So far in 2023, the banking sector has not become a particularly profitable sector for investors. For example, Invesco KBW Bank ETF So far this year, the turnover is about 19 percent.
According to that standard, Bank of America (BAC 3.36%) “Only” has done relatively well, with stock price declines of 14% or so. But if you’re looking to buy bank stocks during the current industry turmoil, here’s more to consider.
Not so good
There are very real reasons for investors to worry about banks today. The two major bank failures so far in 2023 were tied to highly specific (and, in retrospect, flawed) business models, with the rising interest rate environment increasing risk to the industry.
Part of the problem stems from the structure of bank balance sheets. To greatly simplify things, there are two ways of classifying bond investments: one in which the bond’s price is updated every quarter, and another where the bond is carried at face value because it is expected to be held to maturity.
Bond prices and interest rates move in opposite directions, so a rising-rate environment has driven down the value of bonds owned by banks. Such changes will not be reflected if the bonds are expected to be held to maturity.
As long as the bank does not sell those bonds before maturity, there is no problem. But if customers cash out in droves and those bonds is Selling to cover exports is a big problem. Suddenly, losses must be recognized on bonds expected to be held to maturity. Or, to put it another way, the money the bank said wasn’t actually there – the main reason behind the recent bank collapse.
Bank of America doesn’t seem at risk of going that route (although it certainly has maturing assets on its balance sheet), but investors are throwing the baby out with the bathwater in the banking sector right now. . For example, if you invested $1,000 in Bank of America at the beginning of the year, it would be worth only $860. That’s better than a similar investment in the Invesco KBW Bank ETF, which would be worth about $810, but it’s not really a huge comfort. What should interest long-term investors is that $1,000 is invested Toronto-Dominion Bank (TD 0.35%) Will be worth $925.
Bank of America isn’t a bad bank, but there is an important difference between it and TD Bank, as Toronto-Dominion is more commonly known. And that is the Canadian government, which highly regulates the Canadian banking industry and has a very conservative bias.
That bias generally translates into major Canadian banks (of which TD Bank is one) being highly focused on security. It’s on display today, as investors clearly don’t believe there’s much risk based on performance differences.
US banking doesn’t have the same level of regulation, so big Canadian banks like TD Bank are expanding south of the border. But they’re usually taking their play-it-safe ethos with them. That’s why long-term dividend investors should look at banks like TD Bank today as an alternative way to invest in the banking sector. But how has this conservative approach translated over time?
An investment in TD Bank at Bank of America has shown higher returns over the past one-, three- and five-year periods. Note that in the three- and five-year comparisons above, it is the most recent recession where performance diverges most significantly. Essentially, when risk in the industry increased, investors stuck with more conservative banks.
And yet Bank of America beat TD Bank over the last 10 years, turning a $1,000 investment into $2,340, while the same amount grew to about $1,490 at TD Bank.
So does this mean Bank of America is a good long-term investment? The time period is important here because it comes after the Great Recession, a period during which Bank of America’s stock collapsed, and it had to cut its dividend to a mere token. TD Bank was able to keep its dividend stable, and its stock price held up very well.
If you drag the graph back to early 2007, that difficult period before the recession began, the numbers are quite different.
If you invested $1,000 in Bank of America at that time, it would be worth about $530 today, while the same amount invested in TD Bank would be worth $2,000. To be fair, Bank of America isn’t quite the bank it was then, but it seems pretty clear that TD Bank’s conservative approach has paid off handsomely for investors over time — and, arguably, when it really matters most.
Would buying Bank of America (paying around 3.1% dividend) be a big mistake in the current banking turmoil? Probably not. However, if you’re looking to live off the income generated by your dividend portfolio, it might make sense to err on the side of caution and look to TD Bank (4.8% yield), or some of its Canadian brethren in US banks. They haven’t suffered as big of a drop as their American peers, but that, in the end, might be the biggest selling point.