U.S. trading revenues may provide a sign of caution for Canadian banks

Better-than-expected secondquarter results by most U.S. financials bode well for Canadian banks in the third quarter, but trading revenues are expected to be a major factor driving sector valuations.

The healthy results by U.S. banks were marked by positive net interest income, steady asset growth and stable margins. However, Barclays analyst John Aiken noted that trading revenues showed signs of pressure.

Since Canada’s Big Six banks benefited from strong capital markets activity in the first half of 2015, any pullback in related revenues could cause some weakness for the sector.

“While investors have not paid up for trading revenue in the past few quarters, its decline would remove a tangible support for the bottom line and could place some pressure on valuations,” Aiken told clients.

Canadian banks generated sequential trading revenue growth above 40 per cent in the past two quarters. But with trading revenues declining an average of 21 per cent at U.S. banks in the most recent quarter, following a seasonally strong Q1, the analyst is anticipating similar weak- ness north of the border.

A strong reporting period for U.S. banks has once again triggered the group’s outperformance versus Canadian peers. Low oil prices and the resulting weak outlook for the Canadian economy have driven this country’s bank stocks to underperform by about 27 per cent in the past year.

Despite trading at a forward price-earnings discount of three times and having a dividend premium of about 2.6 per cent versus their U.S. peers, Aiken believes the more positive economic and interest rate outlook in the U.S. will cause banks there to continue outperforming in the near term.

The analyst noted that National Bank of Canada, Bank of Montreal and Royal Bank of Canada generated the largest percentage of total revenues from capital markets in the past 12 months, so they could feel the biggest hit from any slowdown in that area.

Most of the trading weakness for U. S. banks was blamed on fixed income, currency and commodity trading, and he pointed out that RBC and National could gain more relative exposure to these businesses.