More writedowns expected at Citi, Merrill

 SINCLAIR STEWART

 NEW YORK — Earlier this week, an unemployed banker named Joshua Persky paraded himself in front of Charles Schwab’s headquarters in midtown Manhattan, handing out résumés and wearing his credentials – quite literally – on his chest: “MIT Graduate for Hire,” announced the placard that dangled over his pinstriped suit.

Mr. Persky, who lost his job six months ago, is a fitting poster boy for life these days on Wall Street, which has already shed tens of thousands of jobs and bled more than $100-billion (U.S.) in losses amid a protracted credit crisis. Unfortunately, the pace of these losses shows no sign of slowing down, leaving investors to contemplate an ugly question: just how much blood is left?

Citigroup Inc. and Merrill Lynch & Co., two of the biggest names in the U.S. financial sector, were hammered in the markets yesterday after analysts predicted yet another round of massive writedowns related to the toxic subprime mortgage sector. Other bank stocks tumbled in their wake, dragging the Dow Jones industrial average down nearly 360 points, or 3 per cent.

There had been cautious optimism this spring that the worst of the storm had passed, especially after the Federal Reserve Bank stepped in to help with the bailout of Bear Stearns. But several key indices tracking the subprime sector have taken nosedives in recent weeks, forcing banks to reduce the value of their loan-backed securities by tens of billions of dollars.

“Fundamentals continue to deteriorate as expected, but the pace of deterioration appears to be far worse than we originally anticipated,” William Tanona of Goldman Sachs wrote in a research note yesterday.

Mr. Tanona, who reduced his outlook on the brokerage sector to “neutral” from “attractive,” added that the turnaround in business trends for investment banks that he had been expecting in the second half of this year may not happen as fast as he thought.

One of the big reasons Mr. Tanona and others have soured on brokerages? The grisly performance of Citigroup and Merrill, among others. He predicted Citigroup, which is trading at roughly one-third of last summer’s value, will take an additional $8.9-billion in writedowns when it unveils its second quarter numbers next month. That is on top of the $44-billion in credit losses it has already suffered.

Analysts expect Merrill to take charges of between $3.5-billion and $4.2-billion, which would drive the retail broker to its fourth consecutive quarterly loss.

UBS AG, Morgan Stanley, Bank of America, and several others have also been battered by their exposure to mortgage-related derivatives known as collateralized debt obligations, or CDOs. CDOs are pools of debt, backed by assets like mortgages, which are then sliced into different pieces with varying credit quality.

Indeed, every quarter seems to witness tens of billions of dollars worth of new charges, and tens of billions of dollars worth of capital raising efforts to help keep balance sheets intact.

“It’s just unfathomable that stuff that was rated AAA is now trading at 11 cents on the dollar, conceded one analyst, whose firm does not allow him to comment publicly. “At 20 cents we thought it couldn’t get any worse.”

Banks now face the challenge of keeping their capital levels strong at a time when the business environment is poor, and when it is difficult to increase revenue. Citigroup has already raised about $40-billion by seeking investments from sovereign wealth funds, issuing preferred shares and cutting its dividend. Some analysts are predicting it will have to cut the dividend yet again in order to free up capital. Regulators require banks to maintain specific capital ratios to ensure a measure of financial soundness.

The Federal Reserve, mindful of the capital constraints facing banks, suggested yesterday it is examining ways to make it easier for large investors like private equity funds to take ownership stakes in the banking sector, according to The Wall Street Journal.

Under current rules, anyone amassing a stake larger than 9.9 per cent is subject to regulatory scrutiny. Those who surpass 24.9 per cent must register as a bank holding company.

With no end to the current problems in sight, most of the financial sector was hard hit by investors. Citigroup fell 6.3 per cent to $17.67 yesterday, its lowest level in a decade, while Merrill’s stock dropped 6.8 per cent to $33.05.

ANGELA BARNES

 WHAT ARE WE LOOKING FOR?

Every summer, George Vasic, strategist at UBS Securities Canada, releases a series of reports on the best dividend-growth stocks in Canada, based on data for the past 10 years. And this summer’s edition is likely to attract more attention than usual.

A year ago, markets, not only in Canada but also around the world, seemed to be going only one way – up. But that changed last August when news of the global credit crunch started to hit the headlines. Down the markets went. And dividend-paying issues probably gained more fans than they had before, because of the market situation.

Yesterday, we updated the pricing information on Mr. Vasic’s summer, 2007 list of stocks included in the S&P/TSX 60 index – the blue-chip issues in other words.

Today , we move beyond that and look at other dividend-growth stocks listed on the Toronto Stock Exchange.

WHY DIVIDEND-GROWTH STOCKS?

Mr. Vasic found that dividend-growth issues make superior investments. He recommends investors don’t chase the high-yield stocks, as the stocks with the best dividend-growth records usually outperform them and the market as well.

As with the TSX 60 issues, a significant number of the dividend-growth stories are in the financial sector. Mutual fund companies are particularly evident in the rankings, including AGF Management and IGM Financial, which numbers Investors Group and Mackenzie Financial among its subsidiaries.

But other sectors were represented as well, including industrial firm CCL Industries, Empire Co., whose holdings include insurance and real estate interests and food stores, and TSX Group, which operates the Toronto Stock Exchange.

WHAT WE FOUND IN OUR UPDATE

Each stock has fallen over the past 12 months, but the range of declines varied all the way from AGF’s 36-per-cent drop to TSX Group’s 1.5-per-cent drop. Moreover, all but four – IGM Financial, AGF and Empire – have lost ground over the past month. Power Financial Corp. was basically unchanged.

We also noted that the dividend yields for this group of companies were closer together than they were for the blue-chip dividend-growth stocks. The range for this group was 1.6 to 4.4 per cent whereas the range for the blue chips was between 0.6 and 6.2 per cent.

Dividend-growth stocks beyond the S&P/TSX 60

SOURCE: GLOBE INVESTOR AND UBS

JOHN HEINZL

June 18, 2008

I’ve given some thought to why I missed out on most of the multibaggers of the past few years – the RIMs, Potashes and Timmincos – and the best explanation I’ve come up with so far is this: I’m a big fat idiot.

Why? Because when everyone else is doing the logical thing and shovelling money into growth stocks that are shooting to the moon, only a big fat idiot would stubbornly sit on a portfolio of boring dividend stocks that are, for the most part, doing jack squat.

And that’s being kind.

Yesterday, I was reminded of my rotten timing as Canada’s benchmark stock index surged to a record, propelled by a 3.6-per-cent gain in Potash, while most of my stocks – banks, pipelines, insurers, mutual fund companies, drug makers – are languishing below year-ago levels.

I haven’t had this much fun since my ingrown toenail got infected.

Why am I inflicting my misery on you, you ask? Because there must be a lesson here somewhere, a pebble of wisdom I can snatch from this dreadful post-credit-crunch lull when I’m getting poorer and everyone else is getting richer.

So here’s my thought for the day: No investing strategy is going to work all of the time. That’s right. At some point, every investor is going to feel like a big fat idiot. And the ones who say they don’t are probably lying.

But if you concentrate on building a low-cost, high-quality portfolio for the long term – and try to ignore the market’s short-term gyrations – you’ll one day feel like a genius. That’s why I’m confident that my conservative strategy – buying and holding stocks that pay rising dividends – will ultimately pay off, even though, right now, it’s like getting a hot poker in the eye.

Folks who have been at this game longer than I have certainly aren’t panicking.

“There will be rough spots and the prices will go down,” dividend growth guru Tom Connolly, who has published the Connolly Report newsletter since 1981, once told me. “Have faith and believe and don’t waver. That’s the key to the whole thing.”

Now there’s a concept: Don’t waver. For it is at times like these when the temptation to waver is strongest. And most dangerous. When stocks of great companies are sucking wind, that’s the time to be buying, not selling.

Perhaps a bit of history is in order. Studies have shown that, over long periods, stocks with dividends that rise regularly outperform those that pay stable dividends or none at all. That only makes sense; companies with rising payouts tend also to have rising profits and cash flows, which, over time, push up the share price.

For long-term investors, it’s far better to buy these stocks when nobody else wants them than to load up when prices are high.

Am I peeved that I haven’t made a killing on Potash and RIM and countless other stocks that have been defying gravity these past few years? Darn right I am.

Am I going to sell my dividend stocks to buy these high fliers now? Hell, no. If anything, I’ll be adding to my existing positions, and reinvesting the extra dividends in even more shares to take advantage of the magic of compounding.

Come to think of it, that’s not such an idiotic idea after all.

BRIAN MILNER AND ROBERT JACKSON

TORONTO, REYKJAVIK – Sheep farmer Bragi Vagsson’s ancestors have worked the same land for 500 years, making his farm one of the oldest in Iceland.

But this year, as Iceland grapples with sky-high interest rates, a crumbling currency and a crippling credit squeeze, Mr. Vagsson, like many Icelanders, is struggling.

He rhymes off the damages from inflation: Fertilizer is up 80 per cent; fuel, 25 per cent; animal feed, 50 per cent; vet’s bills, 25 per cent; bank interest on overdrafts, 21 per cent.

“It is going to be a tough year,” Mr. Vagsson says. “Prices are shooting up.”

On this resource-rich island in the North Atlantic, the global credit crisis has claimed its first national casualty, undermining a fragile currency and driving inflation and the official interest rate into double-digit territory.

Stagflation has struck with a vengeance. Over the past fifteen months, the rate of inflation has nearly doubled and is forecast to hit 15 per cent by July.

Economists are forecasting growth of less than 1 per cent this year and next, and official interest rates are at 15.5 per cent – the highest of any developed economy.

Many Icelanders are openly questioning whether the country should abandon its independent currency, the krona, in an effort to right the listing ship.

The question is whether Iceland is the first of several dominoes to fall – or a unique case.

Iceland may be tiny, but because it has its own floating, freely convertible currency and bankers and entrepreneurs who have aggressively cast their nets in foreign waters, its place in global finance outweighs its minuscule economic impact and lack of market significance.

It serves as a useful laboratory for economists, because changes in policies can have dramatic consequences in a remarkably short span.

“Inevitably, given its size, it basically means that when things go well, they go very well,” said Beat Siegenthaler, chief emerging markets strategist with TD Securities in London. “And then you have some backlash.”

Iceland’s painful experience serves as a showcase of what can happen to a rich country when a population falls in love with easy credit and a central bank takes its eye off the inflation meter in a financial system whose rapid growth has been fuelled by low-cost borrowing in foreign currencies.

The tiny, import-dependent island has a mere 313,000 people – fewer than half the number of residents on Vancouver Island – and occupies an area slightly smaller than Newfoundland.

Until recently, it was enjoying the fruits of a remarkable transformation triggered in the 1990s. Once largely dependent on fishing, the country boomed after the government liberalized the financial sector and cut taxes. Its three major banks have grown so large that they are now about eight times the size of the country’s GDP.

The government also lured foreign investment. Aluminum producers eager to take advantage of Iceland’s relatively low-cost hydro and thermal power spent heavily to build smelters.

Almost overnight, the economy jumped into high gear as privatized banks took advantage of their new flexibility – including considerably lower reserve requirements – to lend aggressively for construction, home mortgages and other domestic activities and to extend their footprints into foreign markets.

The Straettos, yellow buses that crisscross the capital of Reykjavik, were covered in posters offering 100-per-cent mortgages and soft repayment terms. But the buses themselves were mainly empty, as many Reykjavikars took advantage of low-interest loans in Swiss francs and euros to acquire vehicles imported from abroad.

In short order, Iceland became a leading importer of Range Rovers, selling more top-of-the-line models than the rest of Scandinavia put together – despite facing combined import duties and road taxes of 100 per cent. Vehicles that cost $100,000 in Canada were flying out of the showroom at the equivalent of $250,000 apiece.

The spending spree was not limited to cars. Newly affluent home buyers flocked to new apartment blocks, filling their parquet-floored homes with heavily taxed, imported appliances, furniture and electrical systems.

The tiny domestic stock market grew fivefold in value between 2002 and 2007.

But it was this growth, financed by foreign credit, that would later trip up the Icelanders when the global financial community turned off the spigot.

The financial world regards the banks as risky because they fear the Icelandic authorities will be unable to bail them out if they run into trouble. To assuage these concerns, Scandinavian central banks have pledged to support their Icelandic counterpart.

Even before the credit crunch and the surge in commodity prices, there were warning signs of danger ahead, because of rising costs and high consumer and corporate debt levels. The ratio of private sector and consumer debt to GDP was about 130 per cent at the end of last year.

But the Central Bank of Iceland was slow to react and was caught completely off guard by the credit mess.

“From a monetary policy perspective, they definitely reacted not soon enough,” said Ingolfur Bender, chief economist with Glitnir Bank, one of Iceland’s large banks. “It was quite evident three years ago that we were in an area which called for quite a harsh monetary stance.”

Instead, the central bank kept rates low as the housing market bubbled over.

Now, the authorities are probably going to react too late again, Mr. Bender said.

“The economy is faced with several shocks. Not just the global credit crunch, but slowing global growth, high oil prices, the end of investment in the aluminum sector here, a cut by one-third in our cod quota and so forth. So you don’t need the monetary policy to cool down the economy.”

Although unemployment remains a low 1 per cent, ordinary Icelanders face tough times because inflation has been raising the cost of their debt and eroding their purchasing power.

“What worries most people now is the mortgages, which are inflation-indexed and keep getting higher while property prices are expected to go down [further],” said Bjarni Brynjolfsson, editor of Iceland Review magazine.

Public sector workers have been seeking – and winning – double-digit wage increases to keep pace with spiralling inflation.

Dairy farmers recently announced an across-the-board increase of 14 per cent on all products and food importers warn of price hikes in excess of 25 per cent. That’s a huge problem in a country that has to import most of what it consumes beyond fish, sheep and dairy products.

But even after a marked slowdown in the second half of last year, the economy still managed to grow at just under a 4-per-cent clip, an impressive level for any developed nation.

Today, the housing market is contracting and prices are falling. Many projects have been put on hold.

“The residential building market is all but dead,” said Gunnar Valur Gislason, chief executive officer of Eykt, one of the country’s leading construction companies. “But the bank analysts predict a return to normality in the tail end of 2009. In the meantime, we are concentrating on a few large commercial projects to keep us going.”

The overheating had to come an end eventually, and if the trigger had not been the credit crunch, it would have been something else, economy watchers say.

“It had to come to a stop,” said Sigurdur Johannesson, a research economist with the University of Iceland’s Institute of Economic Studies. “I don’t think it was sustainable.”

Click on the link to view the Post
Lack of Transparency = Shareholders get Ratcheted