For the past decade, investing in Canadian banks was probably the smartest move an investor could have ever made. A simple look at the following chart will convince you:
|Bank||Ticker||10yr Return||Q Div 10yr ago||Q Div today||Div Growth|
I included the quarterly dividend 10 years ago (Q Div 10yr) and their latest quarterly dividend to show you how they have increased their payout throughout this period. As you can see, both stock returns and dividend growth are phenomenal. Buying these 6 stocks equally would have given a 10yr return of 109.70% (total return). This is incredibly higher than the TSX (87%) and the S&P500 (49%) if you consider the dividend growth.
This is probably why many investors cherish Canadian banks as the core of their dividend portfolio. I plead guilty on that as I own shares of BNS and NA and am definitely thinking of keeping them. Their dividend payouts are strong (all over 3.50% right now) and their payout ratios are relatively low. So is it worth it to pick anything else than Canadian banks? We all know that diversification is good, but how come you can ignore such high and stable returns? When I look at the overall market, I can't be too bullish with regards to their futures though… here's why:
Canadian Housing Market Threats
I already covered the topic of a potential housing bubble burst in Canada in this blog. The simple fact that the CHMC has been reducing access to mortgages through several rule changes over the past three years is a clear example that the Canadian Government is concerned about the situation. At the moment, there are more condo towers being built in Toronto than there are on the US east coast. Do you really feel that our economy is booming at this point?
Bad mortgages hurt banks on two fronts; they not only suffer from the defaults but they also have to increase their overall provision for bad debt. This provision doesn't automatically imply that banks will lose money (customers may pay their mortgages nonetheless) but it has a direct impact on their balance sheet and capitalization ratios. Since capitalization ratios are crucial for banks, the housing market could definitely hurt bank stocks. For the record, TD and CIBC have the biggest exposure to the overheated housing market such as Toronto, Vancouver and Calgary.
Canadians' Critical Indebtedness Situation
I'm not only concerned about the housing market in Canada, I'm also concerned about the overall Canadian indebtedness situation. We are currently hovering around 160% in terms of debt ratio. This situation could be sustainable if we could anticipate a booming economy and substantial salary increases. However, this is definitely not what we are looking at for the moment.
On top of this, the Bank of Canada will eventually have to increase their interest rate which will hurt consumers' wallet. Here again, Canadian banks will have to increase their bad debt provisions in the future. But there is more to it; if consumers have a hard time managing their debt, it also means that they won't save money.
We saw a similar trend in the US post 2008: Americans stopped consuming and started to pay back their debts. So investment is reduced and debts are being paid back… not the best scenario for banks!
Going Outside Canadian Banks' Comfort Zone
Another reason why I'm afraid of the financial sector in Canada is the future growth potential. There is none in Canada for the reasons stated above. This is why Canadian banks have no other choice but to look outside the Canadian market. RBC got burned once with a bad experience in the US and it's not the only one.
Evolving in another market than ours involves several risks. You have to make sure that you fully understand that people do business and deal with banks outside Canada. Since it's very different than our current business model, this will certainly take some time (and massive money injection) to compensate for the learning curve.
Scotia Bank is showing a great experience in South America and may be one of the banks that will show the highest outside of Canada growth. Another bank that should do well is the National Bank. Being a super-regional bank, it has a lot of room for growth as compared to "The Big 5". National Bank has completed several acquisitions in the private wealth management sector and has multiplied its business partnerships to ensure growth and diversification.
But I Will Continue Buying Canadian Banks Nonetheless
With a pretty dark portrait of the Canadian banking industry, I didn't want to leave you with a bad taste in your mouth. I still believe in Canadian banks for many reasons. The first one being their incredibly solid balance sheet; these banks are among the most solid in the world. After 2008, they have become very important players on the world map. This experience and financial solidity will allow them to get through their national difficulties.
If the Canadian economy does slow down, they can also go elsewhere and become successful. While it's riskier than growing on your own playground, it doesn't mean that they can't make it. Plus, if we are super lucky and the demand for natural resources continues to grow, Canada might avoid a recession and give some room to Canadian banks.
My picks are already made in this sector and I will keep my positions in National Bank and ScotiaBank. I particularly like National Bank since it's the bank that has produced the biggest growth over the past five years and it's not slowing down.
What do you think about Canadian Banks? Buy/Sell, Hold? Which one is your favorite?
Disclosure: long National Bank and ScotiaBank.