Following Q1 quarterly earnings season, we made two portfolio changes with respect to the Canadian bank portfolio. First, we reduced our portfolio weighting from ~15% to ~12% (in favour of certain U.S. mid-cap banks). Second, we swapped out a large-cap Canadian bank with Laurentian Bank (LB). We explained these changes in the following two short HBG Manager Comments: Reducing Energy Exposure; Going Modestly “Underweight” Canadian Banks and On HBG, Adding LB to Reduce Energy Risk; Retain 5% Tax Efficient Yield. Our main rationale was to reduce the ETF’s exposure to energy lending, since the banks were entering a credit cycle from energy lending, while LB had zero exposure. At the same time, we retained exposure to the high tax efficient yield the sector provides.
The reason we bought LB is its history of outperformance during periods of rising loan losses. Q2 2016 was an example of this outperformance; LB materially outperformed its peers on credit quality, and therefore, earnings growth this quarter. For LB, loan losses in Q2 actually declined over 30% sequentially and over 25% year-over-year, while its larger peers saw provisions rise well over 50% year-over-year (excluding NA’s sectoral). Not surprisingly, LB emerged with a higher EPS growth rate than its larger peers, rising 6% Q/Q and 5% Y/Y. For its larger peers, earnings growth was actually modestly negative in aggregate, suffering under the weight of rising loan losses.
Coming out of the quarter, we remain underweight the Canadian banks with the sector screening overbought on a technical basis.
Note: Comments, charts and opinions offered in this commentary are produced by Hamilton Capital and are for information purposes only. They should not be considered as advice to purchase or to sell mentioned securities. Any information offered is believed to be accurate, but is not guaranteed.