In August, 12 financial institutions—including CIBC World Markets, Desjardins Financial Group, National Bank Financial, Scotia Capital, and TD Securities—finalized the acquisition of 80% of TMX Group Ltd. It’s official. Canadian banks control primary stock exchanges in Canada. But what does this mean for the average investor, and how can we make the most of it?
Read: Vik’s Pick: TMX takeover leaves questions
The good news…sort of
Canadian banks are now too big to fail. If they get into trouble, Canadian taxpayers will have to bail them out.
All parties will officially deny this; however, the implication is that bank credits are effectively as good as Government of Canada (GoC) credits.
So selling 10-year GoC bonds (1.80%) and buying bank bonds (3.40%) will pick up a fair yield spread with nominal, if any, incremental credit risk.
I have always counselled clients to own Canadian bank shares because of their market dominance. Investors can get exposure directly (see “Option 1: Direct exposure”) or through ETFs (see “Option 2: ETF exposure”).
OPTION 1: Direct exposure
| Stock (Symbol) | Capitalization | % all Banks | Dividend Yield | Price/Earnings |
|---|---|---|---|---|
| Royal Bank of Canada (RY) | $73.2 billion | 25.8% | 4.48% | 16.2 |
| Toronto-Dominion Bank (TD) | $71.7 billion | 25.3% | 3.64% | 12.0 |
| Bank of Nova Scotia (BNS) | $59.6 billion | 21.1% | 4.01% | 11.5 |
| Bank of Montreal (BMO) | $36.7 billion | 13.0% | 4.90% | 9.9 |
| Canadian Imperial Bank of Commerce (CM) | $30.0 billion | 10.6% | 4.85% | 9.7 |
| National Bank of Canada (NA) | $12.0 billion | 4.2% | 4.24% | 8.5 |
| TMX Group Ltd. (X) | $3.5 billion | NA | 3.40% | 16.0 |
OPTION 2: ETF exposure
| Exchange-traded Funds (Symbol) | Bank Exposure | Management Fees | Yield/Distributions | Price/Earnings |
|---|---|---|---|---|
| BMO Equal-Weight Banks (ZEB) | 99.3% | 0.55% | 4.39% | 12.9 |
| iShares S&P/TSX Capped Financials (XFN) | 78.6% | 0.55% | 4.2% | 13.0 |
| iShares Equal-Weight Bank and Lifeco (CEW) | 62.8% | 0.55% | 3.98% | 10.8 |
| BMO Covered-Call Banks (ZWB)1 | 99.7% | 0.65% | 7.70%1 | 12.9 |
| Horizons Enhanced Income Financials (HEF)1 | 51.0% | 0.65% | 9.04%1 | 12.4 |
| First Asset Can-Financials Covered Call (FXF)1 | 25.0% | 0.65% | 7.26%1 | 10.6 |
| Horizon Betapro Capped Financials Bull+ (HFU)2 | 75.0% | 1.15% | NA | 13.0 |
1Covered-call ETFs 22X Leveraged
ETFs offer investors several ways to access Canadian banks. The three ETFs at the top of “Option 2: ETF exposure” offer different degrees of bank exposure. iShares Equal-Weight Bank and Lifeco (CEW) and iShares S&P/TSX Capped Financials (XFN) include life insurance companies that add diversification, but also additional business risk in today’s low-interest-rate environment. Only XFN uses a traditional capitalization-weighted index.
