Bank stocks benefit from higher interest rates

Canada’s two biggest banks keep duking it out for top spot among Canada’s big 5 banks. Both Royal Bank and Toronto-Dominion Bank are ‘buys’ for growth and income.

Bank_StocksUnlike utility stocks, Canadian bank shares have held up relatively well as interest rates have risen. That’s because higher rates typically increase the banks’ profit margins on loans. Then too, higher rates usually accompany stronger economic growth, which can lead to more bank loans, lower loan losses, and more profit from robust capital markets. Thus bank shares have outperformed the S&P/TSX Composite this year.

Among the banks, Canada’s largest bank by market capitalization has held up better than its group average, with a loss of 1.5 per cent year to date. Royal Bank of Canada (TSX—RY) is one of North America’s leading diversified financial services companies. It provides personal and commercial banking, wealth management, insurance, investors services and capital products and services on a global basis.

The bank reported record earnings in fiscal 2017. For the year ended Oct. 31, 2017, Royal made $11.5 billion, or $7.56 a diluted share, compared with $10.5 billion, or $6.78 a share, in the same period of 2016.

The results reflected strong earnings in personal and commercial (P&C) banking, capital markets, wealth management, and investor and treasury services, partly offset by lower earnings in insurance. Both periods include gains from the sale of assets.

Provision for credit losses (PCL) was $1.2 billion, down 26 per cent from fiscal 2016, mainly due to lower PCL in capital markets, P&C banking and wealth management.

RBC has a growth strategy that targets high-growth client segments within its priority markets of Canada, the US and in select global financial centres. In Canada, the bank is number one or two in all key banking segments. To maintain that lead, it wants to transform its physical bank network and digitize operations to meet customer needs. In the US, the integration of City National is letting it serve more commercial and high net worth clients.

Royal should earn $8.05 a share in fiscal 2018. The stock trades at just 12.6 times that estimate. The annual dividend of $3.64 a share yields 3.6 per cent. Buy.

TD achieves record earnings

Fiscal 2017 marked another year of record reported earnings for TD Bank—$10.5 billion. The bank generated double-digit growth in net income and earnings per share. And return on equity reached 14.9 per cent, up more than 160 basis points from the previous fiscal year.

Toronto-Dominion Bank (TSX—TD) is Canada’s second-largest bank by market capitalization and assets. The bank has branches in Canada, the US and other countries.

For the year ended Oct. 31, 2017, TD Bank made $10.6 billion (adjusted), or $5.54 a share, compared with $9.3 billion, or $4.87 a share, in the same period of 2016. The increase reflected revenue growth, and lower insurance claims and provision for credit loss, partly offset by higher interest expenses.

By segment, reported net income rose nine per cent to $537 million in Canadian retail, 12 per cent to $363 million in US retail, and 12 per cent to $119 million in wholesale banking.

TD’s earnings growth in fiscal 2018 looks like it will be better than that of the average Canadian bank.

TD trades at a reasonable 12.1 times its likely fiscal 2018 earnings of $5.91 a share. The annual dividend of $2.40 a share yields 3.3 per cent.

TD Bank is a buy for growth and income.

This is an edited version of an article that was originally published for subscribers in the February 16, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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