Canadian Banks: Don’t Invest for Yield Alone

Canadian bank stocks have become extremely tempting with dividend yields at levels that I cant remember. Bank of Montreal had a yield of over 11% yesterday while other banks are yielding in the 7% – 8.5% range.

On the surface, those looking for yield will choose Bank of Montreal. The next question one should ask after looking solely at yield is how safe the dividend is in the future.

Rob Sedran, Bank Analyst at National Bank Financial, discussed the outlook of the Canadian banks on a conference call today. He believes that the dividends are safe for now on all of the banks without any guarantees.

That being said, the dividend payout ratio should be looked at closely to determine how safe a particular companies dividend may be. We can just look at income trusts and how distributions get cut when cash flow or net earnings drop.

Bank of Montreal’s dividend is the highest but their payout ratio is also the highest as 75% of their net earnings right now go to pay dividends on their common shares. This leaves 25% of earnings to grow the business which is not a great use of capital in the long-term.

The other major banks have payout ratios in the 40% – 59% range of forecasted 2009 earnings giving them a greater cushion to maintain their dividend that will allow them to increase their dividends quicker when things turnaround.

What are your thoughts on the Canadian banks? Will they cut their common share dividends or will they maintain them going forward?

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One Response

  1. I don’t completely agree. Each of the CDN banks have had payout ratios in the 75-90% range (or higher) more than a few times over the past 25 years (look to 1985-1995). The question becomes will earnings be depressed for more than a few quarters as they aggressively take reserves for losses?

    These banks are still well capitalized with Tier 1 ratios above 10%. They’re not lending out that capital as freely as before so what else are they going to do with all that cash? The extent of toxic assets in CDN banks is no where near their global peers. Yes loan losses will increase, but that’s why they took (and continue to take) additional loss provisions each quarter.

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