Canada’s big banks have regularly earned more and paid higher dividends. There’s fear that a recession will hurt their financial results. This gives you an opportunity to buy the banks cheaply. Our view is that there are also a number of factors working for the banks.
An opportunity to buy the big banks cheaply
The big five banks are all expected to earn more this year and trade at attractive (price-to-earnings or P/E) multiples. They also regularly raise their dividends. The big five banks are Canadian Imperial Bank of Commerce (TSX—CM; NYSE—CM), Royal Bank of Canada (TSX—RY; NYSE—RY), Toronto-Dominion Bank (TSX—TD; NYSE—TD), Bank of Montreal (TSX—BMO; NYSE—BMO) and The Bank of Nova Scotia (TSX—BNS; NYSE—BNS).
The banks’ dividends provide generous yields (roughly four to five per cent). Growing numbers of income-seeking retirees will continue to bid up their share prices in the years ahead. Outside of the big five is National Bank of Canada (TSX—NA) also remains a buy for long-term share price gains as well as high and growing dividends.
One positive factor for the banks is that interest rates are higher and rising. This should strengthen the banks’ traditional business. It widens the difference between the interest banks pay on liabilities such as deposits and the interest they earn on assets such as loans. Over complete fiscal cycles, the net interest margin should improve.
We expect interest rates to go up further. The Bank of Canada, the Federal Reserve and the European Central Bank plan to raise interest rates by larger-than-usual amounts. That’s because it looks like they were ‘asleep at the switch’. Inflation surged faster than expected. Now the central banks want to eliminate it before it permanently unmoors long-term inflation rate expectations. Even so, inflation doesn’t unduly affect the banks.
Many are in decent financial shape
Many Canadians are in decent financial shape. Those who worked from home spent less on transportation, at restaurants and bars, on clothing and dry-cleaning and so on. They built up substantial savings. These Canadians are in a better position to service their bank debt. In addition, labour shortages can also shorten spells of joblessness. And average incomes have improved as Canadians sought better jobs and received raises.
House prices are up sharply
Mortgage debt climbed during the pandemic as Canadians moved and renovated or upgraded their homes. Higher interest rates will raise the cost of servicing mortgages. But house prices climbed so much that most homeowners could sell their houses at a profit if they face financial difficulties. Only recent buyers are out of such luck.
The big banks are broadly diversified
Also keep in mind that the big five banks are diversified. With the dissolution of the ‘four-pillar’ financial system, the banks have become large players in the brokerage, investment-banking, mutual fund and trust company industries. The only pillar that has partly resisted the banks is the insurance industry. As we point out from time to time, the banks have a finger or fist in every financial pie.
All of the big five banks have also diversified geographically. They have built up significant foreign businesses. And, of course, the banks can open branches anywhere in Canada. This enables them to expand into faster-growing provinces such as Alberta, British Columbia and Ontario.
Big poverty risk
There are some risks. The pandemic-related emergency payments are largely gone. The Bank of Canada is quickly tightening monetary policy. If it does so too far and too fast, the hoped for ‘soft landing’ could turn into a crash landing. The decline in stock and bond prices and higher inflation could make people feel poorer. If consumers cut back on their spending and Canada enters a recession, this would have a negative impact on the banks.
This is an edited version of an article that was originally published for subscribers in the June 3, 2022, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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The Investment Reporter •9/4/22 •