A man talks on his cell phone as he walks down Bay St in the financial district in Toronto, Thursday January 22, 2015 One reason why Canadian banks have come under stress is the return of short-sellers to their U.S. listings.Mark Blinch/The Globe and Mail
Though they sit on opposite sides of the world, Canada and Australia are, in some respects, two very similar countries.
Both are wealthy, developed nations blessed with natural resources, tied to powerful economies that serve as key trading partners. Both have also faced warnings about frothy housing markets and high levels of household indebtedness.
But the share prices of the two countries' banks have reacted differently to the downturn in commodity prices, particularly those of oil and iron ore. Since the end of November, the price of iron ore delivered to Qingdao, China, and the spot price of West Texas intermediate crude oil have dropped by more than 15 per cent. While the Big Six Canadian banks have declined, on average, by more than 5 per cent over this stretch, the Big Four Aussie Banks (Commonwealth Bank of Australia, Westpac Banking Corp., ANZ Banking Group Ltd. and National Australia Bank Ltd.) have posted an average gain of 15 per cent.
When comparing the Canadian banks with their Australian counterparts, Credit Suisse analyst Kevin Choquette finds reason to favour the Great White North over the Land Down Under.
"It seems the market is aggressively discounting Canadian macroeconomic risk via bank valuation," Mr. Choquette said. "The concern seems to be the earnings risk and earnings growth outlook given the headwind of an expected struggling Canadian economy and a pending housing slowdown."
However, the consensus call among analysts is for Canadian banks to post superior earnings growth in 2016.
Both countries, no doubt, face a dimming economic outlook, but the analyst sees the risks facing Australia and Canada as roughly equal. The price-to-earnings ratios for Canadian banks are two standard deviations below the mean relative to the Australian banks, the analyst observed. In a scenario in which this situation reverted to the mean, Canadian banks would gain 22 per cent on their Australian counterparts, see earnings shrink by about 18 per cent, or a combination of the two, said Mr. Choquette.
One reason why Canadian banks have come under stress is the return of short-sellers to their U.S. listings. Royal Bank of Canada has seen short interest as a percentage of float rise to 2.1 per cent on the New York Stock Exchange, not far from its March, 2009, level of 2.4 per cent. This accumulation of shorts may have been affected by extenuating circumstances – investors looking for a merger arbitrage opportunity in light of the bank's proposed acquisition of City National Corp., which has yet to close.
However, the same does not apply for the very domestically oriented Canadian Imperial Bank of Commerce, which has seen short interest as a percentage of float rise to 3.66 per cent, exceeding its financial crisis peak.
"It seems that Toronto/Canada's proximity to New York and extrapolation in general of U.S. Banking & Housing to Canada versus Melbourne may create more visibility for Canadian banks as short candidates," said Mr. Choquette.
While short interest reflects skepticism about the growth outlook for Canadian financials, it is also a potential source or upward pressure on prices should short-sellers look to close up those positions en masse.
The big four Australian banks have an average dividend yield of 5 per cent, a percentage point higher than their Canadian peers, but the spread relative to 10-year government bond yields is nearly identical. Since the new millennium, however, Australian banks have typically had dividend yields about 1 1/2 times larger than the Canadian banks.
And at 76 per cent, the payout ratio for Australian financials – the share of earnings dedicated to dividend payments – is 30 percentage points higher than for the Canadian banks, giving them more scope to increase distributions in the future, though regulatory approval would likely be required.
Canadians are inundated with calls to go short domestic banks, but Mr. Choquette has a wholly different recommendation for investors: Go long Royal Bank and TD Bank while shorting Westpac as a pair trade.
Disclosure: The author of this story owns shares of TD