Many investors are turned off to the idea of U.S. financials. There’s a laundry list of recent scandals at big banks, including money laundering at HSBC Holdings (NYSE:HBC), Britain’s largest bank, the “London Whale” at JPMorgan Chase (NYSE:JPM) and Barclays PLC (NYSE:BCS) manipulating a key interest rate known as LIBOR.
There’s talk of more layoffs in the financial industry, with Bank of America (NYSE:BAC) and Citigroup (NYSE:C) in the crosshairs, among others.
Then, of course, there are the share prices. After surging to start the year, the vast majority of banks are down double-digits since mid-March, with the benchmark Select Sector Financial SPDR (NYSE:XLF) down about 5%.
Clearly the big banks are suspect … but our neighbors to the north aren’t doing too badly. If you’re looking to play the financial sector with a little less risk, then perhaps sleepy Canadian banks with big dividends are worth a look. Five of the largest and most well-heeled Canadian financial stocks trading in the U.S. on the NYSE are:
- Royal Bank of Canada (NYSE:RY): $74 billion market cap, 4.3% yield
- Toronto-Dominion Bank (NYSE:TD): $72 billion market cap, 3.6% yield
- The Bank of Nova Scotia (NYSE:BNS): $60 billion market cap, 4.1% yield
- Bank of Montreal (NYSE:BMO): $37 billion market cap, 4.9% yield
- Canadian Imperial Bank of Commerce (NYSE:CM): $30 billion market cap, 4.8% yield
These banks are not without risk. Recently S&P cut its outlook for a number of banks, including Canadian institutions. And as InvestorPlace.com writer and Canadian resident Will Ashworth wrote recently, consumer debt and a shaky housing market raise serious concerns north of the border. Investors know first-hand how painful a downturn in residential mortgages can be for financial stocks.
But there are a few good reasons to look to Canadian banks, too. While most are just tracking the market right now, they might be a good place to look for dividends or for a secular recovery in 2013.
They Are Akin to U.S. Regional Banks
Consider that some of these five Canadian megabanks are significantly smaller than some U.S. regional banks.
U.S. Bancorp (NYSE:USB) has a $60 billion market cap, for instance — double Canadian Imperial. And PNC Financial Services (NYSE:PNC) is worth $32 billion with about $270 billion in assets and about 2,900 branches. Canadian Imperial has just 1,070 branches across Canada.
This smaller size actually is a plus for many investors. After all, the problem of JPMorgan’s crazy traders in London doesn’t exist at a bank that focuses mainly on commercial and residential banking. Also, smaller size means there still is room to grow, either by buyouts or expansion.
Click to Enlarge The strength of regional banks vs. the big “Too Big To Fail” financial monstrosities is clear to investors. Just consider the performance of the SPDR KBW Regional Banking ETF (NYSE:KRE) — which boasts top holdings in Regions Financial (NYSE:RF), KeyCorp (NYSE:KEY) and Texas Capital Bancshares (NASDAQ:TCBI) — vs. the big-bank-focused XLF fund. The regional KRE fund is up 15% in the last 24 months vs. a flat XLF, and up 23% in the past 12 months vs. 14% for the big-bank ETF.
If you like regional banks, you should consider Canadian financials, too. Here’s why:
Stronger Capital Reserves and Better Balance Sheets
One thing that Canadian banks trump even U.S. regionals on is their Tier 1 reserves. Consider the Tier 1 ratio at Bank of America was 11.2% at the end of the last quarter. These Canadian banks were over 12% — with Canadian Imperial Bank of Commerce at 14.7%!
In case you don’t know the lingo, Tier 1 capital is the core measure of a bank’s financial strength. It is comprised of a bank’s cold, hard cash in reserves and common stock equity — not funny money from derivatives or investments that might or might not come through.
There’s a lot of fuss in America over reforms that demand banks keep a certain amount of Tier 1 capital to avoid catastrophe in the event of another crisis. After all, we got into this mess because big banks didn’t have a cushion to fall back on.
Canadian banks have bigger rainy-day funds, and thus more stability. You might think this means smaller profits if the banks are sitting on their cash. However, that’s not necessarily true.
Take Bank of Nova Scotia. “Scotiabank,” as it is called, has a five-year growth rate of 6.6% annually. Its earnings have grown year-over-year for nine consecutive quarters. It’s not even fair to calculate the growth rate for Bank of America or Citigroup considering the depths of their losses in 2009 and 2010 — but even considering the easier year-over-year comparisons, they can’t match Scotiabank’s track record.
These banks avoided posting annual losses even in the worst of the global economic downturn. And aside from RY and CM posting a single quarterly loss in mid-2009 during the worst of the downturn, they remained in the black the entire time. While they might not be as aggressive as their American peers, that could be a good thing for low-risk investors.
It’s not hard to trump the penny-per-quarter paydays from BofA and Citi. Even small-cap stocks can do it. But Canadian banks are not just paying nominal dividends — they are trumping some big U.S. payers in the utility, consumer and health care sectors. Case in point, Bank of Montreal yields almost 5% at current prices.
These dividends are not just big, but sustainable. The strong balance sheets we discussed previously are part of the proof. Further evidence comes from a reasonable dividend payout ratio of between 40% to 50% of earnings for all of these stocks. That means even if profits dip slightly, the payouts are secure.
Just be advised that the dividend history of these stocks is more spotty than in American companies. Some of these banks pay dividends only twice a year, and the payouts are not locked, so they change each time.
While not as reliable as U.S. dividends, however, the safety of these banks’ balance sheets and reasonable payout ratios ensures the distributions will at least hold firm at 4% or more — and might even tick up in the months ahead.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.