Compared to the losses recorded by many American and European banks, the Canadian financial services sector has weathered the subprime crisis with far less pain. But if the oil boom fades and structured investment product losses continue to mount, Canada might face a serious economic slowdown.

At last count, total write-downs at Canada’s six largest banks stand at approximately $11 billion dollars or roughly 5% of the total global subprime write-downs to date. Though not an insignificant number, that pales to the total of $200 billion of combined global bank write-downs since last summer and is far less than Union Bank of Switzerland’s (UBS) cumulative $38 billion in losses alone.

Canada, however, is not immune to the woes now affecting its largest trading partner, the United States.

Canadian GDP Contracts 0.3% in First Quarter

Despite a bull market in raw materials this decade – which has enormously benefited Canadian exports and the Canadian dollar, the country is starting to show strains in lending, housing and manufacturing. Indeed, a slowdown has already arrived. Canada’s economy contracted in the first quarter for the first time in five years, mainly because of a slump in auto manufacturing caused by a surging Canadian dollar and pervasive weakness in U.S. auto sales.

Meanwhile, some Canadian banks can’t escape the relentless wrath of subprime and other losses tied to illiquid structured financial products.

First quarter profits at Canada’s largest six chartered bank points to an acceleration of write-downs for Royal Bank of Canada (RBC) and Canadian Imperial Bank of Commerce, or CIBC. Canada’s biggest six banks logged a first quarter profit of $2.5 billion dollars in the January to March period, down almost 50% from a year earlier when combined earnings were $4.7 billion dollars. Most of these losses, however, are tied to CIBC and Bank of Montreal – the hardest hit since 2007.

CIBC Hit the Hardest, TD Escapes Subprime Wrath

Some Canadian banks have fared much better than their peers since the advent of the credit crisis last year. Of these, Toronto-Dominion Bank (TD) has almost escaped without any serious losses at all since last July while the Bank of Nova Scotia has also easily absorbed modest losses tied to subprime and other structured products.

In fact, TD Bank ranks among one of the best performing major banks in North America in 2008 – up 8% compared to a loss of 14% for the KBW Bank Index in the United States.

But the story is altogether different for Canada’s other big banks.

RBC and CIBC now share the dubious distinction of featuring among the global banking sectors’ top 40 list for the largest write-downs and credit losses since the banking sector started hemorrhaging last fall. And Bank of Montreal (BMO) is ranked second only behind CIBC for posting rising losses tied to structured products and other write-downs in Canada. RBC is Canada’s largest bank by market capitalization.

From its all-time high last year, the Bank of Montreal has seen its stock plunge 31%. CIBC, which takes the booby prize for Canada’s biggest loser in the subprime crisis because of its largest U.S. presence, is 33% off its best level.

CIBC has already written off a cumulative $6.7 billion dollars since the onset of the subprime crisis; that number is almost twice the figure posted by Canada’s other five largest banks put together.

Since last fall earnings have eroded and write-downs have accelerated as the U.S. credit crunch that battered the U.S. housing sector knocks the wind out of the banks' sails; everything from consumer and corporate lending to mortgages has been adversely affected as Canada finally begins to feel the impact of an American slowdown or recession. Over 85% of Canada’s trade is with the United States – the two largest trading partners in the world measured by the volume of goods and services.

But the news isn’t all gloomy. Dividends were largely unchanged over the first quarter while Bank of Nova Scotia actually raised its payout.

In addition to subprime losses, many banks were also hit by exposure in asset-backed commercial paper or ABCP. Other smaller lenders and brokers, including Canaccord Capital, saw losses in the hundreds of millions tied to illiquid short-term commercial paper.

Canada now Slowing but will Avoid Recession

The Canadian economy is now slowing in 2008. Stripping away booming oil and gas exports, the country’s merchandise trade balance is now in deficit. Without commodity exports, Canada would probably be in an economic recession. First quarter GDP data confirms this trend. Manufacturing belts in Ontario and Quebec continue to suffer from a soaring Canadian dollar, up over 50% since 2002 versus the U.S. dollar while the unemployment rate is rising, housing is showing signs of slowing and commercial bank lending is gradually contracting.

The Canadian economy should escape a serious slowdown this year. The country’s trade balance and budget surpluses are indeed shrinking amid a slowing global economy but remain well managed compared to most industrialized economies. Canada’s housing market is also in far better shape than America’s since “zero-money down” was never a part of the country’s housing culture. But a continued strengthening of the Canadian dollar and more losses tied to structured investment products could tilt the nation into recession if combined with a significant decline in crude oil and gas prices.