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Perspectives sectorielles : Services financiers*

Source : Robert Poole, CFA
Date de publication : mars 26, 2020

* En anglais seulement

These are extraordinary times for markets and Canadian banks. The environment today is quite a bit different than the global financial crisis (GFC). The banking system is much more sound, with capital and liquidity levels significantly stronger and a lot less reliant on short term wholesale funding. In the GFC, the crisis started in the financial system and made its way into the real economy. Today we have a real economy stress that will inevitably make its way into the banking system. Here are some considerations when thinking about financials in today’s economic environment.
 

  • It is extremely evident that banks and regulators globally have been working very closely. Regulators are looking to the banks and their balance sheet to help become a transition mechanism for getting money into the real economy, especially those who need access to liquidity like small and midsize businesses (SMB’s) and industries which are coming under direct and indirect stress from COVID-19.
     

  • The caution we have with the space, and our preference for high quality banks is based on our view that bank balance sheets will be used as shock absorbers during this crisis. Un-committed lines will (and are currently) be drawn on, credit quality of the underlying books will inevitably face negative migration and risk-weighted assets will inflate. This will result in capital levels getting drawn down for the group. We believe we could see a ~100bps drawdown in capital ratios for the banks in the not so distant future which is greater than a full years worth of capital generation. We are already seeing the negative repercussions as buybacks have been halted and dividend increases are prohibited for the foreseeable future.
     

  • From an earnings power standpoint we believe we are facing a near-term structural change in bank earnings. Net interest margins will be negatively impacted by zero interest rate policy, core loan growth should moderate with demand, loan modifications over the coming quarters will drive higher non-performing loans over time and will likely take time to work out, which we believe will take years, not quarters. We believe return on assets will be impaired for a multi-year period following this shock. To put this in perspective, we don’t believe the banks group will generate the same earnings power they did in 2019 until 2022 at the earliest.
     

  • Coming out of this market shock, capital levels will need to be built back up which we believe will hamper buyback and dividend increases for multiple years to come.
     

  • Bank return-on-equity (ROE) entered the GFC at 20%+ with price-to-book value (P/BV) ratios north of 2.5x and exited at ~15% with P/BV ratios at 1.5x. We enter this crisis with ROE’s at 14% and we believe that we will be exiting it at ROEs in the 10-12% range which would justify a multiple closer to where the group trades today (1.2x).
     

  • There is no doubt that today dividend yields look attractive, but we don’t believe we see dividend growth for multiple years. Price-to-earnings valuations look cheap, but earnings estimates have yet to be adjusted. P/BV valuations also look cheap but also reflect an environment where ROE’s are set to be structurally lower.
     

  • Finally, here’s a look at how the banks performed following the GFC relative to North American indexes. While Canadian banks outperformed the S&P/TSX Composite Index, they underperformed the S&P 500 and most importantly, the variance in returns amongst the Canadian banks was significant. Buying the cheapest bank stock with the highest dividend yield didn’t necessarily pay off. Royal Bank which was the highest valued Canadian bank in the depths of 2009, outperformed CIBC, the cheapest bank during the period (March 1, 2009 – March 25, 2020). The variance in performance is even more pronounced when considering the regional banks. It isn’t as simple as finding the highest dividend yielding bank, something many portfolios are often already overexposed to.
     

    Total cumulative return includes dividends reinvested. Performance as of March 1, 2009 to March 25, 2020.

This material has been published by Picton Mahoney Asset Management (“PMAM”) on March 26, 2020. It is provided as a general source of information, is subject to change without notification and should not be construed as investment advice. This material should not be relied upon for any investment decision and is not a recommendation, solicitation or offering of any security in any jurisdiction. The information contained in this material has been obtained from sources believed reliable, however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All investments involve risk and may lose value.

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