The banking sector has been a bit more turbulent lately than some investors might like. Bank runs in 2023 and higher interest rates that depressed loan demand and raised default risk are just some of the headwinds buffeting financial institutions right now. But if you are looking to invest $1,000 into a bank today, you'll probably want to examine Royal Bank of Canada(NYSE: RY), Bank of Nova Scotia(NYSE: BNS), and Toronto-Dominion Bank(NYSE: TD) Here's why.
Royal Bank of Canada is exposed to, well, Canada
Royal Bank of Canada is the largest bank in its home market of Canada based on market capitalization. That's both good and bad news. On the positive side, Canadian banks are highly regulated, leading to entrenched positions for the biggest players. Also, tight regulation has resulted in a conservative ethos that pervades most Canadian banks. These facts are true of all large Canadian banks, including Toronto-Dominion Bank and Bank of Nova Scotia.
The negative of being the largest bank in Canada is that Royal Bank of Canada -- or RBC, as it is often called -- has material exposure to the country's housing market. Canada's housing market was on fire for a number of years until interest rates started to rise. At that point, house prices stalled out and higher interest rates brought with them the specter of payment problems for existing loans. Until the Canadian housing market starts to recover, RBC will likely have to deal with some turbulence.
But the bank had a strong Tier 1 capital ratio of 14.9% at the end of the fiscal first quarter of 2024, which was the highest in the country at the time. The Tier 1 ratio is a measure of a bank's ability to deal with adversity and RBC is better positioned than any of its peers for what may be ahead. Meanwhile, the yield is an attractive 4.2%, which is well above the average bank yield of 2.8%, using SPDR S&P Bank ETF(NYSEMKT: KBE) as a proxy. Basically, RBC is a financially strong bank with an entrenched industry position and a high yield.
Bank of Nova Scotia is shifting things around
Bank of Nova Scotia, or Scotiabank, is sporting a dividend yield of 6.7%. That's huge, but there's a good reason for it. First off, it shares all of the pluses and minuses that come along with being a Canadian bank, just like RBC. But Scotiabank's unique geographic footprint is a bit more risky. Unlike most of its peers, which have looked to expand in the U.S., Scotiabank has looked to expand in South America. That's an inherently riskier stance and investors have priced the stock accordingly. Worse, the risks the company has taken on have left it lagging its peers on key industry metrics, like earnings growth, return on equity, and non-interest revenue growth.
The bank is making moves to improve its performance, focusing on more important markets, like Mexico, while looking to turn around or exit less desirable ones, like Colombia. There are no quick solutions here, but management has openly stated that it is committed to maintaining the dividend during the process. And the fiscal first-quarter 2024 Tier 1 capital ratio rose to 12.9% from 11.5% a year earlier. In other words, the company is undertaking a big overhaul, but it seems well prepared for it. If you can stomach a little uncertainty and want to maximize the income you generate, Scotiabank might be a good fit for you.
Toronto-Dominion Bank has stumbled
The story with Toronto-Dominion, which is usually just called TD Bank, is a bit more complex. Like RBC and Scotiabank, it is exposed to the good and the bad of being a Canadian bank. It is the second-largest bank in Canada by deposits, so it's right up there with RBC on the risk front with regard to the Canadian housing market. But there's another problem here that is unique. TD Bank was recently forced to call off an acquisition in the U.S. because regulators were not pleased with the bank's money-laundering controls.
TD Bank's growth plans are largely driven by expanding its U.S. footprint from the East Coast, where it is now, further across the country. The quickest way to do that is to buy smaller banks in the highly fragmented U.S. banking sector. Although TD Bank can still open new branches, acquisitions are probably off the table until U.S. regulators are appeased. That will likely require paying a fine and some time, during which the company's growth will be slower than investors might like.
This unique negative has pushed TD Bank's yield up to 5.3%, which is not only high for a bank, but it is historically high for TD Bank. Value-focused investors will probably like the sound of that, assuming they can stomach some near-term uncertainty. And yet investors probably shouldn't get too worried about the bank: It ended the fiscal first quarter of 2024 with the second-highest Tier 1 capital ratio in Canada at 13.9%.
Three Canadian banks for the long term
To be fair, investors looking at RBC, Scotiabank, and TD Bank need to think long term. All of them are facing headwinds -- some more so than others. But that's why their yields are so attractive relative to other banks. If you have $1,000 and are thinking about banks, the risk/reward trade-off here looks like it is skewed in your favor if you think in decades and not days.
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Reuben Gregg Brewer has positions in Bank Of Nova Scotia and Toronto-Dominion Bank. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.
