Better-than-expected second-quarter results for most U.S. financials bode well for Canadian banks in the third quarter, but trading revenues are expected to be a major factor driving sector valuations.
The healthy results by U.S. banks were marked by positive net interest income, steady asset growth and stable margins. However, Barclays analyst John Aiken noted that trading revenues showed indications of pressure.
Since Canada’s Big 6 banks taken advantage of strong capital markets activity within the first half of 2015, any pullback in related revenues could cause some weakness for that sector.
“While investors haven\’t paid up for trading revenue in the past few quarters, its decline would remove a tangible support for the bottom line and could place some pressure on valuations,” Aiken told clients.
Canadian banks generated sequential trading revenue growth above 40 per cent in the past two quarters. But with trading revenues declining typically 21 per cent at U.S. banks in the most recent quarter, carrying out a seasonally strong Q1, the analyst is anticipating similar weakness north of the border.
A strong reporting period for U.S. banks has once again triggered the group’s outperformance versus Canadian peers. Low oil prices and also the resulting weak outlook for the Canadian economy have driven this country’s bank stocks to underperform by approximately 27 percent in the past year.
Despite trading at a forward P/E discount of 3x and achieving a dividend premium of about 2.6 per cent versus their U.S. peers, Aiken believes the more positive economic and rate of interest outlook within the U.S. may cause banks there to continue outperforming in the near term.
The analyst noted that National Bank of Canada, Bank of Montreal and Royal Bank of Canada generated the biggest percentage of total revenues from capital markets in the past 12 months, so they could feel the biggest hit from the slowdown on the bottom.
Most of the trading weakness for U.S. banks was attributed to fixed income, currency and commodity trading, and that he pointed out that RBC and National could gain in relative exposure to these businesses.