Royal Bank (TSX:RY) and Bank of Nova Scotia (TSX:BNS) resisted the temptation to make big U.S. acquisitions in the past year, unlike two of their Big Five peers. This could play in their favour after the recent chaos in the American banking sector.
Market outlook
Canadian bank stocks took a big hit in recent weeks amid rising fears that the latest bank failures in the United States and Europe could signal a wider global problem in the financial sector. Contrarian investors with an eye for value are wondering if the selloff in Canada’s banks is a buying opportunity.
Tight regulations, strong balance sheets, very profitable operations, and large capital positions set the Canadian banks apart from their global peers in most cases. This doesn’t mean they can’t get into trouble, but fears might be overblown in the market right now.
Investors will want to watch the housing market, however, for signs of panic selling, as real estate investors start to get hit with higher borrowing costs when they renew their loans. For the moment, a meltdown in house and condo prices isn’t expected. Soaring rent and strong population growth driven by immigration should put a floor under the Canadian housing market, even if an economic downturn triggers a jump in unemployment.
Royal Bank
Royal Bank is Canada’s largest financial institution with a current market capitalization near $175 billion. The company ranks among the top 10 banks in the world based on this metric.
Being big has advantages right now, as investors worry that smaller banks will fail. Deposits being pulled out of small banks need to go somewhere, so Royal Bank should actually benefit in the current environment.
Royal Bank generated solid fiscal first-quarter (Q1) 2023 results. Higher provisions for credit losses resulted in lower reported earnings compared to the same period last year, but adjusted net income actually rose 4% to $4.3 billion. That’s decent profits for three months of operations.
Adjusted return on equity (ROE) remains robust at 16.8%, and Royal Bank finished fiscal Q1 2023 with a common equity tier-one (CET1) ratio of 12.7%. This is a measure of the bank’s capital position and reflects its ability to ride out a crisis. The Canadian banks are currently required to have a CET1 ratio of 11%, so Royal Bank has excess capital.
The stock trades near $126 per share at the time of writing. That’s down from the recent high near $139 but still up from around $118 in October.
Investors who buy RY stock at the current price can get a 4.2% dividend yield.
Bank of Nova Scotia
Bank of Nova Scotia trades for close to $65 per share right now. The stock price has been on a downward trend for most of the past 12 months after topping $90 in early 2022.
Investors are concerned that the international operations could take a big hit if the global economy slides into a meaningful recession in the next 12-24 months. Bank of Nova Scotia has a large presence in Mexico, Peru, Chile, and Colombia. The four countries are members of the Pacific Alliance trade bloc and offer attractive long-term growth potential. That being said, political uncertainty and a reliance on oil and copper prices for revenue makes these markets potentially more risky for investors.
Bank of Nova Scotia has a new chief executive officer this year. Investors are eager to see if there will be a major shift in the company’s international strategy. BNS stock has underperformed in the past five years. The stock is down about 15% over that timeframe. Royal Bank is up nearly 30%.
Bank of Nova Scotia finished fiscal Q1 2023 with a CET1 ratio of 11.5%. Adjusted earnings slipped from the same period last year and adjusted ROE came in at 13.4% for the quarter.
Investor who buy the stock at the current share price can get a 6.3% dividend yield.
Is one a better buy?
Royal Bank and Bank of Nova Scotia both appear cheap right now for a buy-and-hold portfolio.
BNS stock is tempting at this level with a juicy dividend yield for income investors, but I would probably take the cautious approach and make Royal Bank the first choice in the current environment.
