An Improving Backdrop for Canadian Banks Spells Growth and Income Potential
October 2024
Third-quarter earnings for the six major Canadian banks were on balance fairly constructive with CIBC, National Bank and Royal Bank of Canada leading the charge. Overall, the Canadian lenders delivered the first quarter of double-digit year-over-year earnings growth since the spring of 2022. The most recent inflation print showed the Bank of Canada (BoC) finally reached its goal of 2%. Overnight lending rates have come down 75 basis points (bps) in Canada and we are projected to see two more cuts before the end of the year—with the possibility of at least one oversized cut of 50 bps at one of those final meetings. Forecasters now predict the overnight lending rate will reach a “neutral” level of around 2.25% to 2.50% (potentially some time in 2025).
Under the present circumstances, it is worth asking the question: does the current rally in Canadian banks have more room to run?
Featured Funds
- BMO Canadian Banks ETF Fund (also available as an exchange-traded fund under ticker ZEB)
- BMO Covered Call Canadian Banks ETF Fund (also available as an exchange-traded fund under ticker ZWB)
Key Takeaways
- Funds provides equal-weight exposure to large, diversified Canadian bank stocks
- Call option writing reduces volatility while producing monthly cash distributions
- Designed for investors looking for a growth solution and demonstrated history of dividend gains
Supported by BoC rate cuts, forecasters see continuing tailwinds from easing funding pressures on borrowers, resumption in loan growth, and stable credit provisions going forward. When interest rates drop this would typically encourage businesses and consumers to borrow more and in turn stimulate the Financials sector along with easing pressure on overall default rates. Canadian bank loan loss provisions should decline under such a scenario, likely benefiting bank earnings.
With the potential of more rate cuts, we are expected to see the yield curve continue to steepen. Banks tend to borrow on the short end and lend on the long end of the curve. Therefore, a steepening yield curve can be good for the banks overall.
Investors may want to consider buying BMO’s Bank funds. Given the wide performance dispersions between the Canadian banks as of late, one may have the opinion that not all banks are considered equal. Indeed, the dispersion is vividly illustrated in the performance spread between RBC and TD, which was as wide as 24.18% over the last 6 months. BMO’s Equal Weight strategy is designed to remove concentration risk in a particular company. With the more recent volatility among certain Canadian banks, we have seen more stable returns from the BMO Canadian Banks ETF Fund and BMO Covered Call Canadian Banks ETF Fund.1
Moreover, the equal weight strategy in the funds’ underlying holdings can act as a natural “buy low, sell high” strategy. When dispersions happen in performance with certain banks, the semi-annual rebalancing will bring the holdings back to an approximate equal weight and in turn allow you to take some profits while redistributing to other quality holdings within the fund.
Canadian banks continue raise their dividends over time which bodes well for income-seeking investors. Overall, Canadian banks have a reliable dividend payment, with underlying ETFs held by the BMO Canadian Banks ETF Fund and BMO Covered Call Canadian Banks ETF Fund boasting annualized distribution yields of 4.14% and 6.8%, respectively.2 Investors are able to benefit from regular monthly distributions from these ETFs.
Both BMO funds are low-cost solutions to gain exposure to Canadian banks. The underlying holdings of both funds remain among the largest, most liquid Canadian bank ETFs in Canada and have gathered over $6.1 billion of AUM since inception.3
Annualized Month-End Returns as of September 30, 2024
| Fund Name | Year-to-Date | 1-Month | 3-Month | 6-Month | 1-Year | 3-Year | 5-Year | Since Inception |
|---|---|---|---|---|---|---|---|---|
| BMO Covered Call Canadian Banks ETF Fund – F Series | 14.50% | 4.34% | 13.89% | 9.17% | 25.03% | 5.24% | 7.72% | 8.59% |
| BMO Canadian Banks ETF Fund – F Series | 18.56% | 6.07% | 17.78% | 12.13% | 33.79% | - | - | 7.08% |
Implementation
For exposure to an approximate equal weighted basket of Canadian banks, consider buying the BMO Canadian Banks ETF Fund or with an enhanced yield component, the BMO Covered Call Canadian Banks ETF Fund.
1 Performance source Bloomberg September 30, 2024.
2 As of September 20, 2024.
3 AUM Flows source BMO Global Asset Management August 31, 2024.
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Distribution yields are calculated by using the most recent regular distribution, or expected distribution, (which may be based on income, dividends, return of capital, and option premiums, as applicable) and excluding additional year end distributions, and special reinvested distributions annualized for frequency, divided by month end net asset value (NAV). The yield calculation does not include reinvested distributions.
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Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.
BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.
Commissions, trailing commissions (if applicable), management fees and expenses all may be associated with mutual fund investments. Please read the ETF facts, fund facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.
Distribution yields are calculated by using the most recent regular distribution, or expected distribution, (which may be based on income, dividends, return of capital, and option premiums, as applicable) and excluding additional year end distributions, and special reinvested distributions annualized for frequency, divided by current net asset value (NAV). Distributions are not guaranteed, may fluctuate and are subject to change and/or elimination. Distribution rates may change without notice (up or down) depending on market conditions and net asset value (NAV) fluctuations. The payment of distributions should not be confused with a BMO Mutual Fund’s performance, rate of return or yield. If distributions paid by a BMO Mutual Fund are greater than the performance of the investment fund, your original investment will shrink. Distributions paid as a result of capital gains realized by a BMO Mutual Fund, and income and dividends earned by a BMO Mutual Fund, are taxable in your hands in the year they are paid. Your adjusted cost base will be reduced by the amount of any returns of capital. If your adjusted cost base goes below zero, you will have to pay capital gains tax on the amount below zero.
Distributions, if any, for all series of securities of a BMO Mutual Fund (other than ETF Series) are automatically reinvested in additional securities of the same series of the applicable BMO Mutual Fund, unless the securityholder elects in writing that they prefer to receive cash distributions. For further information, see the distribution policy for the applicable BMO Mutual Fund in the simplified prospectus.
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