Friday, February 13, 2009

Bank Dividend Cuts Unlikely, but Risk Remains

Financial Post, Jonathan Ratner, 13 February 2009

Nobody wants to say it will happen, because it probably won’t. But given what we’ve seen in the U.S. banking sector and elsewhere in the world, the prospect of dividend cuts for Canadian banks continue to weigh on investors minds as the economic uncertainty persists.

Plunging share prices have pushed dividend yields for Canadian bank stocks to their highest level in 24 years. At 6.8%, the last time they were this high was in June 1984, when yields climbed to 7.0%. However, bond yields were 13.8% back then, versus just 2.9% today.

So while the Big 5 Canadian banks have not made a dividend cut since World War II in 1942 and before that the Great Depression in the 1930s, climbing yields have looking at what might force them to make such reductions.

UBS analyst Peter Rozenberg continues to project surplus capital generation even with peak provisions for credit losses (PCLs). However, he thinks an extended period of very low earnings or unexpected government intervention could have a negative impact on dividends.

A weaker economy could push PCLs higher than expected. Assuming they climb to a similar level to the 1992 peak, which Mr. Rozenberg does not expect, profits could decline an estimated 27% to 33%. This would result in “moderately high” dividend payouts of 76% versus 52% currently. Banks target a range of 40% to 50%.

However, the analyst said historically low corporate leverage, average consumer debt service and lower exposure for both the sector and individual names, make peak PCLs unlikely.

Current dividend payouts combined with a 10.1% Tier 1 capital ratio suggest lower dividends are not on the horizon, Mr. Rozenberg told clients. However, higher potential payouts mean the risk remains.

He suggested that Toronto-Dominion Bank appears to be least vulnerable to a dividend cut and Bank of Montreal the most at risk. Meanwhile, Mr. Rozenberg does not anticipate any dividend increases in fiscal 2009.

“Concerns regarding higher PCLs and implied equity dilution continue to weigh on global sector valuations,” the analyst said. ”However, we think valuations reflect peak PCLs and we continue to expect Canadian banks to outperform.”
The Globe and Mail, David Parkinson, 13 February 2009

The rich dividends at Canada's big banks look safe, but further substantial erosion in the banks' earnings base would put those dividends at risk this year, UBS Securities Canada Inc. said Friday.

In a new report, UBS banks analyst Peter Rozenberg noted that the banks' current dividends represent a ratio of 52 per cent of forecast fiscal 2009 net income – not far off the banks' typical payout targets of 40 to 50 per cent. But he said the threat of rising loan-loss provisions could drive earnings below current projections, which would raise those payout ratios well above the banks' comfort levels and potentially convince some of them to trim their dividends.

For example, if earnings were to come in 10 per cent below current forecasts, the payout ratio for the major banks would rise to 59 per cent. At a 20-per-cent earnings reduction, the ratio would be 66 per cent; at a 30-per-cent earnings decline, the ratio would jump to 76 per cent.

He said, though, that even this might not be enough to trigger dividend cuts, if they considered the rising ratios to be a short-term phenomenon.

"While this would be outside of the banks' targeted range … management would likely consider its dividend policy and capital requirements over the medium term.”

Most at risk, Mr. Rozenberg said, is Bank of Montreal, whose payout ratio already stands at 68 per cent based on the current consensus fiscal 2009 earnings forecast. If earnings came in at 30 per cent below that forecast, BMO would be looking at a dangerously high payout ratio of 97 per cent.

The bank least at risk, he said, is Toronto-Dominion Bank, whose payout ratio would still only be 65 per cent even with a 30-per-cent drop in projected profits.

But even if you take seriously the risk of a 30-per-cent undershoot of profits, it doesn't necessarily follow that you should sell Canadian bank stocks. Mr. Rozenberg noted that at current stock prices, the market has essentially already priced in such an earnings erosion this year. And he considers that such a decline would represent loan-loss-provision peaks that he considers “unlikely.”