What Makes a Moat for Canadian Banks

Dan Werner: Recently, we published our framework for assessing bank moats in which we increased the moats on Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), and Bank of Nova Scotia (NA) to wide from narrow due to their local market positions and expected excess returns over the long term.

The Canadian banks have long been known for their stability, diverse revenue streams, and strong returns on equity over time. While they all have traditional, personal, and commercial banking businesses, each bank has its own niche in the overall banking landscape, both in Canada and abroad.

For Royal Bank of Canada, it has generated significant revenue over the last couple of years in capital markets, with trading revenue up as well as equity underwriting and debt underwriting with low interest rates and stronger equity markets.

Toronto-Dominion Bank has a strong retail-banking presence in Canada and in the U.S., while Scotia Bank has a stronger international personal- and commercial-banking business, which makes up a third of its profitability, primarily in Latin America and Asia.

Bank of Montreal has a U.S. presence in the Midwest focused on asset management--both in the U.S. and Canada--while [Canadian Imperial Bank of Commerce (CM)] has a strong Canadian retail-banking segment with an eye to grow most of its fee businesses. On the other hand, National Bank of Canada (NA) already has strong fee businesses, both in capital markets and wealth management.

While home pricing has been under pressure in the oil-producing provinces, we are still concerned about housing-price levels overall relative to incomes and rent, especially in Toronto and Vancouver. However, at this point, there is little to indicate that pricing will decline in the near term, given the lack of catalysts.

Our favorite name is wide-moat Toronto-Dominion Bank, which is trading at an 18% discount to our fair value estimate. Given the growing strength of the U.S. consumer, we believe this will have a positive impact on TD's growing franchise in the dense U.S. markets in the Northeast.