Inflation is generally perceived as a bad thing. Prices are going up, and that difference has to come from somewhere, like your pocket. When it comes to investing in the big banks, the perception is that inflation is a bad thing.
That’s not entirely true, though. For some of the banks, inflation can actually provide more than a few benefits. Here’s what that means for the big banks, and for investors.
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Inflation can be a boon for bank investors
When inflation does hit the market, the Bank of Canada responds by increasing the policy interest rate to slow the growth in prices. The result of that increase is that it becomes more expensive to borrow money. That drives the prices of loans and mortgages up.
By extension, that means the big banks can charge higher rates, which translates into bigger profits. Inflation also provides a lift to some bank assets, leading to a bump in revenue and profits.
It’s a delicate balance because too steep an increase can impact the ability of borrowers to pay back their loans and cause market volatility.
So, how does it impact big bank stocks? Each is impacted in similar yet very different ways.
TD offers cross-border growth
Toronto-Dominion Bank (TSX: TD) is the second largest of the big banks. TD has a large portfolio of branches both in Canada and in the U.S., which is the bank’s primary growth market.
In recent years, rising interest rates in both the U.S. and Canadian markets helped to bolster TD’s net interest income.
The other key point about TD is its unique ability to weather varying economic conditions. A perfect example of this was the Great Recession, whereby TD emerged significantly larger thanks to a series of well-executed acquisitions in the U.S. market.
Prospective investors contemplating TD should also note that the bank pays out a handsome quarterly dividend. As of the time of writing, TD’s yield works out to a respectable 3.68%.
Scotiabank has an enviable international portfolio
Like TD, Bank of Nova Scotia (TSX: BNS) stands out for its international growth-focused footprint. Where the banks differ is in where that focus lies. Scotiabank is known as Canada’s most international bank, and that’s for good reason.
Scotiabank’s growth-focused international segment has shifted recently away from developing markets in Latin America. In its place are the more mature markets of North America.
This makes the bank less vulnerable to international shifts, allowing it to benefit from the impact of higher interest rates, such as a boost in revenue.
Like TD, Scotiabank offers a tasty quarterly dividend, currently yielding 4.83%.
BMO offers cross-border growth and centuries of dividends
As a big bank, Bank of Montreal (TSX: BMO) is the oldest of its peers. Not only has it been paying out dividends longer than its peers (nearly two centuries without fail), but it also has a strong commercial banking segment and a growing U.S. presence.
Like both TD and Scotiabank, BMO benefits from the rising-rate environment provided that inflation remains moderate. Commercial lending is sensitive to both interest rates and business activity in Canada and the U.S.
In short, a higher interest rate environment translates into higher revenues for the bank. If, on the other hand, interest rates rise too quickly, businesses could be squeezed, resulting in credit losses.
Turning to dividends, BMO’s dividend works out to a 3.71% yield. The bank also has an established history of providing annual upticks to that dividend going back years.
Big bank = big growth and big income
The big banks are regarded as some of the best and safest long-term options on the market. Not only do they offer reliable revenue generation and stable growth, but they also offer significant defensive appeal and growing dividends.
In my opinion, they should be part of any well-diversified portfolio.
