Canadian banks: Big Six are well prepared for a downturn

Canada’s bank stocks are outperforming their Wall Street counterparts. Share prices for the Big Six — Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia (Scotiabank), BMO, Canadian Imperial Bank of Commerce and National Bank of Canada — are down 14 per cent on average in 2022. The KBW Nasdaq Bank Index, which tracks 24 US national and regional names including Citigroup and JPMorgan Chase, has fallen 24 per cent.

Canada’s relative outperformance might not last, however. The recession fears casting a shadow over US banks affect Canadian lenders too.

Yet there are reasons to think Canada’s banks can keep punching above their weight. The Big Six have strong domestic franchises and dominate retail and commercial banking in their home market. Collectively, they pulled in C$57.7bn (US$46bn) in net profits in the fiscal year that ended in October. Return on equity at the banks ranged between 14.4 per cent and nearly 21 per cent. That is higher than the range for America’s largest institutions.

The banks have also been slower to release credit reserves built up during the worst of the pandemic. This gives them a relatively larger capital buffer against a downturn. Domestically, the risk of a housing market collapse remains remote. Mortgage debt is expected to grow 10.6 per cent this year and next, according to the Canada Mortgage & Housing Corp.

Canadian lenders have also proved adept at making money in the US market. At BMO, the US unit’s return on equity was 15.8 per cent in fiscal 2021. It has done a good job of controlling overheads. Its adjusted efficiency ratio, which measures expenses as a percentage of revenues, was 50.8 per cent — below most American peers.

Valuation wise, the Big Six Canadian banks trade comfortably above their book values. In the US, the same can only be said of JPMorgan and Morgan Stanley. In a time of market turmoil, boring comes at a premium.