Download Sector Outlook: Financial Institutions Group

Sector Outlook: Financial Institutions Group
The Financial Institutions Group (FIG) consists of public companies involved with
fabrication and sale of financial instruments and services. This cluster of organizations
enjoys great variety and diversity as it includes sub-sectors like commercial banking,
wealth management, financial advisory, P&C insurance, and several others.
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Toronto-Dominion Bank (TD)
Bank of Montréal (BMO)
Manulife Financial Group (MFC)
Genworth MI Canada (MIC)
Canaccord Genuity (CF)
Visa Inc. (V)
Citigroup (C)
Element Financial (EFN)
JP Morgan (JPM)
Senior Analyst: Karn Jariwala, BBA 2017
Junior Analysts: GianPiero Gigliotti, BBA 2018; Waqar Din, BBA 2018
Research Analyst: Jonathan Chan, BBA 2019
Sector Overview
Following a prolonged period of economic uncertainty and heightened regulatory pressures
contrasting the increasing net profits, financial services sector has begun enjoying
sustainable but slow growth. The Big Six banks have tackled the downward pressure from
tumbling oil prices and low-interest rates with charisma as their consolidated earnings rose
to CA$35 billion, with Royal Bank's record $10-billion profit leading a very healthy pack.
In contrast to the banking sector, the Canadian Asset Management Industry entered an
extremely turbulent ride with rapid changes in the commodity prices and tanking investor
confidence. Although there are several determinants of growth within the industry, FIG is
predominantly driven by the macroeconomic factors and socio-economic situation at its
place of operations. Beyond the conventional elements, in recent years, the sector has
proven to be tremendously mutable by downfall in commodities, technological
innovations, and alternative investment trends.
Outlook
As discussed previously, since the outcome of FIG is highly dependent upon macroeconomic variables and underlying industry drivers, the 2016 outlook is essentially
contingent upon the following fundamentals:
Interest Rates – Canada
The Bank of Canada has maintained a low interest rate environment in 2015. In July interest
rates were cut by 25 basis points to 0.5% in response to a technical rescission arising from
decreasing demand for oil which accounts for about 30% of Canada’s exports. Poloz held
the rate constant at 0.5% in January 2016. This was an effort to maintain consumer
confidence and inflation as the value of the Canadian dollar paired with plunging oil prices
were putting downward pressure on Canadian purchasing power. However, despite the
duplicity in Canadian economic growth story, the interest rates will likely slip another 25
bps by June. Due to its effects on NIMs, a lower interest rate may cause some disruption
in the Canadian banking sector depending on the top-level strategy of the sector.
Interest Rates – U.S
In December of 2015, the Federal Reserve increased the Federal Funds Rate for the first
time since the 2008 financial crisis. The range of the benchmark rate was set between
0.25% - 0.5%. This was done in an effort to manage economic growth as the central bank
believes that the U.S economy has been performing well, and is expected to do so for the
time being. The Fed also plans on maintaining a gradual increase of interest rates in order
to create a “safety net” as the U.S economy continues to recover. Should there be
considerable instability in the future, the Yellen would have room to lower rates to a certain
threshold. Given that the U.S economy is confronting an upward trending interest rate
environment, Canadian financial institutions with greater exposure to the U.S. (TD, BMO,
EFN) will benefit from these circumstances.
GDP – Canada
After two months of negative and flat economic growth, the Canadian economy grew 0.3%
in November. This was a result of an increase in goods and services producing industries.
Growth in goods-producing industries was surprisingly led by greater output in the oil and
gas extraction sector. Factors which originally caused the economic slowdown, such as
production shutdowns have been slow to recover. Despite the silver-lining, weak
conditions will prevail throughout the first half of 2016 while gradual recovery remains
likely in the third and fourth quarter depending on oil markets and exports to U.S. Given
the plunging prices of oil and anemic GDP growth, it is likely that, corporate lending and
financing will continue to decrease as investor confidence plunges. Negative effects in the
top line growth of many Canadian financial institutions (especially the ones without ample
USD exposure) will be a norm in 2016.
GDP – U.S
There has been an escalation in the worry about the U.S economic growth, leading to
increased risk aversion and a stock market sell-off. However, fourth quarter results display
overall economic health, with weaknesses concentrated in areas of the economy directly
exposed to the oil and gas sector. In the final quarter of 2015 the American economy grew
by 0.7%, and 2.4% for the entire year. However, one alarming statistic is that investment
in structures fell by 5.3%, most likely caused by reduced investment in the oil and gas
sector. Although a decrease in net exports has continued due to the strength of US dollar,
domestic demand growth appears to be healthy. The decrease in investment and corporate
lending alongside imminent downturn of the investment banking sector may result in
volatile short term conditions but overall outlook remains strong.
Canadian Dollar
In January 2015 the Canadian dollar reached its weakest point in thirteen years. The low
value of the dollar actually has positive effects on the Canadian manufacturing and exports,
as this makes Canadian goods relatively cheaper to that of our competitors. However, this
does have adverse impacts for firms involved in the capital markets, due to the decrease
brought about in international purchasing power. As a result of the low value of the
Canadian dollar, and the advantages this brings to the manufacturing sector, there will
likely be an increase in foreign direct investments.
U.S Dollar
The recent increase in the value of the U.S dollar is resultant of both cyclical and
fundamental factors. Global uncertainty has increased due to slowing Chinese growth
paired with falling oil prices. Subsequently, many investors perceive U.S assets as a safehaven and have increased their positions within U.S Treasuries. The U.S has also overcome
many barriers still weighing on economies across the globe. This outperformance has been
attainable as a result of the States’ divergent monetary policy. A high U.S dollar is
advantageous to U.S industries heavily involved in importing, such as the technology or
automobile industry.
Housing Market
The past year has been the second strongest year on record for Canadian home resales
with much of the rise occurring in Toronto and Vancouver – Canada’s “hot markets”.
Due to their sensitivity to the weakness in the energy sector, market conditions in Calgary
and Edmonton are expected to further deteriorate following significant downward
pressure on demand and prices. Lower starts in oil-producing regions are expected to be
partly offset by higher starts in regions such as Ontario and Quebec as they are set to
experience economic growth in 2016. At the other end of the spectrum, Vancouver set
new record highs for both home resales and prices in 2015 with annual price gains up
18.9% y/y. With a weakening loonie and historically low interest rates, increased foreign
interest has been a driving force behind the strong growth in Toronto and Vancouver’s
housing markets. In the near-future, these trends are expected to remain stable and largely
benefit the property insurance sub-sector in the short-term.
Oil and Gas Environment
The oil and gas industry plunged in 2015 with over 250,000 layoffs in the past twelve
months. Total industry profits for 2015 are expected to shrink by 20 to 30% y/y amidst
one of the worst commodity downturns seen in the past 30 years. Due to global
oversupply of oil and natural gas, commodity prices have plummeted and companies
have shifted their focus to adjusting their business models to account for the lengthy
slump in the markets. Traditional banks have been under pressure from federal regulators
to decrease their exposure to the energy industry due to the deteriorating quality of loans.
Many banks have refrained from taking direct ownership of companies or assets through
foreclosures and have instead focused on negotiating loan extensions and debt
restructurings. Bank portfolio managers have also been hesitant to liquidate assets due to
potential loan impairments being locked in at a low point in the market. In the short term,
we can expect to see declines in loan underwriting as banks try to bolster reserves against
potential losses.
FinTech –Transitioning Industry
Over the past year, investors have funneled over $14 billion into FinTech companies (an
increase from less than $3 billion in 2012) and hope to experience record amounts of
growth in the sector. FinTech adoption among financial institutions is set to double in
2016 as top groupings like cryptocurrency, online lending, and personal financial
management demonstrated healthy confidence. Moreover, FinTech now poses a risk for
traditional banks as barriers to entry have weakened and start-ups have the opportunity to
disrupt the financial services industry by undercutting larger players. Over the past few
months, revolutionary wealth management platforms have been developed which utilize
complex algorithms to strategically determine investment allocation strategies.
Blockchain technology has been a frontrunner as bulge brackets began experimenting
with the technology to provide easier payment services to consumers. The significant
amount of funding being poured into FinTech start-ups and rise of millennials are
indicators of the forthcoming transitionary phase.
Closing Remarks
In the imminent future, the financial institutions group of Canada is expected to perform
poorly, below than the market average. This forecast is dependent upon persistently low
oil-prices and prolonged presence of the low-interest environment, as the Canadian
economic forces have essentially denominated to the perception O&G landscape. Alberta,
Newfoundland and Labrador, and Saskatchewan will put downward pressure on
employment-rate and GDP growth to further weaken the economic conditions while
slowdown in emerging markets will negatively impact Ontario and B.C. However,
continued strength of the American economy will provide a cushion by pumping up
national exports.