If you are involved in any kind of business or financial transaction in Canada, you have to make a decision on a Canadian bank. Choosing the right bank is a very important financial decision for consumers as well; banks tend to compete aggressively for more affluent consumers.

 

This is even truer with investing. Almost every portfolio in Canada, retail or institutional, involves making an investment decision around which Canadian bank to own. In fact, when new accounts are transferred in, we are often surprised to see portfolios holdings all 5 of the big Canadian banks. Either the investor or the investment advisor has chosen to hold the whole sector rather than selecting specific names. This is a big mistake.

 

For decades, investing in Canadian banks has been a wonderful thing. The banks have large scale branch networks and there are legal restrictions preventing foreign institutions from competing. Furthermore, banks learned from past recessions to diversify their loan book, derive more fee income, and have been well regulated. Canadian investors saw how well the Canadian banks escaped the worst of the financial market meltdown in 2008 and 2009, and began to consider Canadian banks as “safe”.

 

This view is now being challenged with the current crisis caused by COVID-19. If you look at the TSX returns the last ten years, not only has the TSX massively underperformed US markets, but also the Canadian banks as a group have not performed well. The current reporting season is showing why. Earnings are reduced by 40% or more, dividends are now close to or exceeding net income (this is very unhealthy), and stock prices have correctly anticipated that the business model is experiencing problems.

 

However, looking at the Canadian banks as being all the same is the biggest mistake an investor can make right now. We feel strongly that some are going to come out of this stronger, whereas others could be in for years of work out. Right now, picking the right bank is probably the single biggest factor in determining future portfolio performance.

 

If you want to more on our views on the Canadian banks, please feel free to reach out to us.