The U.S. banking system is like the Wild West compared to the way things are handled in Canada. That’s one big reason why, during the Great Recession, even the largest U.S. banks wound up having to cut their dividends while Canadian giants like Toronto-Dominion Bank(NYSE: TD) and Bank of Nova Scotia(NYSE: BNS) didn’t.
That said, these two banks, my favorite high-yield banks right now, aren’t hitting on all cylinders. But that’s exactly why you might want to buy them along with me.
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Without getting into the nitty-gritty of it, Canada takes a vastly different approach to its banking system than does the United States. The country’s regulators have, pretty much, given a handful of very large banks entrenched industry positions because of the important role that banks play in the economy.
Regulators are also heavy-handed on a day-to-day basis. For example, during the Great Recession, Canadian banks were barred from raising dividends because regulators wanted to ensure that there was enough financial liquidity at the banks.
Image source: Getty Images.
Not that there was a problem, given that the largest Canadian banks simply paused their dividend increases and then, when allowed, started increasing them again. That’s vastly different from what transpired in the United States, where many of the largest banks ended up cutting their dividends.
That’s not to suggest that Canadian banks are risk-free — they most certainly are not. But heavy regulation has left the biggest players with protected industry positions and, just as important, generally conservative management teams.
I’m a fan of buying fallen angels. That basically means owning good companies that have found themselves dealing with temporary problems. When it comes to large banks, which are highly complex entities, I’m inclined to focus on Canadian banks because I’m confident that Canadian regulators are holding their feet to the quality fire, if you will. Thus, the pool I’m fishing in is safer than the U.S. banks, where it sometimes feels like anything goes. (Remember the bank runs in 2023?)
Right now, my favorite banks are Canadian giants Toronto-Dominion Bank, more commonly called TD Bank, and Bank of Nova Scotia, usually shortened to Scotiabank. Here’s why.
Even though Canadian banks are generally conservative, that doesn’t mean their businesses don’t go through difficult periods, just like every other company. I tend to buy stocks when they are dealing with difficult periods because that’s usually when their dividend yields are historically high. Both TD Bank and Scotiabank are in a funk right now.
Scotiabank’s problems are strategic. When most of its Canadian peers chose to grow their businesses via expansion into the U.S. market, Scotiabank chose to focus on Latin America. That logic was sound, given that the emerging economies in that region potentially offered outsize growth opportunities. That said, the higher economic volatility in Latin America ended up leaving Scotiabank trailing its peers on key performance metrics, such as earnings growth and return on equity.
The company is shifting gears in what will likely be a multiyear effort. The plan is to exit less desirable markets while refocusing around more desirable markets and, notably, increasing the bank’s U.S. exposure. It wants to be a financial giant, facilitating finance from Mexico through to Canada.
I like the Latin American angle, so I’m on board with the long-term goal. And I’m happy to reinvest the fat 5.6% dividend yield while Scotiabank works through this period. Notably, it has moved quickly on the U.S. front, recently buying a roughly 15% stake in Keycorp(NYSE: KEY).
TD Bank’s problems are a little harder to handle, but I’ve been a long-time shareholder, and I’m not giving up on the generally well-run bank now. To sum up a very complex and ugly event, TD Bank’s U.S. system was used to launder money, which, understandably, upset U.S. regulators. There was a large fine, TD Bank had to update its internal controls, and the company is under an asset cap. The first two are largely taken care of, but the asset cap is going to be a lingering problem. Effectively, TD Bank can’t grow in the United States without regulatory approval.
That’s why the stock has been something of a dog. And the dividend yield is a historically high 5.2%. The downside here is that TD Bank’s growth is going to be slow for a while, perhaps a few years. It needs to earn back regulator trust.
But the Canadian business is unaffected, and the bank is generally well run. I’m confident that TD Bank will manage through this period and come out stronger on the other side. In the meantime, I’ll keep reinvesting the big dividend and growing my position in one of North America’s largest banks.
From a big-picture perspective, I’m not worried about the long-term future of either of these Canadian banks. In fact, both have paid dividends every year for well over 100 years. Meanwhile, I’m thinking about retirement, but I’m not quite there yet. So grabbing a pair of high-yield stocks that I believe are temporarily out of favor (and reinvesting the dividends) is a perfect fit for me.
If that sounds good to you, you might want to jump aboard. That said, given that I’m confident in the strength of the dividends, you could spend that dividend cash, but you would just be giving up the compounding effect the huge dividend yields offer.
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Reuben Gregg Brewer has positions in Bank Of Nova Scotia and Toronto-Dominion Bank. The Motley Fool recommends Bank Of Nova Scotia. The Motley Fool has a disclosure policy.
