What are we looking for?
Efficiently managed North American banks, with healthy credit exposure and high-quality sources of capital.
The screen
Donald Trump's surprise victory last week caught global markets off-guard, expectations across both polls and financial markets were for the opposite – a Hillary Clinton win – yet initial negative sentiment quickly reversed overnight, leading to a 5.36-per-cent and 3.8-per-cent weekly gain across the Dow Jones industrial average and S&P 500, respectively. Financials, in particular, rallied thanks to Mr. Trump's promises to revamp Dodd-Frank – which has been the subject of both big and regional bank complaints owing to the regulatory costs imposed by the legislation – and plans to boost the economy through fiscal stimulus, shifting up expectations of future inflation and probability of a Fed rate hike up this December.
We screen for banks well positioned to leverage this rally should it continue. Our screen criteria are based on metrics covering fundamentals, credit quality and capital relative to industry medians:
- A dividend yield greater than 2.2 per cent and price-to-earnings ratio of less than 17.
- An efficiency ratio of less than 65 per cent. It measures the cost to the bank of each unit of revenue, so lower values are better.
- A Tier 1 capital ratio greater than 11.5 per cent. It measures banks’ core equity capital to total risk-weighted assets. This ratio shows us how well a bank is able to absorb losses in the event of market stress. Higher values are better.
- Gross non-performing loans less than 2.5 per cent. This is the ratio of loans that are in default or close to being in default to total loans.
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What did we find?
The screen highlights eight companies that fit our criteria, with Royal Bank of Canada experiencing the largest price growth this quarter relative to its domestic peers. This is partly owing to RBC's U.S exposure through its capital-markets and wealth-management businesses. Canadian financials should be approached with caution because of their sensitivity to the Canadian housing market and declining growth in consumer debt – both of which may be under pressure if the recent rise in Canadian bond yields is here to stay.
This commentary does not provide individualized advice or recommendations for any specific subscriber or portfolio. Investors should conduct further research before investing.
Khaled Eniba works in the financial and risk unit of Thomson Reuters and specializes in banking and research.