ZEB: Banking on Banks

Nov. 28, 2022
  • Canadian banks have underperformed the broader Canadian equity market this year, with the BMO Equal Weight Banks Index ETF (ZEB) delivering -3.3% year-to-date on a total return basis compared to -1.8% for the S&P/TSX Composite (TSX).1
  • While the Canadian banks have rallied over the last month, the underperformance in the group has been due to the banks increasing their respective loan loss provisions. Rising interest rates have become a concern for investors, as it would place greater pressure on borrowers. With household debt in Canada still at historically high levels, it could lead to a greater number of defaults on loans. In addition, higher rates would place pressure on borrowers with variable-rate mortgages and even for those on fixed rates who need to refinance at higher rates in the coming year.
  • However, when taking a closer look at non-performing loans at the Big Six” banks, levels have not increased in recent months, ranging between only 32 and 69bps of the total loan portfolio (see chart below). The recent underperformance of the banks and their valuations would suggest the bad news has already been priced into the shares.
  • The banks currently trade at a price-to-earnings ratio of 10.1x compared to 13.5x for the TSX, which is a further illustration of the negatives already reflected in share prices. Investors can view this as buying the banks at a -25.2% discount to the broader market. Moreover, the banks also trade at a steeper loss relative to the group’s 52-week highs compared to the TSX.

Canadian Banks Trading at a Discount to the S&P/TSX Composite 

Canadian Banks Trading at a Discount to the S&P/TSX Composite
Source: Bloomberg, BMO Global Asset Management (current price-to-earnings ratios as of November 232022).

Discount to 52-Week High

Discount to 52-Week High
Source: Bloomberg, BMO Global Asset Management, as of November 232022.
  • Furthermore, Canadian banks remain well capitalized. The Tier-1 capital ratio is a core measure of a bank’s financial strength used by regulators. Canadian banks maintain ratios that not only easily meet the Basel-3 requirements, but also the more conservative OSFI minimum requirements. This suggests that Canadian banks are well-capitalized and have significant buffer to weather a potential downturn. 
Loans to Total Loans
Tier 1 Capital Ratio





Source: Bloomberg, BMO Global Asset Management, as of November 232022.

  • Canadian banks currently have an average yield of 4.4% and have a strong history of paying dividends. The last dividend cut by a Big Six” Canadian bank was in 1992
  • Although Canadian banks have rallied in recent weeks, current valuations still suggest they are deeply discounted. The BMO Equal Weight Banks Index ETF (ZEB) allows investors to efficiently access the Big Six Canadian banks, which arguably are some of the best businesses in the world. Significant barriers to entry, being conservatively managed and having well diversified business lines has led the group historically to significantly outperform the broader TSX. 

Canadian Banks Have Historically Significantly Outperformed the Broader TSX

Canadian Banks Have Historically Significantly Outperformed the Broader TSX
Source: Bloomberg, BMO Global Asset Management, as of November 23, 2022. (Index shown is of the S&P/TSX Composite Banks Industry Group GICS Level 2 Index from December 311987).

1 Bloomberg, BMO Global Asset Management; annualized returns as of November 23, 2022; 1-month: 8.5%, YTD: -3.3%, 1-year: -2.9%, 3-year: 10.7%, 5-year: 8.3%, SI (October 20, 2009): 11.0%.


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