Banks can be complex businesses, but the industry's basics are pretty simple to understand. A swift rise in interest rates has been a notable headwind, pushing down share prices across the sector.
Two stocks that are getting beaten down but that are still worth a very close look are Toronto-Dominion Bank (TD 0.46%), or TD Bank, and Bank of Nova Scotia (BNS 0.71%), or Scotiabank. Here's why.
Boring northern neighbors
Canada, the country from which TD Bank and Scotiabank both hail, has a highly regulated bank sector. This has resulted in the largest banks having entrenched industry positions. Moreover, industry regulators have a keen focus on safety, so Canadian banks tend to be risk-averse. The conservative nature permeates their entire business, regardless of where the companies are operating.
Image source: Getty Images.
This is important for investors because the banking sector has been a bit volatile of late. The bank runs in early 2023 are a good example of the risks that can crop up when banks get too aggressive. Rising interest rates were a key factor in those runs, but the pain of rising rates is being felt throughout the entire banking sector. That's why even good banks are being shunned by investors.
While rising rates allow banks to charge higher interest rates on new loans, they also require banks to pay more interest to bank account holders. Higher rates also reduce the ability of financially weak customers to pay their interest costs, potentially increasing delinquencies. Right now, meanwhile, the incredibly rapid rate rise has disrupted the housing market, reducing demand for new mortgages.
There are a lot of moving parts, but the truth is that good banks can navigate tough times like this. Both TD Bank and Scotiabank have been around for over 100 years. They have muddled through odd times before and will likely do so again -- which brings up the historically high yields these banks are offering today.
TD Dividend Yield data by YCharts
Scotiabank's dividend yield is a hefty 6.9% while TD Bank's yield is 4.5%. The yields were last at these levels during the pandemic-driven recession in 2020 and during the Great Recession before that. So, in this way, the stocks look like they are trading at historically attractive levels.
Core and explore to where?
That said, there is a difference between the yields here. TD Bank is by far the more conservative investment option -- it's one of the largest Canadian banks and has a material, and growing, presence in the U.S. So it has two mature markets in which to operate. For risk-averse income investors, it is probably the better fit.
Notably, TD Bank also happens to have the highest Tier 1 Capital Ratio in North America right now at 15.2%. The Tier 1 ratio is a measure of how well a bank is prepared to deal with adversity. It is also worth highlighting that its U.S. exposure is largely focused on the East Coast, which means that it has a significant long-term opportunity to expand geographically across the country.
Scotiabank is a bit of an odd duck, comparably. It has a large Canadian business that it uses as a foundation, just like TD Bank. But Scotiabank chose to focus on building out banking businesses in several South American countries. It has notable operations in Mexico, Chile, and Brazil, among others.
This positions the bank to benefit from the long-term growth of these emerging markets but exposes it to more risk in the near term. However, if you like the idea of owning a bank that reaches well beyond North America, that might be right up your alley. Note that the Tier 1 ratio is 12.7%, which isn't as good as TD Bank's, but it is still quite strong (and up from 11.4% a year ago).
Buy both and cover the Americas
As mentioned, conservative investors might want to lean toward TD Bank. But there's an interesting option here if you buy both TD Bank and Scotiabank because it provides you with exposure across the Americas. And the doubling up on exposure to Canada just means you are more heavily exposed to one of the most tightly regulated and conservative banking regions. That's not such a bad thing.
If you are looking for discounted bank stocks to own for decades into the future, this pair could be exactly what your portfolio needs even if they are facing some near-term headwinds.
