RBC Says Hedge Funds Targeting Canadian Banks

Oct 14 2011 | 10:49am ET

Hedge funds are shorting Canadian banks, convinced their shares—which have held up well this year compared to their global counterparts—are due for a fall.

“The hedge fund community has shown an increased interest in shorting Canadian bank shares of late,” RBC Dominion Securities, the brokerage unit of Royal Bank of Canada, said in a research note this week. “While we recognize downside risks in a recessionary scenario, we ultimately believe Canadian banks will hold up relatively better than other sectors in the event of a downturn.”

Shares in Canada’s five biggest banks—RBC, Canadian Imperial Bank of Commerce, TD, Bank of Nova Scotia and Bank of Montreal—trade at some of the highest price-earnings multiples in the industry.

Canada’s strong economy carried the banks through the financial crisis, but foreign investors are now looking at the country’s rising household debt and wondering what will happen if the housing market cools.

“The key investment concern from U.S.-based investors is the Canadian consumer’s health, and the level of indebtedness in the mortgage market,” Cheryl Pate, a New York-based analyst with Morgan Stanley, which has a “neutral” rating on Canada’s banking industry, told the Globe and Mail. “We are looking broadly for a slowdown, but I would say it’s a slowdown to a normalized level.”

The Globe points out that although Canadian banks may look expensive compared to their global counterparts, other measures show their valuations are par for the course: the banks now trade at an average of 11.5 times earnings, versus an average of 11 for the past decade. 

“The Canadian banks are great companies with very durable business models, but we would be careful with the idea that the Canadian banks are immune to global events,” Rob Wessel, managing partner at Hamilton Capital, a Toronto-based fund manager specializing in financial services stocks, told the paper.


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