Making sense of the markets this week: July 12

The big banks are more diversified and less exposed to traditional credit risk compared to 25 years ago. 

Since 1957, Canadian bank returns were positive in about 73% of the years and have outperformed the TSX index in approximately 67% of the years. 

Most of the banks’ outperformance versus the index comes in September, October and November. 

Dividend payout ratios have been in the range of 40% to 50% of earnings in recent “normal” years. Dividend growth was very strong from 2000 to 2007, with a growth rate of 15% per year on average, but dividend increases were rare from 2008 to 2010. All of the eight publicly traded banks resumed dividend increases at the end of the 2008–2009 recession. In March 2020, OSFI announced dividend increases and share buybacks to be halted for Canadian banks for the time being. 

Which begs the question: are the banks’ beloved dividends safe? 

The RBC report’s authors see payout ratios rising to the range of 49% to 68%, noting that, “Overall, we believe the large Canadian banks’ dividend sustainability is high.” They expect no dividend growth, even in 2021. That said, there is sense that the dividends will be maintained through the crisis. It suggests that banks would raise equity instead of cutting their dividends. 

TD and BMO have higher vulnerability on loans due to COVID, followed by Scotiabank. RBC and CIBC have held up the best in the recent decline. 

Canadian banks have underperformed the market since February of 2020. But we know the long term history of the outperformance of the big banks vs. “the market.” Could be an opportunity? 

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