Overview

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. Due to persistently low oil-prices putting downward pressure on GDP and prolonged presence of the low-interest environment, the sector is expected to perform below the market average. Our current watch-list includes several companies including: 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), and JP Morgan (JPM).

Overarching Themes

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.

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.

Macroeconomic Outlook and Industry Drivers

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.

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.

Beyond the basics, 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.