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Canadian Bank Stocks Are Crashing: Should You Buy the Dip?

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Written by Andrew Button at The Motley Fool Canada

Bank stocks are crashing this year. For the year, the S&P/TSX Capped Financials Index is up only 0.8% and down 8.4% from its March 2023 highs. It’s not hard to see why this is happening. In March and April of this year, several U.S. banks failed after they suffered bank runs and lacked the liquidity needed to pay off depositors. No Canadian banks failed, but the U.S. banking crisis spooked investors enough that Canadian equities fell in solidarity with their U.S. regional cousins.

The question investors need to ask is, “Is this time to buy the dip, or stay away?” On the one hand, TSX banks have gotten cheaper, both in absolute terms and relative to earnings. On the other hand, there are many macroeconomic risks facing the big banks today. In this article, I will explore the question of whether Canada’s big banks are worth buying on the dip.

Why bank stocks are crashing

There are two main reasons why Canadian bank stocks are crashing this year:

  1. After-effects of the U.S. regional banking crisis

  2. Lukewarm earnings

I already briefly touched on the first factor, but to go into it in a little more depth: the U.S. regional banking crisis saw several mid-sized regional banks fail due to bank runs and inadequate liquidity. As treasury yields rose, these bank clients took their money out to invest it elsewhere. As a result, the banks had to come up with the cash to pay depositors off, but they lacked the liquidity needed to do so. In the end, the U.S. FDIC had to bail out depositors. Canadian banks weren’t affected by the banking crisis, but sentiment toward them dimmed when investors became aware of the risks caused by rising interest rates.

Second, Canadian banks’ earnings have been lukewarm this year. Whereas the biggest U.S. banks mostly saw high double-digit earnings growth last quarter, Canadian banks barely grew. Some actually saw their earnings decline. So while U.S. financials are apparently riskier right now, the ones that survive have better growth than Canadian financials do.

How banks are performing

Canada’s big banks are performing “so-so” this year. They’re managing risks better than their U.S. counterparts, but they aren’t enjoying much growth.

Consider Royal Bank of Canada (TSX:RY), for example. In its most recent quarter, it delivered:

  • $14.4 billion in revenue, up 19%.

  • $3.9 billion in net income, up 8%.

  • $2.73 in diluted earnings per share (EPS), up 9%.

  • A 14.6% return on equity (ROE), unchanged year over year.

  • A 14.1% CET1 ratio, well above the regulatory requirement.

RY’s most recent earnings release was quite typical of Canadian financials in the most recent quarter – that is to say, very strong revenue growth, but slower earnings growth. The slower earnings growth was due to higher provisions for credit losses (PCL) – money set aside to cover non-performing loans. When PCLs go up, earnings go down, but if the expected defaults don’t materialize, then banks can reduce their PCLs later, causing earnings to spike.

Foolish takeaway

Are Canadian bank stocks worth buying on the dip? On the whole, I’d say that they are. There are certainly many risks stemming from the housing market and interest rates, but on the other hand, the banks are practising sound risk management. I have some of my money in Canadian banks, and I don’t regret my decision to put it there.

The post Canadian Bank Stocks Are Crashing: Should You Buy the Dip? appeared first on The Motley Fool Canada.

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Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.