Are all Canadian banks the same? You could be forgiven for thinking that way, given how they all seem to fit the same description: Conservative, dividend-gushing and cash-generating machines.
But Murray Leith and Dan Hincks at Odlum Brown make a convincing case for why investors should favour some banks over others, and this choice could become very important in the near future depending on where the U.S. economy and the Canadian housing market go.
For exposure to the Canadian market, it’s hard to top National Bank of Canada and Canadian Imperial Bank of Commerce. In terms of their loans in the third quarter, 100 per cent and 92 per cent, respectively, were dispersed in Canada. By comparison, 25 per cent of Bank of Montreal’s loans and 23 per cent of Toronto-Dominion Bank’s loans were dispersed in the United States, making them much more a play on the U.S. economy.
Bank of Nova Scotia stands out for its international exposure: 29 per cent of its loans in the third quarter were dispersed internationally. The next highest bank, Royal Bank of Canada, has just 6 per cent exposure internationally, in terms of loans.
Next, there is a big difference among the banks in terms of their Canadian residential mortgages. CIBC is the most exposed here, at 57 per cent. BMO and TD are at the low end of the scale, at 29 per cent and 36 per cent, respectively.
No wonder bank stocks have delivered very different returns to investors. This year, Royal Bank (full disclosure: I own this stock) has been the top performer, gaining 11.3 per cent after factoring in dividends. National Bank trails the pack with a total return of 6.1 per cent.
Over the past five years, the differences have been even more pronounced. National Bank has risen 74.8 per cent, again after factoring in dividends. CIBC is by far the worst, with a total return of just 2.6 per cent.
For all the apparent differences, Mr. Leith and Mr. Hincks can’t help but approach banks as a group in terms of their overall attractiveness.
“We continue to have mixed feelings about the Canadian banks. On one hand, they are very profitable institutions with enviable competitive advantages, in large part due to the oligopolistic nature of the domestic banking market,” they said in a note, released to clients last week.
“On the other hand, growth is getting tougher to achieve.”
And that makes choosing the right bank stock crucial. They believe that geographical diversification has been a defining characteristic, as domestic loan demand moderates and lending margins compress.
For that reason, they favour TD, BMO and Scotiabank – TD and BMO because they have expanded into the United States, where Odlum Brown feels increasingly confident about the economic recovery; and Scotiabank because of its international presence.
“We consider CIBC and National Bank the least attractive of the Big Six Banks because they have the most gearing to the Canadian economy,” they said.
Meanwhile, they reduced their recommendation on Royal Bank to “hold” from “buy” because of what they believe is a premium valuation and a larger exposure to capital markets-related businesses.