Three days in New York gave us the opportunity to meet with a broad-based group of financial services companies, largely based in the U.S., but several operating globally. Included in the mix were several holdings of the Hamilton Global Financials Yield ETF (ticker: HFY) and the Hamilton U.S. Mid-Cap Financials ETF (USD) (ticker: HFMU.U), both of which invest in the broader financials services sector. The former (HFY) emphasizes reliable dividend payers with good growth prospects, while the latter has a bias for medium-sized U.S. companies with a distinct earnings growth advantage, owing to the economic backdrop of their operating footprint and/or their business/operating model.
Note to Reader: This Insight includes references to certain Hamilton ETFs that were active at the time of writing. On June 29, 2020, the following mergers took place: (i) Hamilton Global Financials Yield ETF and Hamilton Global Bank ETF into the Hamilton Global Financials ETF (HFG), (ii) Hamilton Australian Financials Yield ETF into the Hamilton Australian Bank Equal-Weight Index ETF (HBA); (iii) Hamilton Canadian Bank Variable-Weight ETF into the Hamilton Canadian Bank Mean Reversion Index ETF (HCA), and (iv) Hamilton U.S. Mid-Cap Financials ETF (USD) into the Hamilton U.S. Mid/Small-Cap Financials ETF (HUM).
Varying in size, sub-industry and operating footprint, the companies we saw offered perspectives as diverse as their market caps. Below are the highlights of our meetings, by sub-sector:
Exchanges – Data the focus; no transformational deals expected
The exchanges were positive on their organic growth prospects, both in terms of ancillary businesses (such as clearing and indexing) as well as opportunities within data analytics and related customer solutions (e.g., compliance surveillance). Data related offerings are anticipated to provide a cushion to the exchanges’ traditional trade execution businesses in the event of a downturn.
Although M&A is expected to be part of the growth strategy, interest tended to smaller scale, bolt-on activities, as opposed to transformational transactions such as with another exchange. This was particularly telling given two of the three presented on the same day the Hong Kong Stock Exchange announced its bid for the London Stock Exchange, which is already involved in its own high-profile bid for financial markets data specialist, Refinitiv.
Business development companies (“BDCs”) – Steady as it goes
A panel discussion of five larger BDCs provided insight to how they are approaching the current environment. Although executives were quick to note that every company is different, consensus was that the economy, as seen through the lenses of their portfolio companies, is still pretty healthy. Credit remains strong. The self-proclaimed bear on the panel said he doesn’t see a recession in the near-term. Nonetheless, everyone is checking in with their companies more often.
The U.S. continues to feel “very investable”, but the BDCs are being more selective in what they fund. Last year’s legislative change allowing BDCs to operate with a 2:1 debt to equity ratio (up from 1:1) gives them additional funding room. However, for this group, the inclination was to keep that dry powder for use in the next downturn. Today, the panel is willing to sacrifice yield/return for quality. So is everyone else, and hence competition is high with some less-disciplined players (e.g., less experienced BDCs, private credit funds, insurers, etc.) offering more lenient terms and/or structures than the panel was interested in. One BDC noted that it is using the abundance of capital in the space to prune some of its lesser-performing investments.
Mortgage insurers – Credit remains benign
As in Canada, U.S. borrowers with less than a 20% down payment for a home require mortgage insurance. Unlike in Canada, approximately 40% of those requiring mortgage insurance get it from a private mortgage insurer (a “PMI”). In general, the PMIs expressed confidence that the economic (low unemployment, increasing wages, home price appreciation) and industry backdrops (stronger capital levels) remain robust for mortgage insurance, limiting their biggest risk, credit, in the near/medium-term. There was less concern that the current refi wave would result in the historical reduction in insurance in-force (as home values appreciate and/or sufficient principal paydowns allow for the MI to be canceled) since this year’s wave has involved more recent originations (and hence still require MI).
Banks – Proactively managing the rate environment
Themes across the bank presentations were fairly similar to those witnessed on recent bank tours (see Notes from Dallas – Big Things Happen Here and Notes from Washington, DC – Investigating One of the Wealthiest MSAs in the Country), with geographical location (high growth areas of the U.S. vs. slower growth areas) and business mix being the biggest factors in differing outlooks. Credit continues to be solid given the strong economic backdrop; any issues have been isolated and not indicative of a burgeoning trend(s). Loan growth remains good, with 1-4 family seeing a pick-up on the refi side given lower mortgage rates. Most banks are taking action to reduce their interest rate sensitivity, including seeking core deposits, hedging exposures, introducing rate floors (where competition allows) and talking with larger clients about reducing rates.
Title Insurers – Riding the refi wave
Lower mortgage rates are driving strong retail volumes for title insurers, with August the “best [title policy] opening month since 2016” according to one executive. Although purchase orders are more profitable that refis for title insurers, the recent refi surge is expected to produce incrementally strong margins, since the insurers had not staffed up in advance (lessons learned from the financial crisis have resulted in the title insurers managing their hiring needs more tightly). Purchase orders, which are less sensitive to rate changes, look to be flat to 2018 overall, setting the title insurers up for a comparably strong second half. On the commercial side, the outlook remains favourable, with strong activity noted in Atlanta, Philadelphia and Texas, and just a few overheated markets (e.g. New York).
Despite the collapse of the Fidelity National/Stewart (#1 and #4 in an industry dominated by four players) deal on the morning of the presentations, the insurers expect M&A to continue to be part of their capital strategy, however much smaller in size. Hence capital return, likely with an emphasis on dividends (the group yield ~3% currently) over buybacks, is expected.
What U.S. Investment Bankers and Banks are Saying about M&A
Notes from Washington, DC – Investigating One of the Wealthiest MSAs in the Country
HFY: Thriving in a Very Challenging Market (Supported by 4%+ Yield)
U.S. Mid-Caps Continue to Generate Outsized EPS Growth; P/Es at ~20% Discount to 5 Year Average
Global Exchanges, E-Brokers and Fin-Tech: Secular and Structural Growth Drivers Abound
HFMU.U Posts Robust 13% EPS Growth Y/Y; 500 bps Ahead of U.S. Large-Cap Financials
Notes from New York: Cards, Payments and Financial Technology Meetings
A word on trading liquidity for ETFs …
Hamilton ETFs are highly liquid ETFs that can be purchased and sold easily. ETFs are as liquid as their underlying holdings, and the underlying holdings trade millions of shares each day.
How does that work? When ETF investors are buying (or selling) in the market, they may transact with another ETF investor or a market maker for the ETF. At all times, even if daily volume appears low, there is a market maker – typically a large bank-owned investment dealer – willing to fill the other side of the ETF order (at net asset value plus a spread). The market maker then subscribes to create or redeem units in the ETF from the ETF manager (e.g., Hamilton ETFs), who purchases or sells the underlying holdings for the ETF.