Over time, we expect to have 50% exposure to North America in the Hamilton Capital Global Bank ETF (TSX; HBG). As stated in our note, “HBG: Post-Brexit Portfolio Changes” (July 6, 2016), we went underweight Canada (to 0%) and increased our exposure to the U.S. (to 44%) heading into Q2 earnings season. Entering earnings season, HBG had positions in 26 U.S. banks, of which 19 were mid-caps (i.e., assets less than US$75 bln)[1].

On a portfolio weighted average basis, earnings per share increased by a very material 13% and 7% year-over-year (Y/Y) and quarter-over-quarter (Q/Q), respectively[2]. This compares to EPS growth of 8% and 5% over the same periods for the U.S. banking sector as a whole[3]. HBG’s impressive earnings growth was generally not expected, with 77% of holdings beating expectations, and the overall U.S. portfolio exceeding consensus estimates by 3%[4]. Many investors/ETFs follow the 13 largest U.S. banks, which on an equal weighted basis grew EPS by 1% Y/Y, materially lower than HBG’s primarily mid-cap bank portfolio. The universals (i.e., BAC, C, JPM, and WFC) actually had a 9% decline in Y/Y earnings.

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What were the drivers behind the strong results?

HBG’s U.S. holdings double-digit earnings growth was supported by strong loan growth, benign credit and a focus on expense reduction. Despite the low rate environment, net interest income increased 14% Y/Y, which was supported by loan growth of 21%[5], which more than offset margin compression (of 11 bps). Deposits – the growth of which is a key driver of franchise value – increased at similar rates (+18% Y/Y), which is significant as many of our holdings are viable takeover targets. Credit quality for HBG’s holdings remained benign in the quarter[6].

Revenue remains under pressure due to the depressed interest rate environment, which is forcing banks to continue with cost cutting measures for EPS growth which supported a falling efficiency ratio (down 61 bps Q/Q). Non-interest income was flat Y/Y, but increased by 19% Q/Q. Profitability (ROE) improved from a weak Q1, but declined by 38 bps over the same period in 2015 to 8.9%. This compares to a 154 bps Y/Y decline for the U.S. universal banks, and a 13 bps increase for the sector as a whole.

This was a solid quarter for HBG’s U.S. holdings, which represent nearly 50% of the fund. We continue to favour U.S. banks – and mid-caps, in particular – given the strong earnings growth potential, active M&A environment, and regulatory tailwind.


Notes

[1] Excluding a single trust bank holding.
[2] Source: Bloomberg.
[3] Source: KBW. Median figures for 224 publicly traded banks covered by the firm.
[4] On a weighted average basis. Weights as of July 26, 2016. Portfolio changes were made into month-end. Analysis excludes trust bank holding and holdings added after they had reported earnings.
[5] Note, this does not exclude the impact of changes due to acquisitions.
[6] Net charge offs/average loans up only 5 bps Y/Y, and down 2 bps from Q1.

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.

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