The planned initial public offering of credit card giant VISA Inc. is likely to offset much of the pain of the almost $2-billion pretax writedown on the Big Six banks’ fourth-quarter earnings, a result of the ongoing credit crunch. However, that may prove to be a temporary salve, as more writedowns are probably ahead.

In aggregate, the Big Six banks have announced $1.9 billion in fourth-quarter pretax charges resulting from their exposure to troubled credit markets, including asset-backed commercial paper (ABCP), collateralized debt obligations (CDOs) and structured investment vehicles (SIVs).

Mercifully, they are also expecting to record about $1.25 billion in pretax gains as a result of the planned VISA IPO. The banks, after offsetting various one-time charges against the unusual gains, are facing a collective hit of slightly less than $1 billion to fourth-quarter earnings.

That’s not inconsequential, but it’s not critical to the banks’ total profit picture. And it certainly doesn’t dent their stability.

It also pales in comparison to some of the losses being taken by the world’s other large financial institutions. Citigroup Inc. is anticipating losses of US$8 billion-US$11 billion when it next releases financial results. And Merrill Lynch & Co. Inc. has announced a US$8.4-billion writedown. (Both performances have led to the departure of the firms’ CEOs.) Several other large financial services firms have also seen losses in excess of $1 billion.

So far, the Canadian banks’ pain appears to be comparatively minor. On an after-tax basis, their collective total writedown is merely $356 million.

Of course, the Big Six banks aren’t affected equally. The biggest loser in the quarter is Montreal-based National Bank of Canada, which is not only planning to take the largest hit from the credit crunch ($575 million pretax, $365 million after-tax) among the group but it is not getting any help from the VISA IPO.

Conversely, Toronto-based TD Bank Financial Group is anticipating a gain from the IPO of $163 million pretax, or $135 million after-tax, and it has no negative impact from the credit crunch to report this quarter.

“All the bad news about structured-credit markdowns at the other Canadian banks can be viewed as good news for TD,” notes Montreal-based Desjardins Securities Inc. in a report.

TD’s clean quarter demonstrates the wisdom of choosing discretion over valour in the financial services business. TD began bailing out of the global structured-products businesses a couple of years ago, after realizing that the products were riskier than commonly thought and that many of the top players didn’t really understand what they were doing.

TD took an earnings hit for that decision at the time, but has, as a result, escaped the current turmoil largely unscathed. The only pre-announcement on TD’s plate this quarter details its expected gain from the VISA restructuring and planned IPO.

Indeed, four of the Big Six are to receive a small earnings boost because of VISA’s plans. In early October, transactions to combine VISA USA, VISA Canada and VISA International and convert the resulting entity from member associations into a private company were completed.

As a result, the banks that were involved with the credit card giant were awarded ownership stakes in proportion to their participation in the association. On Nov. 9, VISA filed a prospectus for an IPO that is expected to occur in the first quarter of 2008.

VISA intends to use some of the proceeds of the IPO to buy out some of the shares held by the banks.

So, for now, the banks’ gains are notional. The banks note that accounting standards require them to record this expected gain at the time of the restructuring. And so, although VISA has yet to go public, each of the banks with a stake in the restructured company is recording a gain based on an independent valuation of their holdings.

These gains are substantial enough to offset the credit-related losses in most cases. Indeed, four of the Big Six banks — TD, CIBC, Royal Bank of Canada and Bank of Nova Scotia, all based in Toronto — are expecting after-tax gains from these unusual items when all is said and done.

Only the banks that don’t have VISA-derived gains to fall back on — National Bank and Bank of Montreal (the latter with predicted credit-related charges of $420 million pretax, $260 million after-tax) — will be showing net losses in their unusual items.

@page_break@BMO doesn’t have a gain due to the pending VISA reorganization to report, but it is anticipating a gain of approximately $110 million pretax, $85 million after-tax, from the sale of shares in another credit card giant, MasterCard International Inc., which completed its IPO in May 2006.

Along with the gains related to shares in recent and imminent credit card company IPOs, two of the banks also announced charges relating to expected increases in the redemptions by clients of their loyalty programs. Royal Bank expects to record a $120-million pretax charge ($80 million after-tax) in increased loyalty program liability. And BMO expects to record a charge of approximately $185 million pretax ($120 million after-tax) for increased liability for redemptions related to its MasterCard loyalty rewards program.

Nonetheless, the credit card IPO gains are providing a nice offset for some of the credit crunch-related losses. And if this quarter proves to be the end of the credit story, then Canada’s major banks are seemingly sailing through it fairly well.

However, analysts say, there will be more pain to come.

Brad Smith, analyst with Blackmont Capital Inc. in Toronto, suggests that attempting to forecast future writedowns is a fool’s errand. “It’s impossible to know what the extent of their exposures are and, beyond that, what the quality of their exposures are — and, beyond that, the willingness of managers and auditors to reflect optimism or conservatism in their estimates,” he says. “The losses will be what they’ll be.”

He suggests that one way investors can attempt to anticipate which banks will have most significant losses is to look at which banks were strategically challenged before the credit crunch took hold. These banks are probably the ones with bigger exposures, as they may have stretched their risk parameters to maintain earnings.

However, banks that were executing superior strategies probably won’t have pushed the risk envelope as much. He points to Scotiabank, with its international strategy, as the best bet to have the least exposure; and geographically and scale-constrained National Bank as likely to have the most.

It will be some time before that theory can be conclusively tested. This latest round of quarterly writedowns is unlikely to represent the end of such losses. Smith anticipates that the losses will continue in future quarters as the fallout from the troubles that started in the U.S. subprime market continue to cascade through financial markets.

“There’s not, in my mind, much hope that any manager or treasurer or board of directors would be able to come up with an accurate estimate of what their ABCP losses ultimately will be at this point in time,” Smith says. “We haven’t even gotten a resolution yet to the stranded ABCP in the non-bank market. So, until you set up the goalposts, it’s really not going to be possible to score.”

Indeed, there remain obvious sources of concern within the banks. For example, BMO’s pre-announcement included the news that it intends to increase significantly its exposure to a couple of troubled SIVs. Part of its overall $320-million charge includes a $15-million charge concerning two SIVs. However, BMO also said that it would invest up to $1.6 billion in the senior debt of those two vehicles.

The Desjardins report notes that none of the other banks that have announced charges have also unveiled plans to increase their investments. Without this added exposure, investors probably wouldn’t be spooked by BMO’s planned charges, it suggests. “But the commitment to invest more in the SIVs will probably be interpreted as risk of further writedowns in the future,” says the report.

Also, just because TD is coming out of this quarter looking the best, there’s no reason to believe that it will escape this episode entirely unharmed.

TD doesn’t have U.S. subprime exposure, but, Smith notes, it does have CDO exposure, which is an area that none of the banks have spelled out in detail. And, he reports, TD has the largest exposure among the Canadian banks to U.S. commercial real estate, which he believes may emerge as the next big worry in the market.

There are similar concerns that the pain on Wall Street could yet intensify, as well. Economic research firm Global Insight Inc. suggests that although there has already been a serious impact on the U.S. financial services industry, firms may face credit-rating downgrades in the coming months as their balance sheets are further battered by the tough credit climate and possible regulatory changes. In turn, this could lead to pressure on firms to alter their strategies, sell assets or seek strategic mergers.

Although the impact of the credit crunch in terms of bank writedowns is getting all the attention, Smith encourages advisors and their clients to take the longer view. Whatever numbers these investment writedowns ultimately reach, he says, it’s very unlikely they’ll be enough to imperil a bank’s solvency.

Rather, investors should focus on earnings growth, dividend growth and return on equity, which will ultimately drive bank valuations.

Smith believes that the recent slide in banks’ share prices don’t represent simply punishment for their balance-sheet risks but also that the market is re-evaluating their earnings prospects in light of the new credit environment. That, ultimately, will dictate how bank stocks perform.

The Canadian Big Six banks’ fourth-quarter charges don’t look that bad, but the industry is probably not out of the woods just yet. IE