Canadian bank shareholders are green with envy.
It’s okay to admit it. After all, five big U.S. banks are increasing their dividends, and some are also planning to buy back their shares, moves that will handsomely reward their investors as the economy recovers from the pandemic.
Morgan Stanley, Goldman Sachs, JPMorgan Chase, Bank of America and Wells Fargo announced their capital deployment plans less than a week after the Federal Reserve confirmed that they and other lenders had passed their stress tests with distinction.
Investors in Canadian bank stocks are naturally suffering from a bit of FOMO (that’s fear of missing out, for those still not familiar with the acronym). Who doesn’t crave plumper quarterly payouts or yearn for the stock price increases that result from share repurchase plans?
Capital returns feel so good.
But instant gratification is often overrated when it comes to investing. So this is a friendly reminder to keep your FOMO in check for a bit longer. Good things come to those who wait.
Canada’s top banking regulator – Peter Routledge, who took the helm at the Office of the Superintendent of Financial Institutions (OSFI) on June 29 – is right to be cautious about lifting the current restrictions on dividend increases and share buybacks. Those constraints were implemented in March, 2020, in response to the pandemic, and removing them prematurely could spell disaster because the global crisis isn’t over yet.
As Mr. Routledge aptly explained to my colleague James Bradshaw during a recent interview: “It’s better to err on the side of keeping these restrictions on a bit too long than unwinding them a bit early.”
His conservative position is entirely appropriate.
Yes, COVID-19 case counts have fallen and vaccination rates are climbing in Canada. But the virulence of the Delta variant of the coronavirus means it’s simply too soon to rule out a fourth wave here.
Cases are rising in other parts of the world, including Indonesia, Russia and in a number of African countries. Moreover, officials in India are bracing for that country’s third wave of infections.
Aside from the potential for further lockdowns in Canada, there could be other economic setbacks once government emergency support programs come to an end. These factors could result in more soured loans for banks at a time when elevated debt levels already pose risks to the financial system.
We should be relieved that OSFI is playing it safe.
Take heart, investors. It’s not as if dividends from Canada’s big banks disappeared during the pandemic. Major lenders have continued to make their quarterly payouts – they just haven’t been allowed to increase them or buy back their shares.
Investors, however, are eager for those controls to end. From their perspective, Canada’s Big Six banks are brimming with excess capital.
Here’s why: On April 30, which marked the end of the industry’s fiscal second quarter, National Bank of Canada had the lowest Common Equity Tier 1 ratio of the group at 12.2 per cent and Toronto-Dominion Bank had the highest at 14.2 per cent.
Still, at least one analyst is offering investors a reality check.
“Given the banks vary in terms of size, risk profile, geography and business mix, we believe the ‘actual’ minimum OSFI requires for each bank will vary (details are not public),” Doug Young of Desjardins Securities Inc. wrote in a research note.
Still, investors are glomming on to a separate OSFI decision as an indirect signal that the end of its capital restrictions is nigh.
It plans to increase one of its key capital cushions for banks, the domestic stability buffer (DSB), to 2.5 per cent of risk-weighted assets starting Oct. 31.
The DSB, which the regulator likens to a rainy-day fund for major lenders, was lowered to its current level of 1 per cent during the pandemic’s first wave, as the industry prepared for the economic fallout.
Consequently, OSFI’s plan to increase it above its prepandemic level is considered a pivotal step toward the resumption of dividend increases and share buybacks.
Even before the DSB plan was announced in June, CEOs were already whetting the appetite of investors.
“When regulatory restrictions are lifted, we will look to accelerate capital return to our shareholders through a mix of share buybacks and higher dividends, given our payout ratio is at the bottom end of our 40- to 50-per-cent range,” Royal Bank of Canada chief executive Dave McKay said on a conference call in late May.
National Bank CEO Louis Vachon echoed at least some of that enthusiasm: “We should be in a good position to increase dividends, probably even quite substantially on a recurring basis, once we get the green light from regulators. On the buybacks, it will depend. I think we’re agnostic.”
Shareholders, though, would still do well to remember that patience is a virtue during uncertain times.
As they gaze longingly at the recent spate of share buyback and dividend announcements from U.S. banks, they should bear in mind that there’s conjecture those lenders will have a harder time replicating such moves next year.
Boring is once again sexy in banking. And Canadian banks, despite their foibles, know it’s hip to be square.
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