Why Canada's Big 5 Banks Outshine The U.S.'s Big 5

|
 |  Includes: BAC, BMO, BNS, C, CM, JPM, PNC, RY, TD, WFC
by: Pragmatic Bear

Recently, there has been a lot of talk in the media about the healthy state of Canada’s financial system and by extension their banks. This has piqued my interest and therefore I have chosen the 5 of Canada’s largest banks as the subject for this article.

The 5 major banks on my list are Royal Bank of Canada (NYSE:RY), Canadian Imperial Bank of Commerce (NYSE:CM), Bank of Montreal (NYSEARCA:BOM), Bank of Nova Scotia (NYSE:BNS), and Toronto Dominion (NYSE:TD). These are the 5 largest banks in the country and are commonly referred to as the "big 5".

Ticker Share Price Market Cap

P/E Ratio

(Trailing- Forward)

Operating Margin Return on Equity Dividend Yield Payout Ratio 5 Year Average Growth Rate
RY $49.37 70.82 Billion 17.10 - 10.17 5.19% 14.50% 4.50% 71% 8.95%
CM $77.02 30.72 Billion 11.57 - 9.51 36.85% 17.23% 4.80% 51% 5.13%
BOM $60.21 38.38 Billion 11.57 - 10.35 34.62% 13.91% 4.70% 54% 5.99%
BNS $53.34 57.95 Billion 11.60 - 10.86 41.80% 17.32% 4.00% 44% 7.02%
TD $77.12 68.37 Billion 13.87 - 10.61 36.63% 12.45% 3.60% 43% 8.31%
Click to enlarge



Royal Bank of Canada: The company is based in Toronto, Ontario. In terms of deposits and market capitalization; RY is the largest bank in Canada. Presently, RY is trading at $49.37 a share with a market cap of 70.82 billion. It is trading at a 17.10 trailing multiple with a 10.17 forward estimate. This bank offers a solid dividend yield of 4.50% that has a 5 year average growth rate of 8.95%. I am less enthusiastic about their payout ratio which is at 71%. It also has a solid operating margin of 35.19% and a return on equity ratio of 14.50%.

Canadian Imperial Bank of Commerce
: This bank is the smallest on the list in terms of deposits and market capitalization. Their stock is currently trading at $77.02 with a market cap 30.72 billion. It has the lowest P/E ratios on the list with a trailing multiple of 11.57 and a forward ratio of 9.51. At 4.80% its takes first place on the list in dividend yield. It also has a very respectable payout ratio of only 51%. However, it has the slowest 5 year average of growth rate of the list at 5.13%. CM places second in terms of operating margin and return on equity at 36.85% and 17.23% respectively.

Bank of Montreal: This bank is the forth largest bank in Canada based on market cap and deposits. BOM is currently trading at $60.21 with a market cap of 38.38 billion. The Bank of Montreal has the second lowest P/E ratios on the list, coming in at 11.57 and 10.35. It missed taking home first place in the yield department by coming up 10 bps short of Canadian Imperial. BOM has a 54% payout ratio with a 5.99% 5 year average growth rate. It currently has the lowest operating margin of the top 5 banks at 34.62% and the second lowest return on equity at 13.91%.

Bank of Nova Scotia:
Bank of Nova Scotia takes 3rd place in the Canadian financial system in terms of both market cap and deposits. The bank's share price is $53.34 and the market cap is 57.95 billion. Its P/E ratios are right in line with BOM and CM with a 11.60 and 10.86. BNS has the second lowest 4.00% with a very low payout ratio of 44%. The banks 5 year average growth rate of 7.02% puts in right in the middle of the pack. However, it does have the largest operating margin and return on equity of all the banks at 41.80% and 17.32% respectively.

Toronto Dominion:
This bank is the second largest bank in terms of market cap and deposits. It is trading at $77.12 and as has a capitalization of 68.37 billion. At these levels TD is yielding 3.60% and payout ratio of 43%. Both of these are the lowest level of the 5 banks. It has the second highest 5 year average growth rate at 8.31%. The company has the lowest return on equity at 12.45% and the second lowest operating margin of 36.63%. TD has made a concerted effort to expand their business into the United States in a big way (a new one just popped up in my nieghborhood).

The "big 5" in Canada have been significantly out-performing the 5 biggest banks in the United States. All we have to do is look at the year to date returns of the two groups. Respectively, The big 5 (RY,CM,BMO,BNS,TD) have returned -5.55%, -1.65%, 4.79%, -6.70%, and 3.94% year to date. This may not look all that impressive but compared to the top 5 American banks it looks great. Bank of America (NYSE:BAC), J.P. Morgan Chase (NYSE:JPM), Citi (NYSE:C), Wachovia (NYSE:WFC), and PNC represent the 5 largest banks by deposits in the United States. Year to date they have returned -46.03%, -21.00%, -40.85%, -21.26%, and -21.28% respectively. It is clear to see by simply looking at the charts that the companies signifigantly diverged along geographical lines. We need to look at the causes behind this divergence.

The most frightening aspect of the canadian financial system is the slowing down of Canada's economy as a whole. The second quater showed a contraction of 0.4% annualized contraction.The financial crisis's effect on Canada was not as intese as it was on United States. Both Canada's banks and their general economy came out of the crisis with with more strength than the US. Most of this was due to stricter regulation in the Canadian financial system and less reliance on sub prime lending. Many economist have viewed Canada as the picture of economic stability over the past few years. However, some analysts are starting to lower their opinion of this stable economy.

There are major headwinds that are beginning to slow Canada's growth and lower some forecast of the economy out into the future. Firstly, Canada is experiencing a housing bubble that is very similar in some respects to one that hit the US a few years ago. The majority of economists are of the opinion that the growth rates that they are experiencing are unsustainable. In the 10 year period starting in 2000 average nominal house price in Canada jumped by 121%. The debate seems to be over if they are heading for a soft decline or an outright crash. Either outcome will not bode well for the Canadian economy and by extension their banks.

The second major factor that is beginning to hold growth back is the weakening demand caused by the global slowdown that the world is experiencing. As a major exporter Canada is reliant on global demand to power its economy. It also does not help that there dollar is appreciating compared to the worlds other major currencies which will weigh on their exports. This week the bank of Canada announced that it would be keeping interest rates at record low levels for the foreseeable future. They sited slow down in global growth as well at the intensifying debt crisis in Europe. This is a reversal of the banks sentiment from earlier in the year when they were considering increasing the rates to head off inflation.

In conclusion, I am of the opinion that the Canadian financial system is healthier and more stable than its counterpart to the south. They look to be solid companies with a more than competent regulatory system. Many income investors may be drawn in by the 4%+ dividend yields that are available. However, with the current headwinds of economic slowdown and a possible real estate crash in the future, I am not optimistic enough to invest any of my money with them at this time.


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.