Banks provide a basic life necessity, financially speaking. It would be very difficult to operate in the modern world without a business that allows you to store your cash and facilitate the payments you need to make. But not all banks are the same, and some very popular bank stocks can expose investors to more risks than they may realize. Which is why I don't like Capital One Financial (COF 2.39%), but I do like two reliable high-yield banks from Canada.
What's wrong with Capital One Financial?
Capital One Financial is a bank, but it really focuses on issuing credit cards and making loans. Often, those cards and loans go to higher-risk, meaning lower-credit-score, borrowers. This can be a very profitable business since such customers often carry balances and are willing to suffer through high interest rates and/or fees in order to get access to credit cards and loans. And over time, Capital One has proven to be a very profitable investment. The stock price is up around 140% over the past decade.
Image source: Getty Images.
There's just one problem. Lower-credit-quality customers often have a hard time paying their bills during recessions. That can result in highly volatile performance for Capital One's business right when I, as a dividend investor, really want stability. Note in the chart below that Capital One lowered its dividend during the coronavirus pandemic and associated recession. In fairness, the dividend recovered quickly, given the brevity of the business downturn, and then grew. But that cut would have been a big shock to a dividend investor.
Data by YCharts.
All in, investors who stuck it out with Capital One did fine through that period of uncertainty. But I'm looking for a bank that's a bit more reliable. That's why I own Toronto-Dominion Bank (TD 0.86%) and Bank of Nova Scotia (BNS 0.38%) instead.
Why I like TD Bank and Scotiabank
To be fair, I'm an income investor. So TD Bank's 4.2% dividend yield and Scotiabank's 5.9% easily beat out the 1.2% yield on offer from Capital One Financial. But that's not the core reason why I have long considered Capital One Financial a non-starter for my portfolio. It really boils down to risk. If I'm going to buy stock in a bank, I want it to be boring.
Canada has far more rigid banking regulations than the United States. This has, effectively, granted a small number of large Canadian banks entrenched industry positions. Both TD Bank and Scotiabank are among the entrenched industry leaders. Moreover, the heavy regulation has left Canadian banks operating with a more conservative ethos than U.S. banks.
One of the best indications of that came during the deep economic downturn between 2007 and 2009, which is often called the Great Recession. While large U.S. banks cut their dividends during that time, including giants like Bank of America and Citigroup, neither TD Bank nor Scotiabank had to resort to a dividend cut.
My preference for Canadian banks, however, doesn't mean I won't take on some risk. TD Bank continues to reliably increase its dividend even as it has faced regulatory backlash in the United States after its U.S. division was used to launder money. Scotiabank, meanwhile, has been forced to adjust its business model away from South America and more toward Central America and the U.S. market. The dividend was paused for a year or so, but it is growing again. More importantly, the dividend wasn't cut despite the change in corporate direction.
I prefer stability over growth
There's nothing wrong with Capital One Financial. In fact, it is likely to see attractive growth in the future owing to its recent acquisition of Discover Financial. However, the basic business model the bank uses is just a bit too aggressive for my tastes. I am fond of reliable high-yield stocks that don't come with many surprises. And even the surprises that do arise are usually just bumps in the road and not events that are likely to derail my income stream. On that score, TD Bank and Scotiabank are industry-leading banks and my top picks in the bank sector, thanks to their Canadian roots. Although I've owned both for years, I believe each of these banks is still an attractive investment today.
