What are we looking for?
U.S. banks to complement Canadian investors' holdings in the Big Five.
The screen
Canada has one of the strongest banking sectors in the world. Five of Canada's 10 largest companies are in the financials sector, which is the largest sector of the overall economy at 34 per cent (by market cap). In the United States, where banks were famously deemed "too big to fail" pre-2008, the financials sector is actually only 18 per cent of the greater economy and only two of the 10 largest companies are financials.
The Big Five Canadian banks have been excellent investments over the past 20-plus years and are ubiquitous in Canadian mutual funds and exchange-traded funds, and individual Canadians' retirement portfolios. Investors may wish to diversify by holding American banks, but since the U.S. financials sector is so much more fragmented, some diligence is needed.
Here are today's criteria:
- First, we filter out U.S. banks that have a Tier 1 capital ratio of less than 10 per cent. Tier 1 capital is the core measure of a bank’s financial strength from the perspective of regulators, and regulation is being implemented that will require a minimum ratio of Tier 1 capital (mostly equity in the bank) relative to risk-weighted assets.
- Second, we look for a net interest margin of 4 per cent or greater. Banks earn money trading securities and currencies, but their core business is earning a higher rate on deposits taken than they pay out in interest to depositors.
- Finally, we look for banks that generate a return-on-equity (ROE) greater than 10 per cent.
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What did we find?
Our screen yields 10 companies, all with a market cap greater than $300-million (U.S.). The two largest – Western Alliance Bancorp and Bank of the Ozarks Inc. – have the highest ROE and net interest margin, respectively.
Western Alliance is based in Phoenix and has operations in Arizona, Nevada and California. The company recently purchased GE Capital's Franchise Finance business, which offers funding to hotel property owners.
Bank of the Ozarks is headquartered in Little Rock, Ark., and has offices across the Southeastern United States. Earlier this month, hedge-fund legend George Soros's Soros Fund Management LLC disclosed a stake in the bank.
This commentary does not provide individualized advice or recommendations for any specific subscriber or portfolio. Investors should conduct further research before investing.
Hugh Smith, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.