Regulators in Europe, the United Kingdom and Mexico may be forcing financial institutions to cut or suspend their dividends, but the same is unlikely to occur in Canada, according to analysts.
Keeping dividends intact is a matter of reputation for Canada’s Big Five, which hasn’t cut payouts since 1940.
Not even the financial crisis, which saw U.S. and European banks slash payouts across the board, made the Big Five waver.
The reliable stream of income, not the stock performance, is why investors hold the group in such high regard.
“The Big Five has such a long history of not cutting their dividends,” said Cormark Securities analyst Meny Grauman. “There’s an investor premium earned as a result of that huge amount of time, safety and security of the dividend. You’d rather keep that intact and go raise equity at less than preferable terms.”
The global economic shutdown brought upon by the COVID-19 pandemic has once again put the Canadian financial sector under pressure. It may not be facing an existential crisis as the U.S. banks did in 2008, but it’s certainly in a crunch due to its connections to our hard-hit energy and real estate sectors and the escalation of loan losses. Prior to a recent market-wide rally, the S&P/TSX Banks Index had dropped 37 per cent from its high in February.
At the same time as they are trying to circumvent these challenges, the Big Five are being relied upon by both the federal government and Canadians to act as a release valve and offer relief on mortgages, loans for small businesses and credit card interest rates.
What the Big Five has going their way is that dividend ratios, the percentage of earnings paid to shareholders, have not yet climbed above 100 per cent — a level only reached twice in the past, according to BMO analyst Sohrab Movahedi. Only National Bank of Canada, the sixth-largest bank in the country, was forced to issue a cut in 1993 when ratios hit 119 per cent, RBC Capital Markets analyst Darko Mihelic wrote in a report last week.
You’d rather keep (the earned investor premium) intact and go raise equity at less than preferable terms
Meny Grauman, analyst, Cormark Securities
More crucially, the banks have a better relationship with their regulator in the Office of the Superintendent of Financial Institutions. OSFI has already warned the banks away from participating in share buyback programs and raising dividends, but has allowed them to continue dividend payouts going forward.
OSFI has the power to step in should the banks allow their capital ratios to sink below a certain threshold. Eight Capital analyst Steve Theriault said a bank’s common equity Tier 1 ratio, a measure that determines its ability to handle unexpected losses, would have to slip under nine per cent for OSFI to get involved and potentially force a cut.
“If you get to a CET1 ratio below nine per cent,” Theriault said, “you start to get into that category where you need to come up with a plan with OSFI right away on how you’re going to get back to where you need to be, which would involve asset sales, equity raises and insuring mortgage portfolios to reduce risk-laden assets.”
The good news, he said, is that none of the Big Five are close to sinking below that level and are comfortably sitting in the 11 to 12 per cent range. The European banks did not have this luxury, Theriault said. Thanks to their dividends cuts during the financial crisis, they don’t have the reputation either.
It’s because of its long history of maintaining dividends under extreme pressure that the Big Five have become crucial pieces in a Canadian investor’s portfolio, according to Movahedi and Mihelic, who both see a cut as being unlikely.
Movahedi wrote that 90 per cent of the banks’ shares are owned by Canadians. About 40 to 50 per cent are retail investors, Mihelic said.
Issuing a cut at this time, Grauman added, would only add further pain to Canadian households and pensioners, convincing him that there’s a “100 per cent probability” that the dividends are safe.
“But then again if you told me we’d be in a situation where the entire world is locked in their homes and the economy is stopped, I would’ve said that probably can’t happen either,” Grauman said.