Royal Bank of Canada (TSX: RY)(NYSE: RY) and The Bank of Nova Scotia (TSX: BNS)(NYSE: BNS) have been burned by bad bets in the Caribbean, and investors are now looking closely at the rest of the operations to where there might be some cracks forming in the foundations of these two iconic institutions.
Royal Bank of Canada
RBC is Canada’s largest bank and has been a favourite among investors during the past couple of years. In its last earnings statement, Royal Bank reported record earnings on the back of a surge in capital markets revenues. The division enjoyed a 66% year-over-year surge in earnings that hit $641 million in the quarter. The capital markets group was so successful, it accounted for nearly 27% of Royal Bank’s total earnings for the quarter.
The wealth management division also pulled its weight at RBC. The group delivered a 22% gain compared to the same period in 2013.
Investors should be careful about betting on the results. Capital markets earnings can be volatile, and Royal Bank’s CEO, David McKay, even acknowledged that the spectacular returns in the capital markets group were unlikely to be repeated to the same degree in the following quarters.
Wealth management earnings are also fickle. Right now, equity markets are on a roll and fund managers are reaping the rewards, but this party won’t go on forever.
Regarding housing exposure, Royal Bank had $189 billion of Canadian retail mortgages on its books as of July 31, 2014. Insured mortgages represented 39% of the portfolio. The loan-to-value (LTV) ratio on the rest was 55%.
Royal is well capitalized. It’s Basel III Common Equity Tier 1 (CET1) ratio was 9.5% at the end of the last quarter. The ratio is a measure of the bank’s financial stability.
Royal Bank pays a dividend of $3.00 per share that yields about 3.7%. The company trades at about 14 times earnings.
The Bank of Nova Scotia
Scotiabank surprised the markets recently with the announcement that it will close 120 international branches and cut 1,500 jobs. The company also announced it will take writedowns on bad loans in the Caribbean.
The Bank of Nova Scotia is betting big on growth in Latin America with investments in Mexico, Peru, Colombia, and Chile. Revenues are growing in the region but high costs are eating into earnings. In the latest restructuring announcement, Scotiabank said it is shifting more of its focus in Latin America to Colombia and Chile and away from Mexico.
The bank has a balanced income stream. In the most recent earnings statement the company earned 33% of its revenue from the Canadian retail division, 24% from global banking and markets, another 24% from international banking, and the remaining 19% from global wealth and insurance.
The company says its 10.9% CET1 ratio will drop by 10 basis points as a result of the announced $451 million restructuring plan. The company will still be well capitalized.
The Bank of Nova Scotia also had $189 billion in Canadian residential mortgages as of July 31, 2014. The insured mortgages represented 52% of the portfolio. The LTV on the uninsured portion was 55%.
The bank pays a dividend of $2.64 per share that yields about 3.9%. The stock trades at about 11.7 times earnings.
Which should you buy?
Both Royal Bank and the Bank of Nova Scotia are strong long-term investments. At the moment, Royal is more expensive and its earnings are heavily weighted to volatile segments. Royal also has a higher percentage of uninsured mortgages on its books. The Bank of Nova Scotia has already aired all its dirty laundry and the stock is quite cheap compared to its peers, so it would be my pick right now.
These are interesting times for the Canadian banks and new investors should be careful about blindly investing in the group. If the banks are on your radar, you might want to check out the following free report.
