Don’t Mess With the Canadian Banks

THE BRIEF

• Canadian banks reported earnings in the last week of May that showed an average ~50% decline in profits in the first quarter of 2020 with no change in dividends.
• Banks reduced their profits on expectations that loans to individuals and businesses will not be paid back from COVID related bankruptcies and defaults.

THE EXPLANATION

Banks earn a large portion of their earnings from interest on loans. As dictated by accounting regulations, banks must estimate the number of loans that cannot be paid back (defaults and bankruptcies) and deduct them from their earnings. This is known as the “provision for credit loss” (PCL) which increased 400% to 600% from the previous year. Last week, large Canadian banks’ earnings were released and stock prices remained largely unchanged, a sign that investors had anticipated the drop in profits.

According to Global Finance Magazine, 5 of the largest Canadian banks ranked amongst the 40 safest banks. US banks were nowhere to be found on that list. When it comes to safety, not even Bonnie and Clyde can touch Canadian Banks.

• Canadian banks came out of the 2008 financial crisis in a stronger position than their US counterparts.
• Higher reserve of cash for rainy days, strict lending requirements, and a lower allocation to risky loans are three of many factors that make Canadian banks safer.
• Dividends, a cash payment to shareholders, have been consistently paid out to investors for over a century by the Canadian Banks.PRO TIP: A record of consistent dividends are a strong sign of financial strength.

Stay tuned for next week’s issue for a crash course on dividends and how you can add them to your investing strategy.

THE ACTION

Financial stocks have a long way to go before they recover to their pre-COVID highs. Economies opening up will spur a rebound in stock prices but fears of widespread bankruptcies continue to drag bank stocks down. Canadian banks offer a safer way to take advantage of an imminent recovery in the financial sector. A steady stream of cash payments in the form of a dividend is an added bonus.

The largest Canadian banks can be found on both the US and Canadian stock exchanges.

• Royal Bank of Canada ($RY), Scotiabank ($BNS), Toronto-Dominion Bank ($TD), Bank of Montreal ($BMO), Canadian Imperial Bank of Commerce ($CM).