Skip to main content

Bay Street in Toronto, Ontario is seen here Thursday Feb. 9, 2012.Tim Fraser/The Globe and Mail

When Canadian banks rolled out their quarterly results this week, you may have felt emboldened: Amid cautious predictions, banks delivered impressive numbers and injected some new enthusiasm into the sector.

But don't leap into a buying frenzy just yet.

For sure, banks have been doing better-than-okay. Earnings at Royal Bank of Canada, for example, hit a new record high of $2.3-billion during the quarter.

They are also signalling confidence ahead. The Canadian Imperial Bank of Commerce announced plans to buy back up to eight million shares over the next 12 months. And Toronto-Dominion Bank hiked its quarterly dividend by 4 cents a share, maintaining a recent schedule of two dividend increases a year.

Share prices have rallied on the good news. The six-member S&P/TSX Banks index rose to a record high this week, bringing gains to more than 150 per cent from the 2009 low during the financial crisis.

Not surprisingly, analysts this week have been raising their target prices on RBC, CIBC, TD, Bank of Montreal and National Bank of Canada.

It's enough excitement to make you wonder if you should be boosting your exposure. However, the issues weighing on banks earlier this year haven't gone away. In fact, they're getting worse.

The Canadian economy is stumbling, giving the banks a difficult environment in which to operate. Gross domestic product rose at a sluggish annualized pace of just 1.7 per cent in the second quarter, signalling a slowdown that will likely weigh on third-quarter forecasts.

In contrast, the U.S. economic growth in the second quarter accelerated to 2.5 per cent.

Domestic lending in Canada also looks troubled, given gargantuan consumer debt levels and rising borrowing costs. According to TransUnion, the credit bureau, the average consumer debt level among Canadians is a record-high $27,000, making you wonder how we can possibly borrow any more.

That number doesn't even include mortgage debt at chartered banks, which has risen above $873-billion, up 90 per cent since the start of 2010.

And speaking of mortgages, rates are rising, posing another threat to a housing market that has already begun to groan under the weight of loony home prices and hyperactive building activity in many cities. None of this is good news for Canadian banks if the trends start to unwind.

What's more, they no longer look like the best investment prospects compared with opportunities abroad. Though they were celebrated as beacons of stability during the financial crisis for preserving their dividends and profitability, their beaten-up global peers have been making a big comeback and offering investors far better returns on the way back up.

Consider that the KBW Bank index, consisting of names like JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc., has risen more than 21 per cent this year, versus a gain of less than 7 per cent for Canadian banks. The outperformance is even more striking in Canadian-dollar terms, since the rising U.S. dollar has provided a nice bonus for Canadian investors.

That said, investors shouldn't avoid Canadian banks. For one thing, it's hard to avoid them: The Big Six account for more than a 22 per cent weighting within the benchmark S&P/TSX composite index. They essentially define the Canadian stock market and serve as the backbone to most dividend mutual funds and index funds.

For another, they offer great dividends and a level of financial consistency that is tough to find elsewhere.

Still, it's hard to get excited about them right now. Their latest quarterly earnings offered a shot of good news, but the follow-up is going to be challenging.