Canadian Banks Benefit From Market Turmoil

The world’s soundest banking system has rarely been so undervalued by investors. As of Oct. 31, the average dividend yield on the Big Five Canadian banks stood at 5.2%, way above the 3.7% yield on 10-year Canadian government bonds. It’s not often bank dividend yields exceed the 10-year government bond yield by such a wide margin.

But with the tsunami of a global commodity bust and severe U.S. recession headed their way, Canadian bank stocks might get knocked down even deeper into bargain territory. Cheaper share prices and richer yields may be the likely consequence of higher loan-loss provisions, slower growth in loan volumes, and declines in market-sensitive business.

An Oct. 31 update on the banking sector by eResearch projects loan-loss provisions for fiscal 2009 of $9.6 billion, double the estimated level for fiscal 2008 (versus a previously projected 30% increase by eResearch). Business-loan losses will contribute nearly half of the jump, while consumer and credit-card loan losses will contribute the other half.

Loan volume growth in Canada was revised down to 2% to 5% for fiscal 2009, compared to “three year annual growth rates of 10% for mortgage and consumer loans and 15% for credit card loans.” The report is also factoring in a 15% decline in revenues from the “market-sensitive” business lines of investment banking, retail brokerage, and trading commissions (which have risen from 19% of total revenues in 2002 to 25% in 2008).

So are the dividends safe? “Yes!” exclaims the eResearch report. Dividend payout ratios currently average 45.8%. The declines in earnings per share projected to fiscal 2009 should raise the average payout ratio to 52%.

While there likely will not be any dividend cuts, there likely won’t be any dividend hikes either in 2009. The average payout ratio of 52% for fiscal 2008 is slightly above the upper boundary for the banks’ payout targets. Royal Bank and TD will still be inside their target range, and so may still have room to increase dividends. Bank of Montreal, with a projected payout ratio of 67% in fiscal 2009, is least likely.

The decline in the Canadian dollar will help offset some of the impact of the commodity bust and U.S. recession, especially for Royal Bank, TD Bank, and Bank of Nova Scotia (because of their foreign operations). Canadian banks also appear to be benefiting from the financial crisis by winning deposits and accounts as clients flee U.S. banks.

The investor’s strategy may be to establish or raise a position in stages, looking for opportunities to buy on the dips when bad news hits share prices. There is a good chance by the end of 2009 that an investor could have four or five of the banks in their portfolio with an average dividend yield geater than 6% – and poised to resume growth at the banks’ historic average rate of 5% to 7% per year.

Bank dividend yields (Oct. 31) 

Royal Bank (RY) 4.3%

TD Bank (TD) 4.1%

Bank of Nova Scotia (BNS) 4.8%

Bank of Montreal (BMO) 6.5%

CIBC 6.3%

Comments

[BILLYGOAT:]

Well it's nice to see banks willing to give so much money back,from all the money they ripped the people off for in the first place,how quaint
the sooner people learn banks are banksters are evil....the sooner this world could start getting it's shit together. use banks only to cash your checques ,and don't use wall street .Can people not see what's going on???

2008 Nov 01 01:36 PM

[bigtime99:]

Banks are evil?
So the system that raised America's standard of living by 7 fold in relative terms over the 20th century (according to Warren Buffett) is evil?
And the warm fuzzy alternative is?

2008 Nov 01 06:48 PM

[Urbane Gori...:]

I go along with BILLYGOAT.. My most despised bank is Bank of America... What dogs!

jegan

2008 Nov 01 07:20 PM

[PeakOiler:]

Take this to the 'bank' : the banks have more turmoil coming, as do most other stocks. When folks open their statements for October (worst month in history for some indexes), they gonna say: "Get me out!" And sell they will, only to regret it a few months later. The other big negative for the next 6 weeks or so is tax loss selling. Selling pressure is going to be heavy. Ain't gonna be any reason to buy until December 15th, the day I'm predicting will be the start of a 50% rally.

Don't be a sucker here, postpone your buying until mid December, after which we will have the mother of all rallies because -------- all the selling will be done at that time and markets will have nowhere to go but up, in the absence of selling. Please, please wait.

2008 Nov 01 07:55 PM

[Brad Ferris:]

Nice to see you as a contributor on here Larry. Keep up the good work on providing meaningful content on CDN investments.

2008 Nov 01 08:31 PM

[OctoberFaith:]

you should read the nation of debter's article. it's written right back to you.
; )

2008 Nov 02 12:03 AM

[MaxRoul:]

The real vote of confidence on the state of Canadian banks was the other banks of the world, the ones that set the LIBOR, not the IMF or any other shill. Canadian banks where froze out same as every other bank, none wanted to lend them money. Banks make money lending money, if there was a bank or a country full of banks that was/is in good shape, the rest of the system would have been falling over themselves trying to get them money. That didn't happen and is not happing.

Keep your head up and your stick on the ice.

2008 Nov 02 01:59 PM