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Mr. Bowman is a portfolio manager at Hamilton-based Wickham Investment Counsel Inc., an adviser to high net worth clients. michael@wickhaminvestments.com
What are we looking for?
North America's biggest, most efficient banks.
The screen
My colleague Rob Belanger and I started with North American banks over $5-billion in market capitalization.
Tier 1 capital is the measure of a bank's financial strength based on the sum of its equity capital and disclosed reserves. A firm's risk-weighted assets include all assets that a firm holds that are systematically weighted for credit risk. Generally, a firm must have a ratio of Tier 1 capital to its risk weighted assets of more than 6 per cent to be considered well capitalized. We are looking for a large ratio.
The efficiency ratio shows the percentage of a dollar needed to produce $1 of revenue. We have sorted the banks based on the efficiency ratio, from best to worst.
We are looking for a low number when examining the percentage of non-performing assets in comparison to total assets. In simple terms, if a borrower fails to make a loan payment for 90 days it is considered to be a non-performing asset.
U.S. hedge funds see Canada's housing market as a bubble set to burst and they want to take advantage of that by shorting the banks that hold the mortgages. The short interest ratio is a sentiment indicator derived by dividing the amount of stock that is sold short by the average daily volume of a stock. It determines how long it will take short sellers, in days, to cover their entire position if the price of a stock begins to rise.
What did we find?
Excluding the yield, one of the best banks on our list is First Republic. A relative newcomer on the scene, the company was formed in 1985 and operates predominantly on the U.S. West Coast. M&T Bank claims the highest short interest ratio at 11.06 days. The firm was started in 1856 and sports the best efficiency ratio but scores relatively poorly in the Tier 1 capital and non-performing asset categories.
While CIBC and the Bank of Nova Scotia are very close in most categories, we'll give the edge to CIBC with its higher yield and better Tier 1 capital ratio.
While Bank of America only scores well in the Tier 1 capital ratio, the stock has doubled in the past 12 months.
Conclusion
Evident on our screen, bashing and shorting Canadian assets has been a popular chant this year. Pacific Investment Management Co. LLC (Pimco), the world's largest bond fund, says the bearishness has gone too far. Playing the short side could be a dangerous gamble. As always, do your own research or contact an investment professional before buying.