Canadian Banks Should Follow Dividend Cut Trend

Includes: BMO, BNS, WFC
by: Wellington Financial

I know that some of you are more keen that others on this stuff (see prior representative post “Deja Vu with a Cobalt hue” December 15-08). Here is a Tweet I did on Twitter on February 23rd:

“If Bank of Montreal (NYSE:BMO) and Bank of Nova Scotia (NYSE:BNS) dividends get cut in half (which I don’t expect) they’ll still be yielding 6% and 4% respectively. Still higher than last yr!”

And this from a column in the DTM on March 7th:

“Plus, even if all of Canada’s Big Banks did cut their dividends in half, their dividend yields would merely fall back to where they were in mid-2008….”

In the wake of the dividend cut at Wells Fargo (NYSE:WFC) I’ve been thinking about what would happen to Canadian bank or insurance stocks if they were to follow the same course of action.

For all of the focus on high dividend rates at Bank of Montreal and ScotiaBank, Manulife is yielding 10.2% while SunLife is at 8.9%.

You have to wonder if high payout ratios are going to become a competitive disadvantage for the Canadian financial services industry. According to a Bloomberg story, Wells Fargo and the rest of the Big 5 American banks that received TARP funds were pressured by regulators to cut their dividends. Whether it be for optics or life preservation reasons, it makes sense in hindsight.

Rationale for a cut

Do Canadian Banks and Life co's need to pay 7%, 8%, 9% or 10% dividends to keep us hanging around? With bank preferred shares being issued at higher than 5% yield these days, you might suggest that the common shareholders deserve more than that given their capital structure ranking… But since prefs have always paid a bit higher yield than commons and don’t provide any real opportunity for capital appreciation that argument doesn’t hold water.

The question of a dividend cut in Canada is all about message management. What’s the rationale, can you get that point across to the marketplace, and will they believe it?

Solvency? Lowering the cost of capital at the bank? Removing the need to issue more common/pref equity or Tier 2 capital for the rest of the year? The regulator made us do it?

I’m not sure that financial services shareholders NEED a high payout to hold the various shares. The flipside is that many of these securities are held by retired people who live off the income. Not a percentage but the actual cash payout; the fact that bank dividends have been raised for years (well ahead of inflation) removes some guilt here.

Who should do it

If you are nervous about the chance of a depression, you might actually want the banks and life co's to keep their free cash flow to themselves to hopefully ensure they stay in business. As much as “higher is better” as Wardo used to say about i-banking bonuses, the time has come for Finance Minister Jim Flaherty, Bank of Canada Governor Mark Carney or OFSI Head Julie Dickson to send up a trial balloon about dividend cuts being a good idea. Portray it not as a solvency issue but one of competitive disadvantage; if other global banks are paying out dividends of 1% or less, Canadian banks would be ill-advised to be as off-market as they currently are.

For my money I’d choose the OFSI Head for the role: This shouldn’t become a political issue, but CEOs of the big 7 financial institutions are in a terrible “Prisoners’ Dilemma” situation right now. No one wants to be the first. Our regulators should take the lid off the kettle and let some of this pent up steam blow off.

Things aren’t getting any better in the world economy. The health of our financial system has helped us avoid some of the pain they are experiencing in the USA. Let’s preserve what’s working.

The time has come to give the backbone of our economy some political cover and call for a reduction in dividends.

Disclosure: We own BMO, BNS and TD in our household.