Canada’s banks were on a tear in the latter half of 2017. In Q3, the six biggest banks gained momentum, with three—RBC, CIBC and Scotiabank—hiking their quarterly dividends. In Q4, BMO was the only Big Five bank to report a drop in profit.
The overall strength of the financial sector last year came as a surprise to David Picton, president and portfolio manager for Canadian equities at Picton Mahoney Asset Management in Toronto, as “stronger economic data” on both the domestic and global fronts was a main driver. Picton Mahoney Asset Management is one of three sub-advisors for the Renaissance Canadian Growth Fund.
As well, there was “a bit of a Trump trade in the U.S. that has driven financials higher, and interest rates moving up tends to help the financial sector,” he says. (Trump’s tax reforms may weigh on some banks in the short term, though. RBC, BMO and TD all expect Q1 earnings to be affected by U.S. tax changes.)
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Heading into 2018, another issue was the financial sector “has been trading close to peak multiples,” says Picton. As of mid-December, “earnings in the space [were] a little bit more sluggish than expected. And, as interest rate increases work their way through the system, we expect to see some pressure on mortgage growth as well as traditional consumer growth,” he adds.
The main reason is the consumer bases of banks may be “a little tapped out and vulnerable to rate increases,” says Picton. “Our expectation would be that earnings growth should be limited, and multiples will start to slip back.”
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In December, Picton said he planned to trim his bank positions in early 2018, if necessary, should the banks start this year with a bang. As of Jan. 15, the stocks of all Big Five banks had gained over the previous 12 months.
Banks to watch
Picton is closely watching RBC, given it “consistently generates good profitability without taking any kind of special provisions like some of the other banks,” he says.
Further, RBC is “a quality operator that is ahead on its technology spend,” he adds. “Their positioning is [good] compared to the others and they have exposure to the U.S., which still has room to go on the upside of its banking sector.”
But CIBC is “most interesting to watch,” he says.
The bank has “really boosted their Canadian business through aggressive lending tactics in the mortgage sector,” says Picton. “That doesn’t mean they’re not covered there, but there could be a sentiment trade away from [CIBC] should real estate begin to peak out as some of those consumer lending statistics start to fade—especially if we need to see any kind of loss provision against the housing sector in Canada.”
(The Renaissance Canadian Growth Fund, for which Picton Mahoney is a sub-advisor, is offered by CIBC Asset Management.)
Looking at mortgage markets, Picton sees “signs at the margin that issues are beginning to crop their way into the [financial] system; issues that aren’t particularly positive.”
He points to Laurentian Bank, which identified issues in December related to some of its mortgages sourced from brokers. Laurentian says it has repurchased $180 million of those problematic mortgages, with the total buy-back expected to be around $392 million, the Financial Post reported.
Some of the bigger banks are now “pulling back on more aggressive mortgages” after new OSFI regulations, Picton says. Overall, “there will be more strain on the ability for people to apply for mortgages, given there has to be more of an income cushion in place.”
Ahead of this week’s BoC announcement, several retail banks have started to raise their five-year fixed mortgage rates. During the week of Jan. 8, RBC, TD and CIBC all announced hikes, and more banks are expected to follow.
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