Profit from Bank Profits.
Canadian banks make a lot of money. This is good for investors. But not so good for bank-fee-paying customers. Fee-paying customers can get some of their fees back by becoming investors. And there are many ways to invest in the banks.
According to urban legend, when reporter Mitch Ohnstad asked bank robber, Willie Sutton why he robbed banks, ‘Slick’ Willie said “because that’s where the money is.”
Most all Canadian investors belong to a Pension Plan of some sort (and the Canada Pension Plan at least) and so already own the banks in abundance. One would be hard pressed to find any Pension Plan that didn’t own a good piece of at least a couple of banks.
Investors love profitable banks. Bank customers hate paying bank fees. With a further investment in the banks, above and beyond their Pension Plan, bank-fee-paying customers can look at bank dividends as a fee rebate. (Bank dividends will help to manage bank-fee-induced rage).
Why are banks so profitable? One of the reasons is fees. Here’s a recent example.
On July 31, I bought US$ merchandise (books), and paid in US$ with my VISA. In effect, I bought US$ and was charged a foreign exchange (FX) conversion rate of 1.031158. But according to FX dealer and trader, OANDA, the mid-point US$ FX rate that day was 0.9962. That’s a 0.034958 gap.
Of course, the books weren’t what I wanted so I returned them. On August 22, my VISA was credited with US$. In effect, I sold US$ at 0.963960. Again, according to OANDA, the mid-point US$ FX rate that day was 1.013.That’s a gap of 0.04904.
As you can see from the chart, the FX rate range from July 30th to Aug 22nd was .9949 to 1.0130. I was charged 1.031158 and 0.963960 … well outside the range. That’s almost $84 for every $1,000 U.S. dollars bought then sold. The imbedded FX transaction fee (spread) would make Slick Willie blush.
Further, my measly transactions were, as are most transactions, all electronic. They cost a fraction of a cent for a bank to execute but the spread over cost is huge. And that’s just two transactions. Think of all the transaction fees a bank charges. Now multiply by a lot of customers paying fees. (CIBC, for example, has over 6 million customers. Scotia (#3) just picked up another 1.8 million new customers with the purchase of ING Canada (#8) … I guess ING should have ‘saved their own money’ … but that’s another blog post).
Bank fees mean profits.
The point is that the utility part of the banks make money, in part, by charging fees. Further still, banks charge fees during good times and bad … making a bank investment somewhat recession proof. And bank competition is not encouraged.
Porter’s Five Forces is a model used to evaluate companies or industries.
- Threats from substitutes. Banks are an essential service (so the deposit taking utility part of a bank is heavily regulated and difficult to replicate). Upstart ING was scoffed at for 11 years … but eventually and inevitably dealt with by Scotiabank.
- Rivals. The Big 5 (maybe 6) are an oligopoly. Competition is difficult to create. Combining ALL Canadian Credit Unions would make a small bank at best with no global reach.
- New entrants. Again, ING started a Canadian bank. Had an appealing, differentiated model. Did well. Then parent ING Groep NV blew up. Then Scotiabank (#3) bought ING Canada (#8).
- (& 5). Bargaining power of customers & suppliers. Customers can complain about the fees, close their account and walk across the street … only to pay fees to another bank.
This is not exactly exhaustive research but it tells me that Canadian banks are profitable investments.
Valuation is always difficult to know. Some research says bank stock is over or undervalued … some says undervalued. It depends on who you read. Long-term, the banks make money. A good on-ramp strategy is dollar-cost-averaging. Or half now, half later.
How to buy the banks.
Canadian banks are very highly positively correlated. They move as a group. Above the 90% level. So if Royal Bank moves $1, TD, BMO, Scotia and CIBC move 90¢ or so. So rather than bet on one, if you like the banks, buy them all (and more) with an Exchange Traded Fund (ETF). See Avoid Cost and Risk with Exchange Traded Funds. Which ETF? It’s tough to find a plain vanilla ETF that doesn’t have bank exposure. Here are a few.
Previous Relevant PostsCIBC Blinks. CIBC’s Revenge Redux CIBC’s Revenge CIBC Strikes Again. Avoid Cost and Risk with Exchange Traded Funds
_____________________________________________________________________________________________Next time? More Risk Management. Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan