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What’s Going on With the Canadian Banks?

Canadian banks enjoyed an incredible run last year, but it appears that the rally has run out of steam. It all started with a story released from the CBC on tellers who were upselling customers to meet unrealistic goals. Toronto-Dominion Bank (TSX:TD)(NYSE:TD) got hit hard by this story, but it was later determined that all of the Big Five banks were doing the same thing.

Home Capital Group Inc. (TSX:HCG) added more fuel to the fire as it crashed, which spread a contagion across the entire mortgage market. Investors are fearful right now, and they’ve grown increasingly pessimistic of Canadian lenders and the Canadian financial system as a whole.

I believe the sell-off of the big banks is completely unwarranted. Although many investors have lost confidence in Canada’s financial system, it’s important to note that the big banks have high-quality, creditworthy loans, most of which are insured by the Canada Mortgage and Housing Corporation (CMHC).

The alternative lenders like Home Capital Group are a completely different beast. They’ve built their business around lending money to non-creditworthy clients that the banks deem too risky. This model was a house of cards, and it was just a matter of time before a breeze sent it crashing down.

Many pundits believe the Canadian housing market is in bubble territory and could be on the verge of popping. Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM) is the Big Five bank which would feel the most pain if this happened since the management team has been loading up on mortgages.

As of October 2016, CIBC owns approximately $103.7 billion worth of uninsured residential mortgages and home equity lines of credit, but it’s unrealistic to expect a meltdown like the one experienced during the Financial Crisis. Unlike the alternative lenders, CIBC has a very thorough process when considering whether applicants will be approved for credit. Sure, CIBC has a lot of uninsured mortgages when compared to other banks, but they’re nothing like Home Capital Group’s subprime swamp.

If you’re betting on a housing crash, then CIBC would definitely face some downside, but I don’t think it will be as much as the doomsayers are expecting. The bank’s high mortgage exposure is already baked in to the stock, and the stock is already absurdly cheap when compared to its Big Five peers.

On the other end of the spectrum, Toronto-Dominion Bank has been hit hard as well, and I think it’s completely unwarranted. Toronto-Dominion Bank has a fantastic risk-management strategy in place, and wouldn’t be affected as much as its peers if a housing crash were to occur. The stock is still down about 8.5% from its peak, so I think all the pessimism is creating a fantastic long-term buying opportunity for value investors.

As Warren Buffett once said, “….be fearful when others are greedy, and greedy when others are fearful.” There’s a lot of fear surrounding the entire Canadian financial sector right now, but I think it’s completely overblown. If you’re a long-term investor, I’d recommend buying shares of your favourite bank on the way down instead of following the herd by selling.

Stay smart. Stay hungry. Stay Foolish.

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Fool contributor Joey Frenette owns shares of Canadian Imperial Bank of Commerce and Toronto-Dominion Bank.

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