Actual finance blog

The Royal Bank of Canada expects to report a 15 per cent drop in fourth-quarter profit to $1.1 billion due to the global financial crisis when it releases its results next week.

The Royal is the latest big Canadian bank to report setbacks stemming from the shakeup swirling through financial markets.

In a preview of its results for the quarter ended Oct. 31, Canada's largest bank said Monday it is booking $360 million in one-time charges after taxes.

"These are challenging times, with extreme volatility in the global financial markets and an uncertain outlook," CEO Gord Nixon observed in a statement.

"However, RBC continues to be in a strong financial position."

The Royal's $1-billion-plus three-month profit contrasts with multibillion-dollar losses at big financial institutions in other countries – notably the United States, where the Bush administration undertook Sunday to rescue Citigroup by investing another US$20 billion of taxpayer money and backstopping US$306 billion of dubious loans.

In Toronto, RBC shares (TSX: RY) initially dipped on the morning's news but by midafternoon were up 5.5 per cent on the day, gaining $2.01 to $38.49 – still down from $54.50 a year ago.

Michael Goldberg of Desjardins Securities said the impact of market turbulence "looks to be relatively small" on Royal's overall earnings. He maintained a "buy" rating on the company's stock.

And DBRS confirmed its AA rating on RBC's senior debt, reflecting the bond rating agency's view "that the writedowns are manageable, given the strength of the bank's earnings profile."

Last week, TD Bank (TSX: TD) said its fourth-quarter earnings will be hit by a $350-million loss on wholesale banking operations, and Bank of Nova Scotia (TSX: BNS) warned of a $595-million impact.

Royal, which will report full fourth-quarter and year-end results Dec. 5, said its market-related charges include $645 million in writedowns of held-for-trading securities free business cards. It also booked $355 million in losses on available-for-sale securities.

These losses were partly offset by a $330-million gain caused by widening credit spreads and a $250-million reduction in provisions for lawsuits related to failed U.S. energy company Enron Corp.

Royal said its provision for credit losses for the fourth quarter to be about $620 million, up from $334 million in the third quarter.

Goldberg pointed out that the Royal is the first big Canadian bank to warn of "some weakness in credit quality in addition to trading losses."

He also called it "sort of a perverse accounting situation" that the Royal's $1 billion of trading losses would be partly offset by $330 million of gains related to the mark-to-market of its own obligations.

The RBC results also are being helped by new accounting measures that soften the blow from trading losses and a souring U.S. lending environment.

In face of mounting concerns over how deep a recession could go, “in relative terms they (RBC) are well positioned," said Goldberg.

The Royal, TD and Scotiabank are "seen to be less sensitive" to credit crunch issues, he added.

"But we still haven't seen CIBC and Bank of Montreal, the two banks considered more sensitive."

The Royal, active in all parts of the Canadian financial services sector, is also a major U.S. regional bank through its Centura unit based in the southeastern states, hard hit by collapsing property prices.

Canada's banks are widely acknowledged as among the most strongly positioned in the world, but have said they won't be unscathed by the global upheaval.

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Bush administration officials have had talks with the nation’s automakers about providing possible federal help for the cash-starved companies, a White House spokeswoman said Monday.

Spokeswoman Dana Perino, responding to questions at her daily press briefing, said a decision had not yet been made about whether federal help will be offered to General Motors (GM, Fortune 500), Ford Motor (F, Fortune 500) and Chrysler LLC.

A number of experts have expressed concern that the automakers, which have suffered a sharp plunge in sales, could run through their cash reserves by next year.

The automakers could get help through the $700 billion Wall Street bailout passed by Congress earlier this month. The bailout was designed to prompt banks and securities firms to loan money to businesses and consumers, but automakers might qualify for help through their finance arms, Perino said.

"It’s possible that some of those financing arms could be a part of the rescue package, the TARP, as they call it, at the Treasury Department," Perino said. "That’s one of the reasons Treasury has been in contact with them."

Earlier this year, Congress approved a separate $25 billion loan program to help the automakers finance a switch in production from larger vehicles, such as pickups and full-size SUVs, to more fuel efficient vehicles.

The government has not started dispersing money under that program. The Department of Energy is working on regulations to govern the loans.

"I think that it’s clear that the automakers are dealing with a very serious situation," Perino said. "They have been for some time."

GM spokesman Greg Martin acknowledged Monday that automakers are interested in getting help from the federal government.

"We have been in contact with a variety of federal officials for some time during this extraordinary and difficult economic period," said Martin, who is the automaker’s Washington-based spokesman.

Martin declined to elaborate on the discussions. "We have said publicly that we believe the federal government should consider all of the tools available to it - some recently enacted - to support industries that are in distress and that are essential to the U.S. economy."

A Chrysler spokesperson said the company "worked hard" after the bailout was proposed last month "to be sure it was broad enough to offer the tools to address the automotive credit liquidity problem."

Ford declined to comment. Industry officials suggested that Ford was the least likely to be pushing for bailout funds because it had the strongest cash position of the three U.S. automakers.

Last week, Michigan’s 17-member congressional delegation signed a letter to Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke asking that the federal government help the U.S. automakers. The delegation is made up of nine Republican members of the House and seven Democrats, along with the two Democratic senators.

"There is no single segment of America’s economy that is more critical to the financial well-being of millions of Americans than the automotive industry," the letter stated. "One in ten American jobs is related to auto manufacturing one hour cash loan.

"In this current economic environment it is imperative that the government ensures that liquidity is restored so that the U.S. auto industry is able to function until normalcy is restored to credit markets," the letter continued.

Officials with the presidential campaigns of Democratic candidate Barack Obama and Republican John McCain have said they want the original $25 billion loan money made available to automakers more quickly. The loan money was originally authorized last year and finally enacted this year as part of an energy bill.

"It should not take 18 months to issue loans that were authorized in 2007," said Douglas Holtz-Eakin, McCain’s senior economic policy adviser.

The Wall Street Journal reported Monday evening that the Department of Energy may release to GM $5 billion from the $25 billion loan program.

Both presidential campaigns said they are open to using the Wall Street bailout program to help automakers, but they didn’t make firm commitments.

Jason Furman, Obama’s top economic policy adviser, said his candidate wants Treasury and the Federal Reserve to explore the subject.

"At the end of the day, Senator Obama has pledged that all options will be on the table to help our nation’s auto industry succeed," Furman said.

Holtz-Eakin said that McCain supports using the Wall Street bailout to help any industry that qualifies.

"It seems pretty clear that GMAC does, although Treasury will have to decide for others," he said. General Motors owns 49% of GMAC, a finance company that has an extensive home loan portfolio in addition to auto loans.

All of the automakers have announced plant closings and payroll reductions in recent years to stem losses from their core North American auto operations. Their combined U.S. sales in the first nine months of this year are down nearly 20% from year-ago levels.

Just last week, privately-held Chrysler LLC announced it would eliminate one in four salaried jobs at the company. It also said it would cut a shift at an Ohio plant and accelerate the planned closure of a Delaware assembly line.

Also last week, GM said that it is on track to meet its goal of a 20% reduction in salaried staff costs, and added that further cuts could be needed because of the weak sales environment.

GM and Chrysler are reported to be in talks about a possible merger that could eliminate tens of thousands of additional jobs in an effort to save billions of dollars. But finding financing for such a deal in the current environment has proved difficult.

Investors have also been scared away from the sector. Last week financier Kirk Kerkorian, the largest individual investor at Ford outside of the Ford family, announced that he had sold 7.3 million shares of Ford and was looking to sell his remaining 133 million shares. The sale means he’ll take a big loss on the Ford stake he purchased earlier this year. 

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Amidst all the chaos surrounding the $700 billion Wall Street bailout plan, the federal government’s other housing rescue program quietly opened for business Wednesday.

But will any mortgage servicers come knocking?

The Federal Housing Administration unveiled its $300 billion Hope for Homeowners program, which allows struggling borrowers to refinance into more affordable mortgages backed by the federal government. The legislation, which was signed into law in late July, was hotly debated for months on Capitol Hill with Democrats supporting it and Republicans opposed.

Before the so-called Wall Street bailout emerged, this FHA program was the federal government’s answer to the mortgage crisis. It was seen as a primary means to stemming the foreclosure tide and stabilizing the housing market.

Even now, foreclosure prevention measures in the current bailout legislation call for the Treasury Secretary to modify more loans through the FHA program.

"For homeowners in trouble, this may be the help they need," said Steve Preston, secretary of the federal Department of Housing and Urban Development, which oversees FHA. "It is yet one more way that families may be helped to weather the current turbulence in the housing market."

Banks, however, didn’t receive the program’s details from the FHA until Wednesday, and say it will likely be weeks before they can offer it to their customers.

Even then, lenders probably won’t rush to participate in the program, which is voluntary, since it requires them to take a pretty significant losses on the loan principal in most cases. Instead, banks have said that they’d prefer to use their own mortgage modification programs where they can better control the terms.

"We will continue to plow ahead with our own efforts to keep homeowners in their homes," said David Bradley, spokesman with Bank of America, which completed 15,750 loan modifications in August. "We’ve already been pretty aggressive in that regard."

Eligible borrowers must:

have taken out their mortgages on or before Jan. 1, 2008 and have made at least six payments.

be unable to afford their current loan, but did not intentionally miss payments.

have a debt-to-income ratio of at least 31%.

live in the house and not own other homes.

have provided accurate information on their loan documents and not been convicted of fraud in the past decade.

Under the program, borrowers will get:

a 30-year, fixed rate mortgage of up to $550,440 (no fax payday loans).

a new appraisal and loan for no more than 90% of the home’s value.

released from second mortgages and prepayment penalties.

But homeowners must pay a premium of 3% of the loan’s value upfront, and 1.5% of the outstanding mortgage amount annually 1500 payday loans. Also, they must share any appreciation in the home’s value with the FHA when they sell.

The law allows the FHA to insure up to $300 billion in new loans.

"This program can contribute meaningfully to stability in the housing market, while at the same time providing the appropriate safeguards and limitations to protect the interest of taxpayers," said Elizabeth Duke, Federal Reserve governor.

But HUD officials Wednesday backed away from the Congressional Budget Office’s original estimate that the bill will help 400,000 troubled borrowers.

"It’s very very difficult to really put a finger on it," Preston said.

It’s tough to forecast the program’s success in part because banks have had a very lukewarm reaction to it. Four large servicers told lawmakers two weeks ago that they would use the program only as a last resort.

The problem is that the Hope for Homeowners program requires banks to reduce the loan’s principal to 90% of a home’s current appraised value, which is likely to be much less than the owner paid for it. Lenders prefer to freeze or cut interest rates so they can at least recover the original amount of the loan, said Tom Kelly, spokesman for JPMorgan Chase, which has worked with 110,000 customers to modify or rework their loans between January 2007 and July 2008.

"You lock in your loss," Kelly said, by reducing loan principal.

Banks might turn to Hope for Homeownership if they feel the loan is hopeless and just want to get rid of it, he continued.

Lenders also won’t be pleased with the new home appraisals, which will show them just how underwater their borrowers are, said James Gaines, research economist at the Real Estate center at Texas A&M University.

He doesn’t see a lot of lenders flocking to the program.

"It will help some people, but it won’t be the universal panacea that people would like it to be," he said. 

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In the span of just 11 days, the Bush administration and lawmakers, seeing ominous warnings in the credit markets, rushed to create legislation to prevent a potential economic meltdown. Monday, the resulting $700 billion bailout package was defeated in a dramatic House vote.

The bill was designed to get financial institutions lending again by letting the U.S. Treasury buy up their troubled assets, most of which are tied to the housing market crash.

But after much contentious debate, and the addition of several taxpayer protections, the package was rejected by the House in a vote that was 228 to 205 against. The measure would have needed 218 votes for the House to pass. The next steps were not immediately clear but supporters were scrambling to put it up for another vote.

"I’m disappointed," said House Financial Services Chairman Barney Frank, D-Mass., talking to reporters after the vote. Noting that the Administration painted a dire picture of economic calamity if legislation didn’t pass, Frank said, "I’d like nothing better than to be proven wrong in the next few days. I was persuaded that we have a serious crisis and we’re threatened with a shutdown of the credit system when the economy is already weakened."

The credit markets had been seized up all day Monday, and after the vote, the Dow Jones Industrial Average started to plummet and ended the day down 778 points, the worst point drop ever. On a percentage basis, though, the Dow drop was only about 7%, far less than the 22% slide on Black Monday in 1987.

Here’s a quick breakdown of some of the bill’s key provisions:

Doling the money out: The $700 billion would be disbursed in stages, with $250 billion made available immediately for the Treasury’s use. Authority to use the money would expire on Dec. 31, 2009, unless Congress certifies a one-year extension.

Protecting taxpayers: The ultimate cost to the taxpayer is not expected to be near the amount the Treasury invests in the program. That’s because the government would buy assets that have underlying value.

If the Treasury pays fair market value - which investors have had a hard time determining - taxpayers stand a chance to break even or even make a profit if those assets throw off income or appreciate in value by the time the government sells them. If it overpays for the assets, the government could be left with a net loss but would get something back on the open market for the assets when it eventually sells them.

If it ends up with a net loss, however, the bill says the president must propose legislation to recoup money from the financial industry if the rescue plan results in net losses to taxpayers five years after the plan is enacted.

In addition, Treasury would be allowed to take ownership stakes in participating companies.

Stemming foreclosures: The bill calls for the government, as an owner of a large number of mortgage securities, to exert influence on loan servicers to modify more troubled loans.

In cases where the government buys troubled mortgage loans directly from banks, it can adjust them more easily.

Limiting executive pay: Curbs would be placed on the compensation of executives at companies that sell mortgage assets to the Treasury quick payday. Among them, companies that participate will not be able to deduct the salary they pay to executives above $500,000.

They also will not be allowed to write new contracts that allow for "golden parachutes" for their top 5 executives if they are fired or the company goes belly up. But the executives’ current contracts, which may include golden parachutes, would still stand.

Overseeing the program: The bill would establish two oversight boards.

The Financial Stability Oversight Board would be charged with ensuring the policies implemented protect taxpayers and are in the economic interests of the United States. It will include the Federal Reserve chairman, the Securities and Exchange Commission chairman, the Federal Home Finance Agency director, the Housing and Urban Development secretary and the Treasury secretary.

A congressional oversight panel would be charged with reviewing the state of financial markets, the regulatory system and the Treasury’s use of its authority under the rescue plan. Sitting on the panel would be 5 outside experts appointed by House and Senate leaders.

Insuring against losses: Treasury must establish an insurance program - with risk-based premiums paid by the industry - to guarantee companies’ troubled assets, including mortgage-backed securities, purchased before March 14, 2008.

The amount the Treasury would spend to cover losses minus company-paid premiums would come out of the $700 billion the Treasury is allowed to use for the rescue plan. 

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Britain is set to nationalize troubled bank Bradford & Bingley on Monday after Spanish bank Santander agreed to buy its retail deposits and branch network.

B&B would be the second British bank nationalized this year and the latest in a string of high-profile banks in Europe and the United States to fall victim to the global credit crunch.

Santander will pay about 400 million pounds ($735 million) to acquire 2.7 million Bradford & Bingley customer savings accounts containing some 21 billion pounds of deposits, a company spokesman said.

It will also take over the mortgage lender’s network of around 200 branches, the spokesman said. The B&B brand will remain for now but the accounts will transfer to Abbey, a British bank bought by Santander in 2004.

Finance minister Alistair Darling is expected to announce plans early on Monday to nationalize the remainder of Bradford & Bingley, people familiar with the matter said free credit report.com.

The Treasury led intense talks on the rescue of Britain’s 9th biggest mortgage provider over the weekend.

The government would have preferred a private-sector buyer to acquire all of B&B, but rivals appeared unwilling to take on B&B’s 41 billion pound residential mortgage portfolio amid the global credit crisis and weakening British housing market.

B&B shares tumbled to a record low on Friday and closed at 20 pence, valuing the company at less than 300 million pounds. 

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Mortgage finance giant Fannie Mae, taken over by the government earlier this month, announced Friday the resignations of four senior executives and said it was restructuring its organization.

The company, the biggest buyer and guarantor of home loans in the country, and its sibling Freddie Mac (FRE, Fortune 500) were taken over on Sept. 7 in a rescue plan that eventually could require the Treasury Department to put up as much as $100 billion for each of them over time if needed to keep them afloat as mortgage losses mount.

The executives and boards of both companies are being replaced. Herbert Allison, the former head of the TIAA-CREF retirement investment fund, was immediately selected to head Fannie Mae, and David Moffett, a former vice chairman of US Bancorp (USB, Fortune 500), was chosen to head Freddie Mac.

The Fannie Mae (FNM, Fortune 500) executives whose resignations were announced Friday are Chief Business Officer Peter Niculescu, Executive Vice President and General Counsel Beth Wilkinson, Executive Vice President and Chief Information Officer Rahul Merchant, and Senior Vice President for Government and Industry Relations Duane Duncan.

In addition, Fannie Mae said its three lines of business - single-family mortgage guaranty, capital markets, and housing and community development - and their top managers will report directly to Allison, who is president and CEO pay day loan. The technology and operations division will report to Chief Operating Officer Michael Willliams, while the structure of the government and industry relations division is under review, the company said.

"Fannie Mae is building a new organizational structure as we take the company in a new direction to serve a dramatically changing market," Allison said in a statement. 

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Waste Management, the nation’s largest trash hauler, is boosting its buyout offer for rival Republic Services by 9% to $37 per share.

Houston-based Waste Management (WMI, Fortune 500) says it is willing to pay about $6.99 billion, for the Ft. Lauderdale, Fla.-based Republic Services Inc (RSG)., which rejected a $34 per share, or $6.19 billion, offer in July.

The new offer, represents a 32.6% premium to Republic’s closing stock price on July 11, the last trading day prior to the public disclosure of Waste Management’s proposal.

Under the new deal, Waste Management would pay Republic $250 million if the companies were unable to close the deal because of antitrust issues payday loans. Waste Management said any deal between the companies could close by early 2009. 

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Mortgage finance giant Freddie Mac on Wednesday reported a much bigger-than-expected loss, slashed its dividend and warned of more problems ahead for the battered housing and credit markets.

Company executives, in a sobering forecast about the nation’s housing woes, said nationwide home prices are likely to drop another 7% to 9%. Those declines, and other problems in the economy, are likely to cause additional losses on the $1.8 trillion worth of single-family loans that Freddie guarantees or owns.

"Today’s challenging economic environment suggests that the housing market is far from stabilizing," Freddie Mac CEO Richard Syron said during a conference call.

Syron and other Freddie executives sought to assure investors that the company is prepared to ride out the difficulties.

But investors were unconvinced. Shares plunged 19% in afternoon trading. The decline also dragged shares of Fannie Mae (FNM, Fortune 500), which operates in the same business as Freddie and is set to report quarterly results on Friday, down 15%.

Early Wednesday, Freddie (FRE, Fortune 500) reported that it lost $821 million, or $1.63 a share, in the second quarter. Analysts surveyed by Thomson Reuters had forecast it would trim its loss to 41 cents a share from the $151 million or 66 cents-a-share it lost in the first three months of the year.

A year ago, the company earned $729 million, or 96 cents a share.

Freddie also announced that it would cut its quarterly dividend to 5 cents a share or less, subject to a final decision by its board, from 25 cents a share in an effort to save capital. Losses have strained Freddie’s capital, and the dividend cut should save the company more than $500 million a year.

Freddie’s year-to-date losses of nearly $1 billion are far below the $3.7 billion it lost the second half of 2007 as it took charges for the value of its loans portfolio. The current losses are driven by the rapidly rising costs of loan defaults and rising provisions for future losses that are certain to rise.

"While we may be roughly half way through the eventual decline, we are still in the early stages of realized defaults," said Patricia Cook, the company’s chief business officer. "Most of the expected losses are yet to be realized."

Since the start of 2007, Freddie’s portfolio of single-family home loans suffered credit default costs of nearly $2 billion. Three months ago the company estimated that those defaults could end up costing between $15 billion and $20 billion during the life of the loans.

But with steeper home price declines now being forecast, and the increasing rate of mortgage foreclosures and delinquencies, Freddie expects those costs to go higher - to as much as $42 billion in what it says is a worst-case scenario.

Freddie officials said the company should have enough capital to deal with even those worst-case losses, once it goes ahead with plans to raise $5 billion in additional capital.

"We have the wherewithal and the earning power to manage through this period," said Buddy Piszel, its chief financial officer.

Freddie said its estimated core capital slipped to $37.1 billion at the end of the quarter from $38.3 billion at the end of March 500 fast cash. That capital level is about $2.7 billion above the level it agreed to meet with its federal regulator.

Provisions for credit losses more than doubled to $2.5 billion from $1.2 billion in the first quarter. The reason: increases in the delinquency and foreclosure rates of the mortgages Freddie owns and guarantees, as well as the continued declines in home prices.

Those provisions for credit losses caused the company to lose $1.4 billion on the guarantees it makes on loans for single-family homes - about triple the $458 million loss on that line in the first quarter. The company made $129 million on those guarantees in the year-ago period.

The company saw losses soar even though its net interest income, the difference between interest paid and interest income soared to $1.5 billion from $793 million a year ago, due to lower interest costs for the firm in the just completed quarter.

That rise in net interest income was more than offset by the $3.3 billion hit in investment activity due to the reduced estimated value of its holdings. That’s up from a loss of $540 million a year earlier.

About $1 billion of the most recent investment loss was caused by the decline in the value of Freddie’s mortgage securities, which are backed by subprime mortgages or so-called Alt-A home loans made to borrowers who did not provide full or any verification of income or assets.

Freddie and Fannie Mae (FNM, Fortune 500), which were set up by the government to provide funding for the mortgage markets, have become the primary source of capital for banks and other lenders making home loans. They are seen as crucial to the recovery of the housing and credit markets.

But investor anxiety about the firms has driven shares of Freddie down by 66% between June 16 and Tuesday’s close, while Fannie shares lost nearly half their value during the same period. It also prompted Congress to pass a rescue measure for the firms, allowing the Treasury Department to loan them an unlimited amount of cash and even buy their shares if necessary.

Syron was asked Wednesday if Fannie and Freddie, known as government sponsored enterprises or GSEs, can continue to operate in a way that both helps the housing market and makes the profits that shareholders demand. He said he believes they can continue to serve both missions going forward, despite these losses.

"I don’t think we’re at a point that the model doesn’t work anymore," he said. "I think we are a point where the model is more stressed."

"I think virtually everyone, including our critics, would say that this would be an extremely ugly mortgage market if you didn’t have the GSEs in it," Syron said. 

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Washington’s plan to rescue the housing market may help shore up the U.S. economy as it copes with the worst slump in the housing market since the Great Depression, but don’t look for a swift recovery.

Investor confidence has been bolstered by the government’s recent proposals, driving stock price higher since last week, and economists agree the move to provide extra funding for mortgage giants Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) is vital.

One unintended consequence, however, has been rising interest rates as the bond market has sold off sharply since the plan was unveiled last week. That risks muting, at least in part, the broader benefit of supporting the two mortgage finance firms.

The U.S. House of Representatives approved the housing plan on Wednesday afternoon, with the Senate expected to vote on it later.

Policy-makers and economists see the government sponsored enterprises as crucial to keeping the housing market open for business since they own or have guaranteed almost half of the $12 trillion in U.S payday advance. mortgage debt outstanding.

Financial markets’ recent loss of confidence in the GSEs led many economists to contemplate the consequences if they were to collapse, convincing many that measures being taken by Congress were necessary.

“It’s necessary and it will have positive benefits to the U.S. economy for a period while we’re in such difficult straits,” Brian Fabbri, managing director of economic research at BNP Paribas, said about the rescue package, which has also been supported by the U.S. Treasury.

“If there is no GSE Treasury help, the housing market wouldn’t just be in recession or declining, it would plunge. We wouldn’t begin to estimate how low it might go if GSEs were not able to fulfill their mission.”  

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Drug developer Merck says its second-quarter profit rose 5% as cost-cutting efforts offset a drop in sales of its asthma treatment Singulair and cholesterol drugs Zetia and Vytorin.

Whitehouse Station, N.J.-based Merck & Co (MRK, Fortune 500). says profit rose to $1.77 billion, or 82 cents per share, from $1.68 billion, or 77 cents per share, during the prior-year period. Sales fell 1% to $6.05 billion from $6.11 billion.

Excluding restructuring charges, Merck says it earned 86 cents per share faxless payday loans.

Analysts polled by Thomson Financial expected profit of 83 cents per share on revenue of $6.05 billion.

Merck shares fell 23 cents to $35.10 in after-hours trading after falling $2.35, or 6.2%, to close at $35.33. 

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