We recently returned from a visit to Dallas (our third in four years) where we met with eight banks operating in the Lone Star State. Five of the eight have footprints beyond Texas, and hence offered a fuller picture of the attractiveness of the Texas economy and business outlook (hint, there’s a reason they’re in Texas). Of the banks we met, three are holdings in our Hamilton Global Bank ETF (ticker: HBG) and Hamilton U.S. Mid-Cap Financials ETF (USD) (ticker: HFMU.U). With our focus on investing in banks operating in regions with strong fundamentals such as Texas (more on that below), both ETFs have considerable weighting to banks with Texan exposure (~10% of NAV for HBG and ~17% for HFMU.U).
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).
Below are the takeaways from our meetings:
A solid economy makes for …
In the more than three years since the energy downturn took a bite out of Texan growth, related worries remain in the rearview window notwithstanding the brief decline in oil late last year (West Texas dropped back below $40, but today hovers closer to $60). In fact, Texas generally and Dallas, specifically, arguably continue to run on all cylinders. Between 2012 and 2017, the Dallas-Fort Worth-Arlington, TX MSA (“Dallas MSA”) – the fourth most populous MSA in the United States – grew GDP at an average annual rate of 4.2% (significantly outpacing the U.S. MSA average of 2.1%). More broadly, GDP growth remains healthy in the country’s second largest economy (at US$1.7 bln, the Texas economy is comparable in size to that of Canada, making it the 10th largest economy in the world), rising at an annualized rate of more than 3% in each of the last four quarters.
Business sentiment remains healthy, with bankers indicating that their clients are very optimistic. In today’s market, their clients’ biggest worry is finding labour to keep up with demand. This is not terribly surprising given Texas recently registered its lowest unemployment rate (3.4% this summer) since at least 1976.
One large regional bank noted how different the environment feels in Texas versus other markets in which they operate such as those in the Mid-West and Mid-Atlantic. He went on to say that almost every call they field from middle market clients in California begins with ‘should they move to Texas?’ Of note, between 2010 and 2016, Texas had the highest net domestic migration by state (at ~867,000) and the fourth highest net international migration (~509,000).
… a benign credit environment
Given the strong economic backdrop, the banks remain confident – though not complacent – on credit. Banks with leveraged loans in their portfolios (roughly half of the group we met) noted heightened scrutiny of the category given expectations that it could be the harbinger of any credit downturn. Despite issues at a peer bank midyear (which were explained as being situational rather than indicative of a trend), no bank cited a notable change in the health of their own loan portfolios. One executive mentioned that they are always watching commercial real estate (“CRE”) but that it was “holding up very, very well”. Non-performing and/or criticized loans in their portfolios generally remain concentrated in well-known areas, such E&P (exploration and production) energy loans and casual dining.
Mortgage lending leading the way
Loan growth continues to be good. In the wake of the falling (Fed Fund and mortgage) rate environment and the significant uptick in refi activity, growth in the 1-4 family and mortgage warehousing business line is outpacing other categories. Management teams were generally positive on middle market business activity as well. Commercial real estate loan growth is expected to be slower with heightened paydown activity continuing, a trend observed in other markets nationwide.
Finding ways to mitigate impact of falling rates
Most of the banks we met are asset-sensitive, meaning the rates on their loan and securities portfolios move faster with changes in interest rates (loans are largely LIBOR-based for this group) than the rates of their deposits. Without intervention, this can pressure net interest margins (“NIMs”) in a declining rate environment. While margins are expected to feel some pressure should the Fed continue reducing rates, the banks are putting to work lessons learned while rates were rising. These efforts include hedging actions (such as rate collars), implementing rate floors in their loans (where competition allows), and pro-active discussions with corporate and municipal clients on reducing deposit rates.
Playing offensive when it comes to M&A
With several banks we met in the midst of integrating prior deals, management teams were approaching M&A thoughtfully, but opportunistically. Two management teams expressed active interest in small, in-footprint deals (where they are the buyer), with an emphasis on quality. There was little discussion of a merger of equals (“MOE”), with the general sentiment being “too much risk” and “not likely”. Nonetheless, the understanding was that more banks are talking to each other than in the past.
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
Insights from Nashville: Titans of Growth
HBG: 12th Straight Quarter of 10%+ EPS Growth; Valuations at Five-Year Lows
U.S. Banks: The Sun’s still shining on Mid-Caps
HFMU.U Posts Robust 13% EPS Growth Y/Y; 500 bps Ahead of U.S. Large-Cap Financials
Insights from Atlanta: (Growth, M&A) Going Strong
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.
 As of September 26, 2019.
 An MSA, or metropolitan statistical area, is “an area containing a large population nucleus and adjacent communities that have a high degree of integration with that nucleus”. Source: United States Office of Management and Budget.
 Sources: U.S. Census Bureau, U.S. Bureau of Economic Analysis
 As of Q1, 2019. Sources: U.S. Bureau of Economic Analysis, Texas Economic Development Corporation
 Source: U.S. Bureau of Labor Statistics. Data dates back to January 1976.
 Source: Comptroller of Texas (https://comptroller.texas.gov)