A Liberal Party campaign pledge to raise taxes on large banks and insurers is weighing on the share prices of large financial institutions and creating uncertainty for investors expecting a windfall from bumper profits the sector has earned so far this year.
Shareholders have been waiting for the banking regulator to lift temporary restrictions on dividend increases and stock buybacks. But if the Liberals are re-elected, their promised tax hikes could eat into the excess cash banks have to dole out to investors.
The share prices of many of Canada’s major banks and insurance companies have fallen between 2 per cent and 4 per cent since Aug. 25, when the Liberals pledged that if they are returned to government, they will increase corporate tax rates on the largest banks and insurers and collect a special fee from financial institutions that have a pretax income of more than $1-billion. The broader stock market has risen by 1 per cent over the same period.
The retreat clipped what has otherwise been a strong run for bank stocks. Before the Liberals unveiled their proposals, shares in the six biggest banks had gained 21 per cent to 43 per cent so far in 2021, according to S&P Global Market Intelligence.
A lack of clarity about how the Liberals would carry out the promise has fed into a wider sense of uncertainty about whether banks will face a tougher regulatory environment no matter which party wins the Sept. 20 election.
Other parties have also targeted Corporate Canada. The Conservatives have promised to get tougher on large companies by closing tax loopholes and ordering the Competition Bureau investigate bank fees, while the NDP has pledged to raise corporate taxes across the board and add a temporary tax on excess profits generated because of the COVID-19 pandemic.
The Liberals have also pledged to require banks to reduce fees such as the ones they charge merchants on credit-card transactions.
Scotia Capital Inc. analyst Meny Grauman wrote in a note to clients in late August that “regulatory risk is rising for the banks, and remains the most significant risk to bank shares after COVID.” The Liberal proposals “brought this topic to the front pages,” he added, “but we view it as a broader issue.”
The Liberals expect their promised policy would raise about $2.5-billion a year over the next four years, divided fairly evenly between the increased tax rate, which would be permanent, and the temporary fee, which they call the “Canada recovery dividend.”
“We believe that this is a significant negative development for the earnings outlook of the Canadian banks and insurance companies,” Barclays analyst John Aiken said in a note to clients the day of the Liberal announcement.
The Liberals say their Canada recovery dividend would raise $1.3-billion to $1.5-billion annually for four years, but the platform does not explain how as details would have to be hammered out with Canada’s banking regulator. A Liberal official confirmed the party has not yet decided how to determine each financial institution’s share – or whether it would be measured against earnings, revenue, capital or another financial metric. The Globe is not naming the official because they were not authorized to speak publicly about the proposal.
With few details to guide them, investors and analysts are trying to estimate the potential impact to shareholder payouts if billions of dollars in bank profits could be diverted to the coffers of a re-elected Liberal government.
Earnings reported by Canada’s banks have more than recovered from lows reached earlier in the pandemic, with pretax income hitting $70-billion in the past 12 months through July 31, up 47 per cent from the depressed 12 months the year before. Earnings initially fell as banks set aside billions of dollars in reserves to cover potential loan losses that have largely not occurred. Now, most banks have released about 40 per cent of those provisions, boosting their quarterly profits.
So far, not much of that good fortune has gone to banks’ shareholders because of a moratorium on dividend increases and share buybacks the Office of the Superintendent of Financial Institutions (OSFI) imposed in March, 2020. Analysts expect the regulator could lift that restriction as soon as October, as banks close the fiscal year. Some banks have said that they would likely respond with larger, catch-up dividend increases to return to their typical payout ratios, and resume spending hundreds of millions of dollars buying back shares on the public markets.
If the Liberals are re-elected and proceed with their tax plan, however, an estimated $10.8-billion of banks’ excess cash could be claimed by the government. The Liberals propose permanently raising the corporate income tax rate from 15 per cent to 18 per cent on the portion of bank and insurance-company earnings over $1-billion. That would raise $5.3-billion over four years, according to an estimate reviewed by the Parliamentary Budget Officer.
The balance rests on the recovery dividend, which would raise a projected $1.3-billion in each of its first two years, and $1.5-billion by its fourth and final year, adding a further $5.5-billion to government revenues by 2025-26.
If implemented, the higher tax rate would apply only to corporate income earned in Canada. All of the country’s six largest banks – Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, Bank of Montreal, Canadian Imperial Bank of Commerce and National Bank of Canada – would be subject to the higher tax because they earn far more than $1-billion in Canadian profits each year.
Manulife Financial Inc., Sun Life Financial Inc. and Great-West Life Insurance Co. would likely be subject to the added tax, while Intact Financial Corp. and iA Financial Group might also qualify. Canada’s insurance holding companies often have multiple insurance subsidiaries and it is still unclear whether the Liberal proposal would be applied at the parent-company level, which would collect more taxes.
For example, iA Financial spokesman Pierre Picard said the company believes, in the absence of detailed legislation, that “the proposal would not affect our business at this time,” because the profits of each of its insurance companies are below $1-billion. Investors, however, have sent iA shares down 2.9 per cent since Aug. 25.
National Bank analyst Gabriel Dechaine used 2019 Canadian earnings – the last full year before COVID-19, to represent a normal year of profits – to estimate the potential impact to future profits. He found the corporate tax increase alone would, on average, reduce major banks’ earnings per share (EPS) by about 2 per cent. (The impact on the insurers was negligible, with EPS dropping by less than one-half of one per cent for the four insurers he examined.)
Based on 2019 profit levels, Mr. Dechaine estimates RBC would have the largest increase to its tax bill, at $437-million, or 2.7 per cent of total earnings, if the Liberal proposal becomes policy. TD and Scotiabank would each pay an extra $200-million or more in taxes, while CIBC and BMO would pay at least $100-million more, and National Bank would owe about $68-million extra, according to Mr. Dechaine’s estimates.
Those figures do not account for the recovery dividend, which would more than double the financial impact, potentially reducing big banks’ total earnings by 4 per cent to 5 per cent relative to prepandemic levels.
Liberal officials say the party’s tax-and-dividend election promise is modest given the banks’ strong financial performance through the crisis. Increased profits, however, are what drive regular dividend increases as investors anxiously await their turn to share in the banks’ recent earnings boom.
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