Why BofA believes U.S. banks offer better value than Canadian lenders, plus a buy-and-hold portfolio that really works

Ebrahim Poonawala, an analyst at BofA Securities, conducted a series of interviews with senior Canadian bank executives and concluded that U.S. banks offer better value for institutional asset managers.

The analyst, who leads North American banking research at BofA, is particularly concerned that provisions for credit losses (PCLs) will remain high. These provisions, money set aside to protect banks’ balance sheets against consumer and corporate loan defaults, are deducted from earnings and limit profit growth.

Higher PCLs are a direct result of the Bank of Canada’s interest rate hikes, which have increased borrowing costs. Mr. Poonawala points out that personal bankruptcies are up 23 percent year-on-year and corporate bankruptcies are up 60 percent, albeit from extremely low levels.

According to BofA, higher interest rates will also lead to a sharp decline in mortgage lending, from a peak of 11 percent year-on-year growth in 2021 to below 4 percent by the end of 2024.

The S&P/TSX Banks Index has underperformed the S&P/TSX Composite Index over the three-month, annual and three-year average return periods. This was not easy to achieve because the large banks make up such a large portion of the benchmark. The banks have not only underperformed the TSX, but also their global peers. Year to date, Japanese, Australian, European, U.S. and Nordic banks have all outperformed Canadian banks.

Despite the underperformance, bank stocks are not cheap. BofA points out that the price-to-earnings ratio of 10.4 times (a 5 percent discount to U.S. banks) and 1.4 times book value (a 15 percent premium to U.S. banks) are close to historical averages.

The banks’ below-average performance so far is all the more surprising given that the earnings revisions for Royal Bank, TD Bank and CIBC were clearly positive. Positive earnings revisions should have resulted in steep share price increases in previous periods, and the lack of reaction now indicates a skeptical investor mood.

Mr. Poonwala’s research report highlights the better risk-reward dynamics of U.S. banks compared to Canadian banks, but in truth they are not viable options for most Canadian investors – familiarity with the banks and tax treatment of dividends keep them in domestic equities. However, the comparison underscores the significant hurdles facing the banks that are likely to limit their earnings in the coming months.

— Scott Barlow, market strategist at Globe and Mail

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