Welcome to Soundbites – insights on market trends and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we speak with James Black, vice-president, Canadian equities, with Beutel Goodman Investment Counsel. We discuss the health of both the banking and the insurance industries, and what threats are looming. And we started by asking why he’s generally bullish on banks.

James Black (JB): Canadian banks have a pretty strong track record at managing through downturns. We look at past performance, we look at ability to manage through crisis, through periods of elevated loan losses, through financial downturns. And the strength of the business is such that they have been able to both survive and ultimately thrive through those downturns. A very good lesson coming out of the craziness of the last 18 months has been the resiliency of the institutions and the stringency of the capital requirements. And I think a very good thing to keep in mind is that this new capital regime was put in place after the global financial crisis of 2008. So, with many of those lessons in mind, banks and institutions were made to hold higher levels of capital and be subject to more rigorous stress tests. And they held up very well as a result.

Trends he’s observing in that space.

JB: The things that we look to right now, as we observe the environment, is there’s greater digitization of transactions and a resulting reduction in physical branch networks. We’ve already seen somewhat of a reduction in branches over the last few years, and I would suspect that’s going to be a trend that’s going to continue. I don’t think branches are going to be eliminated. I think they’re going to remain an important point of customer contact for consumers who want a customer-facing experience. And the more that they demand that, the more the banks are going to be forced to make that available. But the number is going to go down and not up.

What threats are on the horizon.

JB: The first thing you need to look at are the large tech companies who are making forays into payments and other aspects of financial transactions. But, you know, this is nothing new. What’s important with the banks is to look at their strength. First of all, their size, the capital that they have backing their businesses, their sophisticated risk management and compliance systems, their entrenched relationships with clients. Right now, the advantage that their competitors enjoy is that they are not subject to the same level of regulation, whether it be capital requirements, know-your-client regulations, anti-money laundering provisions. You know, they’re subject to some, but not nearly all. And at some point, it’s likely that if fintechs become a larger and larger share — and they’re still relatively quite a small share — that more regulation is inevitable. And that would likely serve to level the playing field somewhat.

On the health of the insurance sector.

JB: Claims relating to the pandemic have been manageable. Sales declined pretty precipitously in the earlier part of the lockdown but they’ve rebounded, quite strongly. Again, we’re seeing greater digitization of transactions there. From an attractiveness perspective, we look at the level and consistency of returns. We’re also very interested when life insurance companies own less capital-intensive, non-life insurance businesses that generate higher returns and come with less risk. And those aspects of these businesses are certainly growing. We’ve always looked at valuation and capital levels to ensure that they’re well capitalized. From a red-flag perspective, for a life insurance company in particular, capital is always the most important consideration. So, we always want to see a good buffer, above regulatory minimums. And, you know, another red flag would be if we thought that there were risks that had not been adequately accounted for in reserves. And we’re constantly looking at trends in actuarial charges, and things like that, to ensure that companies are adequately reserving for their liabilities.

And finally, how regulations could impact the sector

JB: The insurance companies have always been heavily regulated, and trends in regulation are generally always to more regulation rather than less. And companies, as they have greater requirements to fulfill, they’re just going to have to do that. The returns of these businesses have remained relatively stable, even through eras of increased regulations, and at this point I don’t have any information that suggests that would change.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to James Black of Beutel Goodman Investment Counsel.

Visit InvestmentExecutive.com, where you can sign up for our AM newsletter. We’ll be back on August 25th for another Soundbite.

Thanks for listening.

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