Large bank stocks declined further as the impact from the failure of California-based Silicon Valley Bank on Friday continued to ripple through financial markets, raising the question of whether Canada’s Big Six banks are too cheap to pass up.
Observers argue that the specific issues that sank SVB – including exposure to the struggling tech startup ecosystem, a large amount of uninsured deposits and assets tied up in long-dated debt securities – mean that a full-blown financial crisis is unlikely.
That supports the case for investing in Canada’s biggest banks, which dominate the Canadian banking landscape through an oligopoly and are diversified across lending lines and geographies. These banks withstood even the financial crisis of 2008 without having to cut their dividends.
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“The big lesson of SVB’s collapse is that the U.S. banking sector needs to become more Canadian,” Meny Grauman, an analyst at Bank of Nova Scotia, said in a note.
In the near-term, though, the direction of bank stocks is anyone’s guess, amid an increasingly gloomy outlook. The Big Six banks fell as much as 3.5 per cent early Monday, on average, before recovering some ground. The sector ended the day down 1.8 per cent.
Bank of Montreal and Toronto-Dominion Bank, two banks associated with substantial exposure to the United States, were hit harder. BMO fell 2 per cent and TD fell 2.9 per cent.
The banking group, the backbone of most dividend mutual funds and exchange-traded funds, is now down about 9 per cent from a recent 2023 high in mid-February.
The initial selloff of bank stocks last month was connected to central banks mulling larger-than-expected interest rate hikes in the face of stubbornly high inflation, raising concerns about credit health, the housing market and economic activity.
Now, the selloff has entered new territory: Bank stocks are reflecting a surge in investor anxiety after the collapse of SVB and what comes next as many other U.S. banks flounder.
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Regulators closed New York-based Signature Bank on Sunday, after a run on the crypto-lender’s deposits. On Monday, the crisis spread further, hitting U.S. regional banks that have a large share of potentially flighty deposits that are not insured by Federal Deposit Insurance Corp.
First Republic Bank fell 62 per cent, Western Alliance Bancorp dropped 47 per cent and Zions Bancorp fell 26 per cent, illustrating how fast investors can lose faith.
The rout developed despite assurances over the weekend from the U.S. Treasury Department, the Federal Reserve and the FDIC that they will fully protect all depositors with Signature Bank and SVB to strengthen public confidence in the banking system.
“The authorities were clearly concerned that systemic risks were real heading into this week,” David Rosenberg, of Rosenberg Research & Associates, said in a note.
Canadian bank stocks are capable of falling 30 to 50 per cent in the case of a bad recession or crisis. Today, they are about 20 per cent below their record highs in early 2022, suggesting they are not yet reflecting a truly dismal future.
But there’s some good news here for investors who can tune out the bad news and focus on the sector’s impressive track record for stability.
For one, if nervous depositors – and finicky investors – are shifting from smaller financial players to larger ones out of fear, then the biggest banks could benefit from an influx of new clients.
For another, while SVB’s ratio of uninsured deposits was nearly 90 per cent prior to the crisis, uninsured deposits at the U.S. arms of TD and BMO are well below that level, suggesting that the risks of a crisis are significantly lower.
They range between 50 per cent and 60 per cent, according to Gabriel Dechaine, an analyst at National Bank Financial. That is consistent with most U.S. regional banks he tracks.
And lastly, although Canadian bank stocks are not absurdly cheap, valuations are low.
According to Darko Mihelic, an analyst at RBC Dominion Securities, the Canadian banking index’s price-to-book ratio – which compares share prices to book values (or assets minus liabilities) – fell to 1.47 on Friday. That’s below the average of 1.79 since 2010.
Still, the current valuation is merely in line with a shallow recession, while price-to-book ratios can fall to 1.2 when banks are under significant stress or even 1 – that is, the stocks trade at book value – during exceptional uncertainty.
The quick translation: There’s downside risk here if a financial crisis is brewing, but the long-term opportunity is looking attractive.
David Berman