Banks are an indispensable piece of your economic life, offering consumers the ability to save money, pay bills, and take on debt. It's that indispensability that makes bank stocks a popular choice for value investors.
Not all bank stocks are created equal, however, so you need to go in with your eyes open to the risks. Still, some banks look incredibly well-prepared for an economic downturn right now and offer generous dividend yields. If you are a value investor looking for bank stocks to consider during this market (and macroeconomic) downturn, you might want to consider Canadian banks Toronto-Dominion Bank (TD 0.70%) and Bank of Montreal (BMO 0.15%).
Conservative by design
Canada's banking system is subject to pretty strict oversight. The government has effectively enshrined a small group of big banks as the industry stalwarts through regulations that limit acquisitions and doing so has made it more difficult for upstarts to compete. That means Canadian banking giants like TD Bank and Bank of Montreal are not going to offer investors huge growth potential (though both have exposure to other markets, like the United States, which provides some avenues for growth). However, if your goal is reliable passive income, they are standout options.
The proof of this comes from the Great Recession, which occurred between 2007 and 2009. During this deep financial-led downturn, many U.S. banks ended up cutting their dividends. Neither TD Bank nor Bank of Montreal cut their shareholder disbursements. Both pay their dividends in Canadian dollars, so the actual value U.S. investors receive fluctuates with exchange rates. And U.S. investors will also have to pay Canadian taxes on the dividends, though those costs can be clawed back come tax time. Still, this dividend consistency is really about the strength of their businesses, which proved they could hold up even during the worst economic downturn since the Great Depression.
Essentially, if you want to include some finance exposure in your diversified portfolio, Canadian banks should probably be on your list. And specifically, TD Bank and Bank of Montreal are good options right now.
Prepared for the storm
What's interesting today is that the market isn't quite sure what's going to happen to banks. On the one hand, rising interest rates are good news because they will allow banks to charge more for loans. On the other hand, there's a very real concern that rising rates will tip the economy into a recession, which will reduce demand for key bank services, like loans, and likely lead to an increase in default rates. That would be bad for banks. With TD Bank and Bank of Montreal stocks down around 20% or more from their early year highs, it appears that investors are erring on the side of caution right now.
That could be an opportunity for long-term investors to buy in at a discounted price. Aside from long histories of supporting their dividends, both banks also happen to have extremely conservative industry positions right now. That's summed up in their Tier 1 ratios, which, to simplify, provide an indication of how prepared a bank is for a financial downturn. Higher numbers are better here, with these two banks at the high side of the industry. Bank of Montreal's Tier 1 ratio is 16%, with TD Bank at 14.7%.
TD Bank pegs its Tier 1 ratio as the second-highest in North America, which means that Bank of Montreal is No. 1. In other words, these two banks are probably the best prepared to deal with an economic downturn if one should occur. Meanwhile, TD Bank offers a generous dividend yield of 4.2%. Bank of Montreal's yield is a bit higher at 4.4%. That compares very favorably to the S&P 500 index, which, despite a major pullback, still yields a miserly 1.4% or so, and the SPDR S&P Bank Index ETF, which yields 2.1%.
For the long term
If you can look past the near-term risks and see the long-term strength built into leading Canadian banks TD Bank and Bank of Montreal, then now could be a good time for you to pick up some shares. Although there could be more uncertainty in the market over the near term, history suggests that these two fiscally conservative banks will survive just fine and, most importantly, keep rewarding investors with reliable dividends right through the turbulence.