In many ways, international banks are the same as U.S. banks. They perform the same basic business functions, and we evaluate their stocks using the same methods. On the other hand, there are some key differences to note, and a big one is in regards to dividends.
In this segment from Industry Focus: Financials, analyst Michael Douglass and Motley Fool contributor Matthew Frankel explain the similarities and differences between domestic and international banks.
A full transcript follows the video.
This video was recorded on March 5, 2018.
Michael Douglass: The first thing we should note here is that international banks, in a lot of ways, are pretty similar to U.S.-based banks. Generally speaking, they take in money as deposits, they lend it out at a higher rate, and that's how they make their money. And they have largely the same valuation metrics as U.S. banks, too.
Matt Frankel: Yeah. Just like the U.S. banks, you can find foreign banks that are purely commercial banks, investment banks, universal banks, kind of like our three-part series that we just did. And you use kind of the same valuation metrics to evaluate them. Price to tangible book is always one of our favorites when it comes to banks. Again, don't put too much stock into the price to earnings ratio with a bank. The price to tangible book combined with profitability metrics such as return on assets, return on equity, which by the way, you want to see about 1% and 10%, give or take, on those, respectively, efficiency ratio, when you put those metrics together it gives you a good picture of what you're buying for your money.
Douglass: And I'll double underline efficiency ratio as such a useful way to understand how effective the bank is at making sure that top line revenue flows down to the bottom line. Of course, foreign banks, international banks, also have some differences from the U.S. One of them that we should note is that every country has a somewhat different framework for how they approach banking. There's a lot of diversity out there. It's very hard to paint with a broad brush stroke. But, there are a couple of things we can keep in mind. One of which is, they aren't regulated by the Fed. Usually, that means they have a little bit more control over their dividend policy.
Frankel: Yeah, because they kind of make their own capital plans. For a couple of sentences of background, in the U.S., banks have to submit to what are called the stress tests every year and submit a capital plan, which is what they intend to do with their profits, including dividends, share buybacks. And the Fed has to approve this, essentially saying that if a bank gave X amount of dividends and bought back X amount of shares, under a worst-case scenario, they would still be just fine, capital-wise.
With foreign banks, you generally don't have that. Like Michael said, different countries have different regulations. But, generally, foreign banks get to set their own dividend policies, which leads to better dividend stocks. Anyone who focuses on income for investments generally doesn't like the U.S. banks because their dividends are stuck at 1-2% right now. But, in the case of foreign banks, one of my favorites that I'm going to talk about quite a bit this episode is c, which most Americans know as TD Bank. They pay close to 4%. The other major Canadian banks pay around 4%. Other major international banks, like Credit Suisse, for example, pays around 4%. So, for income investors, the fact that these foreign banks are allowed to set their own dividend policies for the most part, is a nice little feature that could add some more income to your portfolio and still give you exposure to the banking sector.