The S&P 500 Index has fallen into a bear market. Inflation is running hot, and interest rates are rising. There are very legitimate fears that the global economy could get hit by a recession. Canadian banks like Toronto-Dominion (TD 0.84%), Bank of Montreal (BMO 2.42%), and Canadian Imperial Bank of Commerce (CM 1.64%) are still worth a closer look.
It could be tough
Rising interest rates are good for banks because it allows them to charge more for lending services. However, if those higher rates squash home-buying rates or push the economy into a recession, banks will suffer.
With fear high and stocks already in a bear market, investors appear to be erring on the side of caution. This helps explain why the shares of TD Bank, BMO, and CIBC have all fallen at least 20% so far in 2022.
NYSE: TD
Key Data Points
Those declines have pushed their dividend yields higher. TD Bank is currently offering a fairly attractive yield of 4.1%, BMO's dividend yield is roughly 4.5%, and CIBC's yield is 5.2%. But the pessimism that has driven these companies' stock prices down and the yields up could be short-term thinking.
Notably, none of these banks cut their dividends during the Great Recession in 2008 and 2009. That's in stark contrast to U.S. peers like Bank of America and Citibank, both of which cut their payouts during the period. The difference here is important.
NYSE: BMO
Key Data Points
A conservative model
The U.S. banking system is fairly open and there are a lot of players, large and small. Canada's banking system is highly regulated, with just a handful of meaningful names, the list of which includes TD Bank, BMO, and CIBC.
Essentially, the Canadian government is unwilling to allow the big banks to merge or smaller players to grow too much, giving the giants an entrenched position. And Canada's regulatory environment tends to err on the side of caution, as well, so the country's banks operate in a fairly conservative fashion. That makes it easier to weather tough times.
NYSE: CM
Key Data Points
To put a number on that, BMO's Tier 1 Capital Ratio, a measure of a bank's ability to weather adversity, was 17.5% in the most recent quarter (higher numbers are better). TD Bank's Tier 1 Ratio was 14.7%. And CIBC's ratio was 11.7% in its most recent quarter. For comparison, Bank of America's Tier 1 Capital Ratio was 10.4% and Citibank's was 11.4%. This suggests the Canadian banks -- even the most aggressive one here -- will be able to handle a downturn better than some of the most prominent U.S. banks.
All three of the Canadian banks have exposure to the U.S., as well, offering them a growth platform to compensate for the high regulation and, as a result, lack of growth in Canada. Investors get the safety of Canadian conservatism, along with steady cash flow, combined with the growth potential that comes with U.S. banks.
That probably will limit the upside potential, but it also limits downside risk. If you like the high yields on offer from out-of-favor banks, that's probably a good mix for long-term investors.
Look to the future, don't forget the past
A recession would be bad news for banks; therefore, they're selling off. But history suggests that the risks posed to Canadian banks like TD Bank, CIBC, and BMO aren't quite as high as they are to large U.S. banks, which didn't handle a recession very well.
That said, recessions, even bad ones, are temporary, so the fear driving the Canadian banks lower could end up being a buying opportunity for more conservative investors looking to add some finance exposure to their portfolios. Wall Street seems to be incapable of such a long-term view right now.
