World financial news

Magna International is on the verge of controlling a major automaker for the first time, in what some analysts describe as a good risk.

Aurora-based Magna, the world’s third-biggest independent auto-parts maker, agreed yesterday on the framework of a deal that will eventually give the company a majority stake in General Motors’ Opel unit in Europe, according to widespread reports from European news agencies.

The blockbuster deal calls on the German government to provide 1.5 billion euros, or $2.43 billion, in temporary loans, while a Magna consortium will contribute unidentified short-term financing so it becomes the preferred negotiating partner in the sale of Opel.

Although that doesn’t clinch a deal for ownership, it would be a key step for Magna and its main partner Sberbank, a Russian bank, in assuming control. Earlier, Magna talked about taking a minority stake in Opel.

Under the deal, Magna will take a 20 per cent stake in Opel and Sberbank will take a 35 per cent stake, giving their consortium a majority. GM will retain a 35 per cent holding, while the remaining 10 per cent will go to Opel employees.

The German government wants to move Opel into an independent legal structure so it can avoid creditors in GM’s looming bankruptcy proceedings in the U.S.

Italian automaker Fiat SpA, the only other serious contender for Opel, dropped out of talks in Germany because of "unreasonable" funding demands.

Magna wants to use Opel’s strengths so it can make a major foray into the emerging Russian market and those of other East European countries.

David Cole, chairman of the U.S.-based Centre for Automotive Research, said the risk to Magna appears small since the industry can’t deteriorate much further and the price was attractive.

"This is probably a pretty good deal for Magna, GM and Opel," Cole said in an interview. "There is always a risk but relative to where we are now, it’s a good one. The industry is at a stage where it really can’t go anywhere but up payday loans."

Industry sales have plunged in North America and around the world in the last year because of the collapse of the U.S. housing market. That has led to a credit crisis and hampered consumers’ ability to refinance debt and buy vehicles.

Cole and economist Carlos Gomes, an auto specialist at Bank of Nova Scotia, noted the deal will fit well with Magna’s drive into Russia.

"I guess there is some risk but this is very much a part of their strategy," Gomes said.

Vehicle ownership among Russia’s adult population represents only one-third of the level of other countries in the European Union.

Magna co-chief executive officer Siegfried (Ziggy) Wolf, who has led the company in its pursuit of Opel, said a few years ago Russia is trying to create a middle class and this will spur major growth in the market during the next decade.

Magna hooked up with Russian industrial oligarch Oleg Deripaska in 2007 to increase revenues in Eastern Europe. But the partnership fell apart last year when the credit crunch caused Deripaska’s company, Russian Machines, to relinquish a big stake in Magna.

Opel, GM Europe’s biggest unit, produced 1.4 million vehicles including the Vauxhall brand last year. That is down 10.5 per cent from 2007.

The company has four assembly plants in Germany that employ about 25,000 workers.

Analyst Dennis DesRosiers said Magna’s interest in Opel represents an "unprecedented opportunity" for the company, but he cautioned it could still be a "high" risk for the firm if the investment sours.

Magna’s Magna-Steyr subsidiary already builds vehicles on contract for several automakers at a plant in Graz, Austria, but Magna CEO Frank Stronach has pushed for an expansion of its vehicle-making capabilities in Europe in recent years.

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Confidence among U.S. consumers rose this month to the highest level since September, while business activity shrank at a faster pace than forecast as the auto slump rippled through the economy.

The Reuters/University of Michigan final index of consumer sentiment increased to 68.7, higher than anticipated, from 65.1 in April. The Institute for Supply Management-Chicago Inc. said its business barometer decreased to 34.9 from 40.1 in April; readings below 50 signal a contraction. A separate report showed the economy shrank less than previously estimated last quarter.

“The worst of the recession has passed, but it will take some time before we will see anything close to normal conditions,” said David Resler, chief economist at Nomura Securities International Inc. in New York.

The Chicago report ran counter to other regional figures this month that indicated manufacturing was starting to improve, signaling that the auto slump in neighboring Detroit may be affecting the entire Midwest. Rising confidence limits the risk that consumer spending, the biggest part of the economy, will peter out after increasing in the first quarter.

Stocks gained for a second day. The Standard & Poor’s 500 index rose 1.4 percent to close at 919.14 in New York. Treasury securities climbed, pushing the yield on the benchmark 10-year note down to 3.47 percent at 4:21 p.m. from 3.61 percent late yesterday.

The confidence index was forecast to rise to 68, according to the median of 53 economists surveyed by Bloomberg News. Estimates ranged from 67 to 71. The measure averaged 63.8 in 2008.

Finances Grim

A gauge of current conditions, which reflects Americans’ perceptions of their financial situation and whether it is a good time to buy big-ticket items such as cars, slipped to 67.7 from 68.3.

The index of consumer expectations for six months from now, which more closely projects the direction of consumer spending, rose to 69.4 in May from 63.1 the prior month.

“Consumers see some light at the end of the tunnel,” said Chris Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York. “This bodes well for the outlook for spending and for the turn in the economy.”

The Commerce Department also reported today that the economy shrank at a 5.7 percent pace in the first quarter, less than the government estimated last month. Following the 6.3 percent pace of decline in the last three months of 2008, the drop capped the worst six-month performance in five decades.

Lower Than Forecast

Economists forecast the Chicago gauge would rise to 42, according to the median of 55 projections in a Bloomberg News survey no fax cash advance. Estimates ranged from 34.2 to 45.

Other regional figures earlier this month were more upbeat. The Federal Reserve Bank of New York factory index rose to minus 4.6, the highest level since August, and the Philadelphia Fed gauge climbed to an eight-month high. The Richmond Fed’s measure showed the first expansion in more than a year.

The Chicago figures are “undoubtedly affected significantly by shutdowns in the ailing automotive industry,” Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc., said in a note to clients. “The rate of decline in manufacturing output will moderate in coming months.”

Consumers’ spirits are being buoyed by the improvement in stock markets and also because gasoline costs are down nearly 50 percent from July highs and mortgage rates are near historic lows, trimming borrowing costs for homeowners.

Recovery Ahead

“Consumers are looking at things like the rise in stocks, they are listening to reports talking about ‘green shoots’ and they believe it,” Chris Low, chief economist at FTN Financial in New York, said in an interview with Bloomberg Television. “They believe that a recovery is coming but they don’t see it in their current job prospects.”

Household wealth is being eroded by lower property values, and the economy has lost 5.7 million jobs since the recession began in December 2007. Economists predict the unemployment rate, at a 25-year high of 8.9 percent in April, may average 9.6 percent next year.

Automakers’ woes may cause more plant closures, production cuts and job losses. General Motors Corp., the world’s largest automaker until its 77-year reign ended in 2008, may file for bankruptcy protection on June 1, people familiar with the matter said yesterday. Chrysler LLC filed for bankruptcy on April 30.

Some executives have expressed optimism. Global capital markets have improved “dramatically,” General Electric Co. Chief Executive Officer Jeffrey Immelt said this week.

“The worst is over” for the economic downturn, Immelt said in a speech in Tokyo. Improved liquidity and the ability to raise equity in capital markets have stabilized the economy, producing “green shoots.” As a result, he’s more confident now than any time in the last nine months, he said.

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Canadian Imperial Bank of Commerce has reported a $51 million net loss in the latest quarter, down from a year-ago $1.1 billion of red ink, as losses continued but slowed on ravaged involvements in structured credit vehicles.

The net loss was 24 cents per share in the bank's second quarter ended April 30, compared with $3.00 per share a year earlier, the big bank reported Thursday. Excluding non-recurring items, CIBC said it would have earned $1.41 per share, two cents above the Thomson Reuters analyst expectation.

Revenue was $2.16 billion, compared with a $126-million top line in the disastrous year-earlier period, and up from just over $2 billion in the first quarter.

Provision for credit losses swelled 124 per cent from a year ago, to $394 million from $176 million. Non-interest expenses declined eight per cent to $1.64 billion.

CIBC said its Tier 1 capital ratio, a key indicator of stability, stands at 11.5 per cent – "amongst the strongest of any bank in North America" – after recent issues of $525 million of preferred shares and $1.6 billion of long-term notes.

Return on equity was minus 3.5 per cent, compared with negative 37.6 per cent a year ago.

Despite the loss, the bank maintained its quarterly dividend of 87 cents per share, yielding 6.3 per cent at Thursday morning's price of $55.17, down $1.86 or three per cent on the TSX session.

"Our core businesses performed well this quarter," declared CEO Gerald McCaughey, adding that retail banking "continued to deliver solid results against a backdrop of a challenging market environment."

"Losses in structured credit did impact our results but the bulk of these losses occurred early in the quarter before market conditions improved," McCaughey stated low cost car insurance.

"The rate of deterioration in the broader economy appeared to slow and liquidity levels recovered during the quarter – both of which are encouraging signs as we head into the last half of the year."

Non-recurring items had a negative impact of $1.65 per share, headed by $475 million, 85 cents per share after tax, on structured credit run-offs, "driven primarily by a deterioration in the credit quality of financial guarantors … as well as mark-to-market losses on certain underlying positions," the bank stated.

There also was a hit of $168 million, 30 cents per share, from the impact of narrowing credit spreads on market values of credit derivatives in CIBC's hedging, along with an assortment of smaller writedowns and writeoffs.

CIBC's retail banking division booked net income of $390 million on flat revenue of $2.3 billion. Loan losses were $403 million, up from $209 million a year ago, as the credit card segment showed “higher delinquencies and bankruptcies related to the deteriorating economic environment."

Investment banking and other wholesale activities lost $373 million on negative revenue of $241 million. The bank ended the quarter with $2.5 billion in exposure to guarantees from financial counterparties, and noted that "further significant losses could result depending on the performance of both the underlying assets and the financial guarantors."

CIBC said its corporate loan portfolio "continues to perform well despite the deteriorating economic environment," with loan losses of $46 million in the second quarter.

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Facebook said Tuesday that it received $200 million from Russian investment group Digital Sky Technologies in exchange for a 2% stake.

The deal puts a $10 billion valuation on privately-held Facebook, according to a company statement.

The agreement also calls for DST to eventually buy at least $100 million of Facebook’s common stock, which the company estimates will happen during the coming months.

Microsoft paid $240 million for a 1.6% stake in Facebook in October 2007. That deal placed a $15 billion valuation on the social networking site. Just about one year ago, the company’s internal valuation was $3.7 billion. (Full story)

"This is good and bad news for Facebook," said Ray Valdes, social networking analyst at Gartner. "The good news is that they can still get a pretty good valuation in a down economy. The bad news is it’s nowhere near the value of the Microsoft valuation."

Experts say the credit crisis has hurt Facebook’s ability to raise capital from investors. "Facebook had to look far and wide to get that kind of investment," said Valdes. "There are a lot of willing investors in Silicon Valley, but not at that number."

Facebook Chief Executive Mark Zuckerberg would not comment outright about the valuation figures. When asked during a conference call if the company is worth less now than it was during the Microsoft (MSFT, Fortune 500) valuation, he said, "I wouldn’t say that," explaining that the deals are not identical.

Microsoft’s deal involved a direct investment and the expansion of a pre-existing advertising partnership bad credit payday advance. DST brings a different type of partnership to the table. The Russian firm says on its Web site that it has raised and invested more than $1 billion in over 30 companies since it was founded in 2005.

"Our investment experience in other regions reveals the tremendous value social networking companies create as they redefine how people communicate and interact," said DST Chief Executive Yuri Milner. "Facebook has a chance to be one of the most successful Internet companies globally."

Most analysts do not believe that five-year-old Facebook has yet turned a profit due to the high volume of new usership and its apparent inability to monetize advertising on a social platform.

While not direct rivals in terms of social networking, big tech companies like Yahoo (YHOO, Fortune 500) and Google (GOOG, Fortune 500) rely heavily on advertising to make money.

Despite a "tough" economic environment, Zuckerberg said Facebook’s revenue numbers are up, the company is "on a track towards creating a self sustaining business."

As a result, Zuckerberg said Facebook has been approached by "a number" of firms. The company chose to team up with DST because of the firm’s "global perspective." Facebook last month surpassed 200 million users, 70% of which the company says are from outside of the United States. 

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Banks will be more closely scrutinized under European Union plans unveiled on Wednesday to apply lessons from the credit crunch and better protect investors hit by the worst financial crisis in decades.

The European Commission’s plans form a core plank of the EU’s response to the market debacle. They are aimed at spotting any build-up of risk earlier and avoiding a need for governments again to fork out billions of euros to prop up banks.

Britain, Europe’s biggest banking center, has already signaled its unease with the plans, fearing a loss of regulatory sovereignty to new, centralized bodies.

The Commission said the plans were ambitious but realistic and took into account the interests of non-euro as well as euro zone countries.

“It’s now or never that we build a consensus on financial supervision. I think we will do it,” Commission President Jose Manuel Barroso told a news conference.

The Commission’s plans are based on a blueprint put forward by former Bank of France governor Jacques de Larosiere and backed in principle by European Union leaders.

They represent an attempt to play regulatory catch-up with a financial market that is already integrated and dominated by cross-border banks like HSBC, BNP Paribas and Santander, even though supervision remains national.

Banks rapidly succumbed to the credit crunch partly because no overall picture existed of how easily instability in one institution could infect others cash loans.

The Commission proposed setting up two pan-EU bodies to correct what it sees as gaping regulatory holes.

A European Systemic Risk Council comprising central bankers and national regulators would monitor any build-up of risks and issue a call for action before they become unmanageable.

The European Central Bank would host and chair the council, a step Britain and national banking regulators say gives too much power to the Frankfurt-based institution.

“Serious risks to financial stability of a systemic nature were not addressed before the present crisis started,” EU Economic and Monetary Affairs Commissioner Joaquin Almunia said.

“In doing so we will be able to ensure we can escape from the boom-bust dynamic that is at the origin of the systemic failure that characterized the functioning of our financial system recently,” Almunia said.

Though the council would have no binding power, an EU state would have to explain why it was not taking action.

The body would work with new global risk warning functions being set up by the International Monetary Fund and the Financial Stability Board. 

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The Toronto stock market closed higher Monday, with financials providing major support a day before Bank of Montreal (TSX: BMO) kicks off a slew of quarterly earnings reports from most of the big banks this week.

"I think the doomsday scenario for the financials is off the table – now they're looking at a nasty recession," said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier.

The S&P/TSX composite index closed up 76.08 points to 10,069.5, while the TSX Venture Exchange moved down 0.08 of a point to 1,096.43.

U.S. markets were shuttered for the Memorial Day holiday while markets in Britain were closed for a bank holiday.

The TSX financial sector was up two per cent as Bank of Montreal moved up 69 cents to $41.56.

CIBC (TSX: CM), Scotiabank (TSX: BNS) and TD Bank (TSX: TD) report Thursday while Royal Bank (TSX: RY) issues earnings on Friday. All four banks were up sharply even though earnings for the group are expected to be down from a year ago – by perhaps eight to 20 per cent overall, analysts project.

"No one likes to see down earnings, but it's relatively minor. Three months ago, in March, there was a doomsday scenario where there was talk these banks were going to cut their dividends," Nakamoto said.

The Canadian dollar was little changed even as Finance Minister Jim Flaherty said the federal deficit will be "substantially more" than the $34 billion for 2009-2010 Ottawa projected in its budget in late January – and growth will be slower.

George Davis, chief technical analyst at RBC Capital Markets, said the markets were expecting the news.

"I think in general a lot of people on the street were expecting a lot more fallout and damage from the recession than what the government and the Bank of Canada originally were (originally ) forecasting," Davis said.

The Canadian dollar closed down a quarter of a cent to 89.01 cents U.S.

The telecom sector also buoyed the TSX, up per cent.

BCE Inc. (TSX: BCE) shares were 66 cents higher to $24.57. Sources told the Globe and Mail that the Ontario Teachers' Pension Plan sold much of its stake in the telecom company on Friday – 30 no teletrack payday loans.6 million shares worth $713-million.

The Toronto energy sector was up a slight 0.2 per cent as oil prices slipped ahead of a meeting by the OPEC cartel later in the week. The New York Mercantile Exchange was closed for floor trading, but late Monday afternoon the July contract was 46 cents lower to $61.21 (U.S.) a barrel in electronic trading.

The Organization of Petroleum Exporting Countries meets on Wednesday in Vienna to discuss a possible production cut to firm up prices.

Imperial Oil Ltd. (TSX: IMO) shares rose 19 cents to $42.23 after it announced it is going ahead with the delayed Kearl oilsands project in northern Alberta at an anticipated cost of $8 billion.

Shares in oilpatch junior Sabretooth Energy Ltd. (TSX: SAB) soared $1.05 to $1.48 after the company announced a $9.4 million private placement, appointed a new board of directors and management team and acquired a private oil and gas company.

The base metals sector was a drag, down just over one per cent as Sherritt International (TSX: S) declined 11 cents to $5.10.

Ivanhoe Mines (TSX: IVN) shed 64 cents to $5.85 over the fate of a draft agreement for the $3 billion Oyu Tolgoi mining project in Mongolia, which Ivanhoe is set to develop with Rio Tino. Concerns mounted after Mongolia's opposition Democratic Party candidate Tsakhiagiin Elbegdorj – who promised to obtain a greater share for individuals of the country's mineral wealth – won the presidential election.

In other Canadian corporate news, Solar panel grade silicon producer Timminco Ltd. (TSX: TIM) has reached a supply agreement with German solar cell producer Q-Cells SE. Timminco shares jumped 60 cents or 48.9 per cent to $1.83.

WestJet (TSX: WJA) shares moved down 37 cents to $12.11 after it said there will be a delay on reaching a codesharing agreement with U.S. airline Southwest (NYSE: LUV) after the U.S. airline decided it couldn't spend any money to develop the deal.

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Anxious autoworkers and retirees, some in tears, cast ballots in three southern Ontario communities yesterday on the latest labour concession package struck between their union and General Motors of Canada.

The tentative agreement, reached last week after days of tough bargaining talks between the company and Canadian Auto Workers union, would slash labour costs by more than $8,000 per worker, while protecting wages and pension benefits.

GM workers in the southern Ontario communities of Windsor, Woodstock and St. Catharines voted on the agreement while workers in Oshawa are to cast ballots on today.

"The St. Catharines meeting was very very emotional. "There were some retirees that were actually crying," CAW president Ken Lewenza said in a telephone interview from St.Catharines following the vote.

"We certainly understand that because it’s been a very, very difficult three or four months."

It’s the third set of negotiations between the GM and the CAW within the past year. Ottawa and Queen’s Park have insisted on further cuts to labour costs for the automaker to get billions of dollars in taxpayer aid.

The vote comes just one week before a government-imposed deadline for GM to complete a restructuring plan or be forced into bankruptcy protection.

In Windsor, Walter Smith, who has been with company for 28 years, said he hopes this is the last time the workers have to vote on a cost-cutting agreement.

"This is the third time and I think all we want to know is this going to stop, when is it going to stop?" said Smith after workers at GM’s transmission plant cast their ballots.

Overall however, Lewenza said the votes are bringing workers a sense of relief.

"When we talk to our retirees and talk about their existing pension funding at 39 per cent, and recognizing that this whole restructuring is going to improve that situation free credit report… and for active members, to think that you have a job and an opportunity to raise a family, with reasonably good income, even with the sacrifices."

The latest agreement, announced Friday, reduces hourly labour costs by between $15 and $16 per worker, on top of a $7-an-hour cut agreed to in March.

The deal also freezes pensions until 2015 and cuts benefit costs by more than $8,000 per worker – including a $3,500 payment to each worker to compensate for vacation time lost in collective bargaining a year ago.

Results of the votes at the four southern Ontario GM plants were not expected to be announced until tonight.

GM has received $15.4 billion (U.S.) in American loans.

The automaker needs holders of $27 billion of its bonds to forgive what they’re owed in exchange for equity in the company, reports Friday said the company’s biggest bondholders won’t support the offer.

GM has already cut its Canadian workforce heavily, with the recent closure of a pickup truck plant in Oshawa eliminating 2,600 jobs. It now employs about 7,500 hourly workers in Canada, and plans a shutdown next year of a transmission plant in Windsor, which employs 1,400.

The entire auto industry has been battered by the recession, which has cut demand for cars and trucks sharply, leaving massive factory overcapacity.

The credit crunch has made it harder to finance car purchases, while changing tastes and high fuel prices have cut into demand for SUVs and pickup trucks, a major market for GM, Ford and Chrysler for years.

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Swollen loan losses, soaring writedowns and slumping profits – it’s enough to make even seasoned bank shareholders run for cover.

But with Canadian bank stocks on a rebound since March, wary investors are wondering whether it would be wise to hang on for the long-term or head for the exits while the getting is still good. Analysts appear divided on the hold `em or fold `em debate, but surmise that next week’s round of second-quarter earnings should provide some sense of direction.

Banks, meanwhile, are facing a delicate balancing act for the remainder of fiscal 2009. In order to stay profitable, they have to keep loans flowing, while boosting some rates because the recession is rife with risk. At the same time, they must sop up climbing credit losses and maintain plump capital cushions – all without jeopardizing the sanctity of their dividends.

While acknowledging that the economic outlook remains murky, bank bulls argue this earnings season marks a turning point for the industry. For the first time in about 18 months, those much-maligned capital markets-related writedowns are not expected to eclipse the earnings parade.

The running tally of those charges hit $20.24 billion for the "Big Six" at the end of January. While more writedowns are anticipated for the February-to-April quarter, some analysts suggest this batch of reports could signal those charges are on the wane. With capital markets on the mend, many are also betting that results from the banks’ trading businesses could even surpass expectations.

Another plus, rebounding stock prices have taken the banks’ dividend yields out of the danger zone, which has dampened speculation of cuts to those sacred payouts. In fact, Michael Goldberg of Desjardins Securities is actually expecting "minimal dividend growth" for the second half of fiscal ‘09.

Those in the bear camp, however, are advising investors to be extremely cautious because bank stocks remain fraught with risks. In short, "the economy still sucks," observed John Aiken of Dundee Capital Markets in a research note to clients. He has a majority of "sell" ratings on Canadian banks, most because they are bracing for more bad loans as the economy sheds jobs and consumer bankruptcies soar.

Provisions for credit losses, the money banks set aside to cover bad loans, have been rising in recent quarters. Craig Fehr, an analyst with Edward Jones, predicts credit conditions will worsen for the rest of this year.

"We are seeing some of the pressures that have existed for the last year or so, largely on the capital markets side, are starting to subside. And we’re exchanging that a bit for the pressures that are coming from good old-fashioned credit deterioration – higher loan losses," Fehr said in an interview.

"I think that we are going to see pretty substantial year-over-year increases in provisions across the board – for all the banks. We’re talking about 50 to 100 per cent increases in provisions year over year."

The key trouble spots are likely defaults in credit-card lending, while commercial mortgages are also expected to show increasing signs of stress. The Canadian Imperial Bank of Commerce administers Canada’s largest credit-card portfolio. It began curbing lending during the second half of fiscal 2008 but remains at risk of more losses, Fehr said cash advance loan no fax.

Toronto-Dominion Bank, meanwhile, has large exposures to the hard-hit U.S. commercial real-estate sector and the sputtering Ontario economy, suggesting its "results might disappoint," said André-Philippe Hardy of RBC Capital Markets. His research also proposes that results from the Bank of Nova Scotia could miss expectations because it "is also exposed to rising credit losses in Latin America and the Caribbean."

While all banks are expected to pad their provisions, it appears to be "less of a negative" for Bank of Montreal, while National Bank of Canada is "least exposed to deteriorating credit quality near term" because of its regional concentration in Quebec, Hardy said.

Royal Bank of Canada, meanwhile, is facing its own challenges south of the border. Last month, RBC pre-announced an $850 million (U.S.) goodwill impairment charge for its international banking business. "The impairment charge is the result of the prolonged economic difficulties in the U.S., in particular the deterioration of the U.S. housing market, and the decline in market value of U.S. banks," noted Scotia Capital’s Kevin Choquette.

Despite those economic hurdles, some analysts contend the Canadian banks’ penchant for being "boring" retail lenders is standing them in good stead for longer-term profit growth.

While the banks’ net interest margins – the difference between the money they make on interest and their own interest expenses – are being squeezed because of historically low interest rates, that pressure is expected to ease going forward for a number of reasons.

First, banks have taken action to hike their rates on popular consumer loans such as personal lines of credit and float-rate mortgages. "Banks have repriced some of their mortgages and we believe banks are now charging a premium of about 75 to 100 basis points over prime on a five-year variable mortgage versus a discount of 75 to 100 basis points before the crisis," Hardy said.

Moreover, the banks’ key short-term funding costs have fallen in recent months. Medium-term funding is also down from crisis levels, while longer-term funding remains elevated. Banks are also benefiting from a surge of new deposits as their customers hoard cash.

Fehr said those various factors have created a wider spread between short-term and longer-term interest rates, which suggests that banks are poised to reap profits from interest income in the not-too-distant future. That’s because banks tend to borrow "cheap" short-term funds to make longer-term loans that feature higher interest rates, he said.

"As we reprice on the long end and keep the short end very cheap, that spread will increase for the banks. And it will actually be a very strong driver of profits for them going forward," Fehr said.

"There’s no doubt in my mind that (loan) volumes will slow relative to peak years. The idea here is that the profitability of each loan they make now has the potential to be higher. So, net interest margins, in my mind, will probably increase as we move throughout the year."

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Stocks closed sharply lower Thursday as optimism about a global economic recovery was tempered by mixed data and a potential downgrade of the United Kingdom’s credit rating.

The Dow Jones industrial average (INDU), fell 130 points, or 1.5%, marking the third straight loss for the blue-chip measure. The S&P 500 (SPX) index dropped 15 points to close 1.7% lower and the Nasdaq composite (COMP) lost 1.9%.

Oil prices fell 1.6% but remained near 6-month highs. Bond prices fell, while the dollar lost ground against the euro and the pound.

The tone on Wall Street turned bleak late Wednesday after the Federal Reserve trimmed its 2009 economic growth targets and raised its unemployment forecast. The gloom was exacerbated Wednesday morning after ratings agency Standard & Poor’s lowered its outlook for the U.K.

Thursday’s selloff gained momentum as jobless data and a worse-than-expected regional manufacturing report raised doubts about the prospects for an economic recovery later in the year.

Stocks have gained some 30% over the last few months amid signs the pace of the recession has slowed. But Wall Street has become bearish in recent sessions as investors look for more concrete signs of economic recovery.

Todd Salamone, director of trading at Schaffer’s Investment Research, said the market is no longer impressed with the "less bad" economic data that helped lift stocks off the 12-year lows hit March 9.

"We’re in a period now where the market gets less of a positive surprise from less bad economic news," he said. "Unless we get even better less bad numbers, it may be difficult for the market to rally."

With economic jitters returning to the forefront, a closely watched gauge of investor fear, the CBOE Volatility Index, or VIX, rose to 32.7 after falling below 30 for the first time since September earlier this week.

No major economic reports or corporate results are due Friday. U.S. trading is expected to be quiet Friday with many market participants absent ahead of the Memorial Day holiday. The bond market will close early at 2 p.m. ET.

U.K. rating: Standard & Poor’s affirmed the United Kingdom’s top-tier credit rating but lowered its outlook for the country to "negative" from "stable."

S&P said its revision was based on the possibility that the U.K.’s debt burden could reach 100% of its gross domestic product, despite the British government’s "further fiscal tightening."

The news raised concerns that other major economies that have borrowed heavily to fund economic stimulus efforts, including the United States, could face similar downgrades.

"The downgrade of Great Britain by S&P certainly damped enthusiasm," said Peter Cardillo, chief market economist at Avalon Partners.

Economy: The Labor Department reported that initial jobless claims declined by 12,000 in the week ending May 16 low cost health insurance.

The number of people filing for first-time jobless benefits totaled 631,000 last week, slightly more than expected. But those filing claims on an ongoing basis rose to 6.6 million, an all-time high.

Separately, the Conference Board’s reading of leading economic indicators, which predicts economic conditions six to nine months in the future, rose 1% in April — slightly better than the 0.8% analysts expected.

The Federal Reserve Bank of Philadelphia said its index of manufacturing activity in the mid-Atlantic region improved to negative 22.6 in May from negative 24.4 in April. Economists surveyed by Briefing.com had expected the index to improve to negative 18.

"We’re starting to see numbers that aren’t quite as damaging," said Ron Kiddoo, chief investment officer at Cozad Asset Management "But I don’t think the market will trade to the upside until you start to see real growth."

Companies: Auto finance firm GMAC is poised to receive a second bailout from the Treasury, according to the Detroit News. The newspaper said the company is due to receive $7.5 billion more in aid.

In other auto news, the United Auto Workers union reached a deal Thursday with the Treasury Department and General Motors (GM, Fortune 500) on changing its labor contract with the troubled automaker. The accord removes a major hurdle in GM’s bid to avoid bankruptcy. GM shares rose more than 30%.

In one of the first Nasdaq initial public offerings of the year, OpenTable, which operates a restaurant reservation system, raised $60 million, one of the deal’s underwriters told Reuters. The company priced its shares at $20 each, which was higher than expected, and rose 59% to $31.89.

Bonds: Treasury prices rose, lowering the yield on the benchmark 10-year note to 3.36% from 3.19% Wednesday. Treasury prices and yields move in opposite directions.

The U.S. government announced more than $100 billion worth of new issuance Wednesday, raising concerns that supply will weigh on bond prices.

Other markets: Investors around the world were in a downbeat mood. In Asia, most shares finished lower. Major indexes in Europe tumbled about 2.7%.

In currency trading, the dollar fell versus major international currencies, including the euro, the yen and the British pound.

Oil slipped from its six-month high, but still continued to trade above $60 a barrel. The price of oil dropped 99 cents to settle at $61.05 a barrel.

COMEX gold for June delivery rose $13.80 to settle at $951.20 an ounce. 

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The Federal Reserve’s latest forecasts for the U.S. economy are gloomier than the ones released three months earlier, with an expectation for higher unemployment and a steeper drop in economic activity.

The Fed’s forecasts, released as part of the minutes from its April meeting, show that its staff now expects the unemployment rate to rise to between 9.2% and 9.6% this year. The central bank had forecast in January that the jobless rate would be in a range of 8.5% to 8.8%, but the unemployment rate topped that in April, hitting 8.9%.

The Fed also now expects the gross domestic product, the broadest measure of the nation’s economic activity, to post a drop of between 1.3% and 2% this year. It had previously expected only a 0.5% to 1.3% decline.

At the April meeting, the Fed decided to once again leave its key federal funds rate near 0%, a level it has been at since last December. The central bank also announced that it did not plan on increasing purchasing more long-term Treasury notes anytime soon.

The Fed disclosed plans to begin buying $300 billion’s worth of such Treasurys in March in order to try and keep long-term rates down and boost economic activity.

But according to the minutes, some members of the central bank’s policy committee indicated they were open to increasing its purchases of Treasury notes and mortgage securities as a way of spurring more lending.

Treasury prices rallied after the minutes were released, pushing their yield, which moves in the opposite direction, down to 3.18%.

Stocks, which have moved sharply higher during the past two months on hopes that the recession may soon be ending, fell Wednesday afternoon.

According to the minutes, Fed members did indicate they expected GDP to increase slightly in the second half of this year. However, it would not be enough to overcome the anticipated declines in the first half. GDP shrunk more than 6% in the first quarter.

Policymakers acknowledged that there were some better economic readings in the period leading up to the April meeting, but added that they were not convinced the economy was out of the woods yet faxless payday advance.

In the minutes, Fed members indicated that there are a number of factors that "would be likely to restrain the pace of economic recovery over the medium term" and added that the credit crunch would "recede only gradually" and that "households would likely remain cautious" in their spending.

Fed members expressed concerns about rising problems in the commercial real estate market as well, indicating that this could cause further problems for financial institutions still struggling with the effects of the collapse of home prices and rising mortgage defaults.

The Fed also reduced its GDP targets for 2010 and 2011, but the central banks still expects the economy to grow in both years.

Rich Yamarone, director of economic research at Argus Research, said that the Fed’s new forecasts were "more of a reality check than a revision," given the deterioration in the labor market and overall economy since January.

But he and other economists said it also appeared from the minutes that the Fed is pleased with how the economy has started to respond to the steps it has taken, including the purchases of mortgages and Treasurys.

"I read [the minutes] as ‘We think it’s working, let’s wait a few months to see how it plays out,’" said Gus Faucher - director of macroeconomics at Moody’s Economy.com. He added that it did not seem like the Fed felt a "sense of urgency" to increase the scope of its Treasury purchase program.

And Yamarone said it’s important to remember that the forecasts and minutes are three weeks old, and that economic readings since the meeting, including home sales and the rate of job losses, have generally showed signs of improvement.

"These minutes look like they have a bleaker assessment, but things were darker then," he said. "I can’t say it’s an accurate interpretation of their outlook today. I think that would be a little more favorable." 

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