestic credit in our view remains limited,” Mr. Smith said in a note.

Another reason for the concern around loss provisions is the sheer scale of the underlying borrowing. While Canadian banks have become global models for conservative risk management practices, the behavior of some of their customers has become a major cause for concern for some industry insiders.

Household borrowing compared with income has risen to 145%, from around 95% two decades ago and could exceed U.S. levels in the next three years, according to Moody’s Canada. The concern is that if the economy suddenly deteriorates or if interest rates take a jump, many of those borrowers could find themselves unable to make the payments on their loans.

Peter Routledge, a senior vice-president at the rating agency, questions whether the banks are properly considering such a scenario. The conventional wisdom is that Canadians will try to meet their mortgage payments even if the house price falls below the value of the loan, and that idea is baked into many bank forecasts.

The trouble is that consumer behaviour is often very difficult to predict and historical performance is not always the best guide, Mr. Routledge said

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