December 22, 2008, 6:00 am

Buying Bank Stocks or Not Buying Bank Stocks; That is the Question!

by: The Financial Blogger    Category: Investment, Market and Risk,Trading
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I am no different than anybody; I’m always trying to find a way to make a few bucks out of the market. Since the past 4 months, Canadian Bank Stocks have been decreasing tremendously. In fact, most of them lost about 40% of their value. Since the Canadian Bank System has been voted to be the most stable and secured in 2008 by the IMF (International Money Fund), I thought it would be a great idea to give this industry a look.

Here’s the plan:

Interest rates are pretty low (it may get even lower due to the historic announcement by the FED last week!). So I have the possibility of borrowing at 1.5% (remember, I am a bank employee 😉 ) and purchase shares of company paying 6 to 8% in dividend. While the stock’s dividend will be paying for my interest payment, I’ll be making an automatic spread of about 5%. On top of that, Canadian Bank stocks might be pretty low for a while, but over the long run, I’m quite sure I’ll get a good return on them.

So I gave a shout to my best friend and partner to ask him for a “good Canadian bank stock”. If you are reading The Intelligent Speculator, you will notice that he knows much more than me in term of stock trading. On top of that, he is a CFA working with traders. Since Canadian banks are high dividend paying stocks, I thought it was a good idea to ask him his opinion on them.

I am not going to give you his position on each Canadian bank, but let just say that he was not as enthusiastic as me! Here are a couple of points he told me:

– Canadian banks may cut their dividend in 2009.

Since dividend rate are pretty high for all banks, they may want to cut their dividend in 2009. This would obviously affect the stock value significantly.

– We don’t know exactly what will be the ABCP settlement.

Most banks are concerned about the ABCP settlement as there are billons frozen in this investment product. This is a huge liquidity problem and it may forces banks to declare more provision (read loss) in their upcoming financial statement.

– We don’t know if there are still surprises such as the ABCP, the CDS or another Maddof to come.

We thought we were done with bad news back in summer 2008, remember 2008 fall? Who know what is coming during winter time 😉

– Banks’ business model will change overtime and become less profitable.

Banks won’t be able to make as much money as they used to on the market. They will have to go back to a more traditional business model (customer services) and will become less profitable. Therefore, their stocks won’t perform as they used to.

– Several Canadian Banks are issuing shares (RBC, BMO, TD), what this all about?

We don’t have the answer to this question yet. It is primarily to maintain their Tier 1 ratio but I may hide something else. Acquisitions (as some banks are for sell)? Liquidity problems related to the credit crunch? I have no clue.

While I am writing this article, I am almost changing my minds on Canadian Bank Stocks. They may give us one of the most solid dividends promises on the market… this is quite a long shot!

Remember the techno? They still didn’t come back from the techno crunch yet. Is it really a good deal to buy Canadian banks? What do you think?

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I’m on board with buying the banks that are on the dividend aristocrat list. It would seem that they’ve worked very hard to get to that point, and it would be unlikely that they would want to throw such a designation away.

If I were buying, I would go with TD and RY; My perception of teh best customer service, and the biggest. Seems simple enough, and probably as good a selection tool as any.

I don’t quite understand what happens to the share value when a company issues more shares. For instance say Company Z has 10 shares at 10 bucks a piece putting the value at $100. They decide they need money so they issue 5 more shares at 10 bucks again, the current trading price. Are they now valued at $150 suddenly, or will the share price drop to $6.66 . . . or some combination of the two?

I suppose it depends on the company and situation, but am I following the math correctly? If it does damage the existing share holders, isn’t it nearly always a bad thing to issue new shares?

I’d also go with TD if I were to buy stocks.

But I am not a fan of bank stocks because I just don’t ‘get’ them. I am more into Tech stocks as it is the industry I work in and I am most familiar with them.

Generally, I just stick to index funds. 🙂 I hate guessing and I am OK with average returns.

Why specifically bank shares? Banking is the industry that basically caused, or at least is at the root, of all the problems we’re facing right now. Your friend is right in that if there are hidden disasters, they’ll be hiding for the bankers while disasters for the rest of us are not as hidden.

That said, banking is pretty much at the center of the economy. I think any share or index will return more than 1% over the next year or two.

Traciatim: The company is valued at $150. They were worth $100 before (had $100 in the bank let’s say) and they just sold 5 more shares at fair market price adding $50 to their bank account., so now they’re worth $150 over 15 shares = $10/share. It is a bit more complicated because the market price of a company reflects all the hopes and dreams and potentials of that company . If the extra $50 allows them to finally finish a product worth milliions, then maybe the share price will rocket up. But if the $50 was a last ditch to inject cash into an insolvent company so they can make payroll one more time then the price may tumble.

Shareholders definitely don’t like it when companies issue shares at below market because that reduces the value of everyone’s shares. Companies do this all the time by granting employees stock options and shares for free. Issuing shares at market price or higher is ok.

Companies issue shares to get cash. They can get extra cash from either getting a loan, or issuing shares and either one is as good as the other. The company just decides which is the least expensive for shareholders. For example, in the 5 new shares example above the company had to sell 1/3rd of the company for $50 so that means that all the future profits are diluted by 1/3rd; althogh you’de hope the $50 would generate profits too. Maybe a bank loan would be a cheaper way to get the $50, but usually no business can get a bank loan for half of their value without it being very expensive.

by: The Financial Blogger | December 22nd, 2008 (11:43 am)

Goal Hunter,
you also have to keep in mind that I am talking about Canadian banks which are less affected by the credit crunch than other banks. They are well capitalized and should declare profit next year as well.

True about that but they’ve had to revalue all their loan portfolios as well as obviously their investments. Brokerage assets and activity are down too. Banks are beaten at every front, but I don’t think any Canadian banks are at the tip of failure like many American banks were.

If they use this time to justify deep cuts in their labour then when the economy turns banks will be even better cash cows than they are now.

I can’t see how they can make money if they don’t want to lend it, other than more gouging at the branch level with more fees etc.

Ultimately, I plan on buying a bank stock but my feeling is to wait a bit – maybe 6 months or so??