CIBC (TSX:CM) and Bank of Nova Scotia (TSX:BNS) recently held their annual investor meetings and both companies pledged to improve returns for investors. Canadian bank stocks took a hit last month after bank failures in the United States and Europe triggered an exodus out of the sector. Contrarian investors are wondering if CM stock or BNS stock is now undervalued and good to buy for a portfolio focused on passive income and total returns.
CIBC
CIBC is Canada’s fifth-largest bank with a current market capitalization near $51.5 billion. The stock trades for close to $57 at the time of writing compared to $75 at this time last year. The 24% plunge over the past 12 months brings CM stock almost back to where it sat five years ago.
The company took a big hit during the Great Recession on bad bets in the U.S. subprime mortgage market. After that happened, management doubled down on the Canadian housing market, aggressively pursuing mortgage loans, as the Canadian real estate sector soared. This proved to be a very profitable move, but investors are now concerned that CIBC is too exposed to a potential crash in Canadian home prices.
CIBC finished the fiscal first quarter (Q1) of 2023 with $267.8 billion in Canadian residential mortgages and another $19.1 billion in home equity lines of credit (HELOC) for total exposure of $286.9 billion. To put this in perspective, Royal Bank, which is about 3.5 times larger than CIBC with its market capitalization of $180 billion, had $390 billion in total residential mortgages and HELOC exposure at the end of fiscal Q1 2023.
Things will have to get really bad for the banks to take a meaningful hit on the Canadian residential mortgage portfolios, but anything is possible, and a steep plunge in property prices would likely hurt CIBC more than its larger peers.
CIBC stock trades for 11.2 times trailing 12-month earnings and offers a 6% yield at the current share price.
Bank of Nova Scotia
Bank of Nova Scotia has also disappointed investors. The stock is down more than 12% over the past five years and off nearly 25% in the past 12 months. At the current share price of $67, the stock trades at just 9.35 times trailing 12-month earnings and offers investors a 6.1% dividend yield.
The bank’s new chief executive officer plans to shake things up to drive better shareholder returns. Investors are waiting to see if this means a major strategy shift could be on the way. Bank of Nova Scotia has a large international business located in Latin America, with operations primarily focused on Mexico, Peru, Chile, and Colombia.
Political uncertainty and the reliance on copper and oil prices make these developing economies more risky than Canada or the United States, where the other Canadian banks have the bulk of their operations.
However, the long-term growth potential is attractive in the four Latin American countries that form the core of the Pacific Alliance trade bloc. Bank services penetration is low compared to developed markets and the combined population in the Pacific Alliance group is above 230 million. As the middle class expands, demand for loans and investment products should increase.
Investors should get more clarity on potential changes at Bank of Nova Scotia by the end of 2023.
Is one a better bet?
Ongoing volatility in the bank sector should be expected in the coming months, as the market tries to figure out how much the steep rise in interest rates will impact the economy and the housing market. That being said, CIBC and BNS pay attractive dividends that should be safe.
If you are looking for a buy-and-hold pick for a portfolio targeting passive income, I would probably make Bank of Nova Scotia the first choice today.
