The banking crisis has roiled the markets this month. And not only bank stocks. The repercussions have been seen across sectors and strain has been quite visible in the broad market volatility.
Canadian bank stocks, on average, have dropped 10%, while the US banks have fallen around 14% so far this month. In comparison, the TSX Composite Index has lost only 4% of its value in the same period.
While regional banks might continue to trade weak, bigwigs will likely remain resilient. But this could be an attractive time to pick some quality bank stocks. Notably, the Canadian banking sector, as a whole, looks relatively well placed compared to its peers south of the border.
What differentiates the Canadian banking sector from that of the US?
First, the Canadian banking sector is much more concentrated than the US. The Big Six banks cater to a substantially large portion of the Canadian population. This facilitates better regulatory vigilance and control. In comparison, the US banking sector is more scattered, with more than 4,000 banks.
Moreover, the Canadian banking system is more conservative, which plays well during turbulent times. During the pandemic, the banking regulator put restrictions on banks not to raise shareholder payouts. Cash retention and balance sheet strength were of utmost importance then. It revoked the ban in late 2021 when there was reasonable clarity about the growth outlook and banks’ financials.
Among the Big Six, the second-largest Toronto-Dominion Bank (TSX:TD) has seen a steeper drawdown, losing around 14% this month. It has large exposure to the US and is considered a key growth driver for the bank. Importantly, TD is in the process of acquiring a regional bank, First Horizon, which has seen significant pressure during this banking fiasco. With a recent drop, TD stock has fallen close to its 25-month lows.
Better capitalized and well-placed to outperform
Another undervalued bank is Bank of Montreal (TSX:BMO), which also has decent exposure to the US banking business. It recently closed the acquisition of the Bank of the West. However, BMO is one of the most well-capitalized banks in the country. Its common equity tier 1 (CET1) ratio at the end of the recently reported quarter came to over 18%. That’s significantly higher than the Canadian banking industry average.
Canada’s largest Royal Bank (TSX:RY) has a CET1 ratio of 12.7%. Its scale and diversified revenue base play well for its earnings and dividend stability.
Overall, the average CET1 ratio of the TSX banking sector is around 14%, while for the US banks, it is around 13%. That’s still way higher than regulatory requirements and indicates a decent capacity to withstand economic shocks. The ratio is an important metric in the banking industry and compares a bank’s core capital with its assets.
Valuation and dividend
After the recent drop, TSX bank stocks have become all the more attractive from a valuation perspective. BMO stock is currently trading at a price-to-book value ratio of 1.1x compared to the industry average of 1.3x. TD is at 1.2x. Royal Bank of Canada stock is trading at around 1.7x. In comparison, US banks, on average, are trading at a price-to-book value ratio of 1x.
Note that this discounted valuation does not mean that bank stocks will surge higher immediately. They might keep trading weak for the next few months, given the gloomy growth outlook and recession fears. However, these are some of the appealing levels to enter for Canadian banks.
On the dividend front, Canadian banks offer juicier yields than their US peers. For example, the average yield of the Big Six Canadian banks comes close to 5%. In comparison, US banking bigwigs offer a dividend yield of around 3%.
Value creators
Considering their stable long-term earnings growth prospects and juicy dividend yields, Canadian banks like TD and BMO will likely continue to create decent long-term shareholder value.
