The Bank of Canada has increased interest rates significantly in the last 18 months to combat inflation. After a five-month pause, the Canadian central bank hiked rates to 4.75% last month and explained the monetary policy is not restrictive enough, according to a report from Reuters.
Despite these hikes, economic growth is quite resilient due to strong employment numbers and improved housing market stats in recent months. Since March 2022, interest rates have risen by 450 basis points and may increase by 25 basis points again this month to 5%.
Interest rates are a double-edged sword for banks. For instance, when rates are hiked, it results in lower demand for loans across verticals as well as higher default rates. But banks are also well positioned to benefit from an expanding bottom line.
Here are two TSX bank stocks to watch as interest rates keep rising.
Royal Bank of Canada stock
Valued at a market cap of $174 billion, Royal Bank of Canada (TSX:RY) is the largest stock on the TSX. The banking giant has delivered market-beating returns for investors in the last two decades, rising 820% since July 2003 after adjusting for dividends.
RBC has a well-diversified business, allowing it to capitalize on opportunities created by changing economic conditions and market dynamics.
It is among the top two players in all key product categories in the Canadian banking sector. It is also the ninth-largest investment bank globally and the largest retail mutual fund company in Canada in terms of assets under management.
In the last 12 months, RBC earned 60% of its revenue from Canada, 24% from the U.S., and the rest from international markets.
It continues to maintain a strong capital position with a disciplined approach to risk. RBC reported a net income of $15.8 billion in fiscal 2022 (ended in October) compared to $11.4 billion in 2020.
Due to widening profit margins, RBC pays shareholders an annual dividend of $5.40 per share, indicating a yield of 4.3%. While RBC is part of a cyclical sector, its robust balance sheet has allowed the company to increase dividends by 9.9% annually in the last 20 years.
Priced at 11 times forward earnings, RBC stock trades at a discount of 8% to consensus price target estimates.
National Bank of Canada stock
Valued at a market cap of $33 billion, National Bank of Canada (TSX:NA) ended fiscal 2022 with $9.7 billion of total revenue and a net income of $3.4 billion. With $404 billion in total assets, National Bank of Canada is the sixth-largest bank in the country.
In the last 20 years, National Bank has returned over 1,000% to shareholders, easily outpacing the broader markets. It also pays investors a tasty dividend yield of 4.1%, and these payouts have risen at an annual rate of 10.4% since late 2003.
If we exclude the provisions for credit losses, National Bank of Canada increased adjusted earnings by 11.4% in fiscal 2022. It also ended the year with a return on equity of 18.8%.
Priced at 10 times forward earnings, National Bank of Canada is very cheap and is forecast to increase earnings by 7% annually in the next five years.
