No one foresaw what was to transpire in the financial services industry over the past 12 months. Although some market sages had worried that credit conditions were too loose and other forecasters had cautioned that the U.S. housing market was overheated, nobody imagined the scale and scope of the transformation that was to ensue — and that continues to play out.

A year ago, economic growth was robust, interest rates were heading higher to keep the economy from overheating and the financial services industry was enjoying seemingly relentless profit increases. A year on, that world view has been shattered.

The credit-market disruption erupted into a full-blown crisis in early August 2007, derailing the global economy. Come August 2008, economic prospects have dimmed, market confidence is shaken and uncertainty reigns.

Having lived through the day-to-day evolution of the credit crunch, it’s easy to forget how much has changed in the past 12 months. In July 2007, the Bank of Canada didn’t even mention the U.S. subprime mortgage sector in its regular monetary policy update. Nor did the BofC even hint at the impending market turmoil that was to break forth in the following month. On the credit front, the BofC simply noted that Canadian household credit growth was “robust” and business credit growth was above average.

Rather than sensing approaching doom, the BofC saw the outlook for the global economy as slightly stronger than earlier believed. “[Growth is] expected to remain robust,” the report said, “over the next three years.”

The only counterweight to strong growth, the update suggested, was the prospect of tighter monetary policy. Indeed, at the time, the bank rate in Canada was 4.5%, and analysts predicted it would rise to 5.25% by the second quarter of 2008. Similarly, the U.S. Federal Reserve Board funds rate was 5.25% and expected to go to 5.75%.

Those forecasts were proven to be spectacularly wrong. As money markets began to falter and the credit crunch took hold, central banks around the world slashed rates in an effort to help keep financial markets functioning, and to stave off the harshest effects on their economies. As a result, throughout the second quarter, rates were well below expectations — sitting at 3.0% in Canada and 2.0% in the U.S.

Interest rates aren’t the only thing that has taken a tumble in the past year — stock markets are down, too. In the 12 months ended July 31, the S&P 500 composite index was down almost 13% year-over-year; the MSCI EAFE [Europe/Australasia/Far East] index dropped 14.6% in the same period.

Canada’s markets have held up better than most, with the S&P/TSX composite index off by just 2%. But that very modest slide conceals more dramatic performances. The financial services sector, the primary source of the markets’ distress, has taken a bigger dive: the TSX financials subindex is down 13.3% over the past year. However, it is far from the worst performer: the consumer discretionary group is down by 30% year-over-year, followed closely by the health-care sector. Conversely, tech stocks are up more than 30%, and materials have gained slightly more than 20%.

Within the financial services sector, the pain isn’t being shared equally among individual stocks, either. Companies with the biggest exposure to the credit crunch — through either their connections to the frozen asset-backed commercial paper market or their exposure to structured investment vehicles and collateralized debt obligations, which also have bedevilled certain large U.S. and European financial services firms — are taking the biggest hits to their stock prices.

ABCP specialist Coventree Inc., a Toronto-based investment bank whose shares were trading at more than $16 a share in mid-2007, will pay the ultimate price by winding up its business. Xceed Mortgage Corp., also of Toronto — which had relied on ABCP to fund its lending — has watched its share price dissolve by more than 80% over the past year. And the share price of the brokerage firm that sold the most ABCP to retail inves-tors, Vancouver-based Canaccord Capital Inc., is down by about 60%.

Among the big banks, those with the most direct exposure to the crisis have suffered the biggest knocks. CIBC’s share price is down by about a third year-over-year, and Bank of Montreal’s is off by more than 25% for the same period.

@page_break@But it’s not just firms with direct exposure to troubled segments of the market that are suffering. Most of the other big banks, life insurers and diversified firms are down over the past year, too. A small handful of financial services firms have traversed the credit crunch relatively well — Bank of Nova Scotia’s stock price was actually up by 3% for the period, and Fairfax Financial Holdings Ltd. saw its shares soar by about 23% as some of its contrarian bets came good. But most firms have been hurt as the turmoil in credit markets has spilled over into other segments of the financial world, depressing market activity generally.

A year ago, none of these declines were foreseen. Instead, analysts expected continued profit growth that would, in turn, fuel price appreciation. So, while it’s bad enough that most financial services stocks are down over the past 12 months, they are missing pre-credit crunch price targets by even wider margins.

Moreover, as profits decline and stocks disappoint, analyst are revising their expectations lower. Price targets have been cut sharply from a year ago, as firms, their investors and analysts adjust to the financial services sector’s new norm — an environment that’s characterized by weakness in most market-related businesses and increased uncertainty in other industry segments as the supply of and demand for credit faces new fundamentals.

Over the past 12 months, many of the notoriously cyclical market-driven businesses have withered. According to data from Thomson Reuters, equity issuance in the first half of 2008 is down by almost 40%, compared with the same period a year ago; IPO activity is off by almost 60%. Debt issuance is holding up better, down by just 8% year-over-year, although certain segments have taken bigger hits: the so-called “Maple bond” market (Canadian dollar-denominated bonds sold by foreign firms) has all but disappeared; corporate issuance is down by 40%; and cross-border issuance has dropped by 43%.

There’s no respite in the mergers and acquisitions advisory business, either; deal volume is down by about 20% year-over-year. More important, deal value (which dictates bankers’ commissions) is down almost by 37% for completed deals and by 77% for announced deals.

Nor is there much joy on the retail side. The latest data from the Investment Funds Institute of Canada shows that in the 12 months ended July 31, mutual fund assets have slipped slightly, by 1.5%. But this masks a bigger decline — about 5% — in long-term assets.

All of this adds up to widespread pain in the financials sector, as the overall decline in business volumes, in turn, hurts firms generally. Indeed, preliminary data from the Investment Industry Association of Canada suggests that securities industry profits are down almost 40% in the second quarter of 2008 from the same period a year ago. These numbers weren’t final at press time, and have yet to be published by the IIAC, so they could be revised. Nevertheless, they suggest that operating revenue is about 15% lower year over year, led by a 29% drop in investment-banking revenue and coupled with a modest rise in operating expenses.

But despite the weakness in revenue and profits, one bright spot in the Canadian securities industry is employment levels, which have so far held up, unlike in some other countries in which large layoffs have occurred.

While just about every financial market-related business has been affected by the credit crisis, the one area that has largely shrugged off the turmoil is the core banking business. Deposits have grown throughout the year, as have various forms of credit (consumer, business and mortgages). However, there are signs that that pillar is weakening slightly. The BofC observes that business credit growth has slowed in recent months, as economic conditions have softened and lending terms have tightened.

The same sort of tougher lending conditions haven’t come to the household sector, the BofC finds, and consumer credit growth has remained robust. Yet, a recent report from CIBC World Markets Inc. detects possible cracks in that story as well, warning: “While on a year-over-year basis the growth numbers are still impressive, the monthly figures clearly suggest that we are at the early stages of a softening trend in the pace of growth in overall household credit in Canada.”

Whether companies will now face weakness in this area, too, will probably be dictated largely by the economy’s performance in coming quarters. On that count, there are decidedly more worries than there were a year ago. Back in July 2007, the BofC was predicting average annual economic growth of 2.5% through to 2009. It now foresees GDP growth of just 1% in 2008, surging back to 2.3% in 2009.

The outlook for the Canadian economy has weakened notably in recent months, and, just as important, it remains highly uncertain. While the BofC sees the risks to the outlook balanced on the upside and downside, it nonetheless concedes that those risks are significant.

As the turmoil of the past year shows, all it takes is one of those big risks to materialize, then everything changes. In fact, in the past 12 months, the financial services industry has been utterly transformed by a risk that wasn’t even on the radar at the time. IE