Canadian bank investors are waiting for a recovery after a weak 2022. Slowing global economic growth amid pressures on credit quality indeed hinders the banks’ outlook. However, strong capitalization and profitability make Canadian banks well placed to withstand those risks. Canadian banks’ earnings, which will be released later next month or early March, will set the tone for bank stocks and, ultimately, the TSX Index.
What’s next for Canadian banks?
The Bank of Canada rose its benchmark interest rate by 25 basis points to 4.5% last week, marking the eighth consecutive hike since last year. The slowing pace of the rate-hike cycle indicates that inflation will continue to ease after peaking beyond 8% mid-last year.
Banks see higher net interest incomes in the rising rate environment. Canadian lenders have been seeing the same since last year. However, the recessionary environment and worries about potential loan losses weighed on their performance.
TSX bank stocks have lost 13% of their market value in the last 12 months. Bank of Montreal (TSX:BMO), the third-biggest Canadian bank by market cap, fared relatively better and lost 7% in the same period.
Like the U.S., Canadian banks might also see higher provisions in their upcoming quarterly earnings, pushing profitability lower. Higher provisions could compensate for the impact of higher net interest income to a large extent. Housing markets, which form a significant portion of lending for Canadian banks, will likely see pressure continuing in 2023.
Moreover, higher mortgage payments due to rapid rate hikes and inflation woes could negatively impact borrowers’ repayment capacities. This coupled with unemployment poses risks for Canadian banks’ credit quality. However, at the same time, decent household savings and strong capitalization place them well positioned for the upcoming challenging times.
What differentiates BMO stock?
Bank of Montreal has seen a relatively stable pre-provision pre-tax earnings growth in the last few years. Its U.S. segment is seeing handsome growth for the last few quarters and accounted for 36% of its adjusted net income in fiscal fourth quarter (Q4) of 2022.
At the end of fiscal Q4 2022, it had a common equity tier-one ratio of 16.7% — the highest among Canadian peers. The ratio indicates that the bank has a stronger capital cushion to sustain an economic downturn. Peer Canadian banks have this ratio of around 12-13%.
BMO also offers stable dividends that yield 4.4%, which is in line with its peers. It has paid shareholder dividends consistently for the last 194 years, marking the longest-running streak for any Canadian company. Its consistent dividends have played out well for shareholder returns in the long term. In the last decade, BMO stock has returned 13% compounded annually, including dividends. In comparison, TSX bank stocks have returned 11% in the same period.
Bottom line
While bank stocks might not see an immediate recovery, the second half of 2023 might be encouraging for investors. Higher provisions might continue to dampen the bottom line for the next few quarters. However, TSX bank stocks look attractive in the long term. BMO stock looks relatively more appealing mainly due to its stable dividend profile, strong capitalization, and visible earnings growth.
