Home » Investing » New Canadian Bank Tax: Should You Buy or Sell Bank Stocks Now?
Canadian bank stocks have taken a big hit in the past two months. Is the pullback overdone?
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Andrew Walker
Andrew has an MBA and has been writing for The Motley Fool Canada since 2014. As a contrarian investor, Andrew seeks out dividend opportunities the market is missing. He is a big fan of harnessing the power of compounding to grow a portfolio for retirement.
Canadian bank stocks are trading at or near their lowest levels of 2022, and some are down more than 10% from their 12-month highs. The pullback in the sector and the arrival of a new bank tax has investors wondering if Canada’s banks should still have a place in their buy-and-hold TFSA and RRSP portfolios.
New bank tax
The Canadian government just released the details of its anticipated new corporate tax on bank profits. Banks will pay a 15% one-time extra tax on fiscal 2021 profits they earned above $1 billion. They are also going to see their corporate tax rate increase permanently from 15% to 16.5%. The largest Canadian banks reported bumper profits last year and are on track to generate strong earnings again in fiscal 2022. Based on its estimates, the government could pull in an extra $6 billion from the banks as a result of the new taxes.
Bank shares slipped ahead of the news, but the net impact on investors should be negligible over the long run. It might slightly reduce dividend growth or cause the banks to trim their share buybacks, but it is also possible the banks will simply raise fees or increase borrowing costs to offset the hit.
Recession fears
Bond yields recently inverted in the United States with the yield on the five-year treasuries moving higher than the 30-year yield. In the past, a yield inversion in the bond market has often indicated a recession is on the way. The timing and severity of the economic slump can vary considerably, and there is no guarantee a recession is imminent, but investors appear to believe the warnings are justified and might be shifting funds out of bank stocks to segments such as utilities and telecoms that tend to be recession resistant.
A slowdown in the economy could hit the banks, as companies and retail customers borrow less money. For the moment, there is no shortage of job opportunities, and the tight labour market is expected to remain in place for some time. Until that situation reverses and consumers stop spending, it is unlikely we will see an economic downturn.
Aside from the recession risk, the yield inversion can also make it harder for banks to boost their net interest margins. Earlier this year, bank stocks soared on the hopes that rising interest rates will help the banks expand their net interest margins, so there are two forces in play at the moment.
Housing market
A strong housing market helped drive profits for the banks through the pandemic, and the trend has continued in the first part of 2022. Looking ahead, there is a risk that a steep increase in interest rates and bond yields will push mortgage costs up so far that new buyers can’t get loans and existing homeowners who need to renew their mortgages won’t be able to cover the increase in the payments. As long as people still have jobs, the rise in defaults should be contained. Even if bankruptcies spike, the banks all have strong capital positions to ride out some tough times.
That being said, a combination of much higher borrowing costs with a steep recession that triggers job losses could trigger a meaningful correction in the housing market. This is unlikely, but not impossible. If things go that direction, the result would be reduced bank profits and a downward move in share prices.
Upside?
At the time of writing, Royal Bank is down 9.5% from the 2022 high, TD is 11.5% lower, Bank of Nova Scotia is off 8%, Bank of Montreal is down 7%, and CIBC has dropped 13%.
The Canadian banks remain very profitable, and dividend growth should continue at a healthy pace. The pullback in the shares of the largest banks now has them trading at 10-12 times trailing earrings. This is getting to a point where the share prices look attractive.
Buying dips in Canadian bank stocks has historically proven to be a savvy move for buy-and-hold investors. I wouldn’t back up the truck today, but it might be worthwhile to start adding the banks to your portfolio on any further weakness.
Investors can take great comfort in the fact that Canadian banks entered 2024 with very strong balance sheets. In examining balance sheets, the first two key considerations are the banks' capital levels, which remain healthy, and loan loss provisions.
In general, TD bank stocks make for a wise investment. It trades at a reasonable stock price of $81.92 per share, relative to its high dividend yield. Also, analysts predict that the market will improve, and interest rates will fall in the second half of 2024.
The banks are tackling global challenges, including a changing interest rate environment, high inflation, and concerns of a potential “hard landing” economic scenario. Canadian banks expect interest rates to decline in 2024, a shift from the rising rate environment seen in 2023.
Canada's banking industry is coming through yet another challenging period. Capital requirements, evolving risks, regulatory changes, technological disruption and macroeconomic volatility continue to complicate Canadian banks' growth agendas as they navigate the early months of 2024.
Should you buy the banks now? The large Canadian banks deserve to be part of a buy-and-hold portfolio. Over the long haul, they tend to deliver attractive total returns. Additional upside is certainly possible in the coming months, but investors should take a cautious approach.
Toronto-Dominion Bank is forecast to grow earnings and revenue by 6.8% and 3.2% per annum respectively. EPS is expected to grow by 7.1% per annum. Return on equity is forecast to be 13.3% in 3 years.
TD Bank (TSX:TD) stock suffered one of its worst days since the pandemic era as shares nosedived around 6% in a day in response to some pretty troubling news relating to the ongoing money-laundering investigation. Undoubtedly, the major money-laundering probe is nothing new.
Comprehensively, the top 10 Global banks companies in the world had a total market cap of $1,879,696 million (as of Mar 31, 2023), with JPMorgan Chase & Co having the highest ($383,549 million), followed by Industrial and Commercial Bank of China Ltd ($235,043 million), and Bank of America Corp ($228,780 million), ...
According to analysts noted that the favorable credit environment at present has bolstered the asset quality of these banks, contributing to the rise in their stocks.
The economy remains resilient as healthy business sentiment, buoyant financial markets and the government's capital spending buffered global economic headwinds and inflation. These factors are conducive for banks to sustain profitable business, provided risks are well-managed.
As of this writing, it's still a good time to invest in Canadian bank stocks, as analysts predict that the local economy will remain steadfast and avoid a recession. Moreover, Canadian bank stocks are still trading at less than ten times their earnings. The average dividend yield of nine of the largest banks is at 5%.
By the end of next year, it predicts interest rates will be roughly half of what they are now. That reduction would put the Bank of Canada's key overnight rate — currently at five per cent — at 2.5 per cent by the end of 2025, according to Desjardins' forecast.
Fitch has a 'deteriorating' outlook for U.S. banks in 2024, with continued pressures on the U.S. banking sector, including slow loan growth, elevated funding costs and normalizing credit quality. We expect the economy to meaningfully slow in 2024 but no longer forecast a recession.
"And that would create some clarity for banks' funding and for the economy in general ." Credit quality overall remains historically strong on the whole moving into 2024 and community banks, on average, were profitable in 2023.
Introduction: My name is Lakeisha Bayer VM, I am a brainy, kind, enchanting, healthy, lovely, clean, witty person who loves writing and wants to share my knowledge and understanding with you.
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