Like most Canadians, I felt proud when our nation's banks romped through the 2008 financial crisis while their international peers stumbled. But that was then. The question now is: How much are you willing to pay for that fading memory?
Canadian bank shares have long since stopped looking like bargains. But does that mean that international rivals might provide much better returns for Canadian investors?
Some indicators say they can. Consider the price-to-book-value ratio, a classic way to evaluate bank shares. Book value represents how much is left if you subtract a bank's liabilities from its assets. It's a handy gauge of the underlying value you're getting when you buy a share. In theory, you should be able to evaluate any bank stock by dividing its share price by its book value. The lower the ratio, the better the deal, everything else being equal.
A comparison of the ratios for Canadian and foreign banks shows how expensive ours have become. Shares of Royal Bank of Canada trade for about 190 per cent of their book value. In contrast, shares of Citigroup Inc., the U.S. heavyweight, change hands for only about 60 per cent of their book value. Shares of Barclays PLC, the British giant, go for about 45 per cent.
If you were to look at only price-to-book-value ratios, you would dump all your Canadian bank stocks and load up on their U.S. and European counterparts. But here's where things get complicated. The problem with those apparently cheap foreign bank stocks is that it's not clear if banking is still a good business in any country. Global bank shares have been in a funk over the past year, and there are excellent reasons why.
Banks are essentially machines for amplifying small returns into much larger ones. The average return on a dollar of a healthy bank's assets has never been large – maybe 1 per cent in the palmy days before the financial crisis. But banks used to employ huge gobs of borrowed money to magnify those tiny profits into hefty returns on equity that often touched 20 per cent.
They're not doing that any more. Regulators have turned leery of highly leveraged lenders, and they have prodded banks to finance themselves with more share capital and less borrowing. They have also crimped activities that used to be quite profitable, like banks trading securities for their own accounts.
Meanwhile, tough competition, bad loans from yesteryear and other problems are hitting bank bottom lines, especially in Europe. Hanging over everything is the impact of ultralow interest rates, which reduce the margin that banks can charge on loans.
The result is that many international financial giants don't make all that much money. Barclays has produced a profit in just two of the past four years. Citigroup has struggled to raise its return on equity to a ho-hum 8 per cent.
To my eye, foreign bank shares remain a dicey proposition. Future returns are likely to hinge on decisions by regulators. It's impossible to forecast what those decisions will be.
But skepticism about foreign stocks also has a way of reflecting back on Canada. Can our banks continue to churn out profits while their international rivals struggle? A look abroad suggests that this may be a good time to avoid bank shares here, too.