Growing cash piles at Canada’s big banks are raising expectations for substantial dividend increases when regulators give banks clearance to resume hikes.
How substantial? An early indication from Royal Bank of Canada suggests that the boost could be big – as in, nearly 30 per cent. At National Bank of Canada, the boost could be 17 per cent or more.
Canada’s Big Six have maintained their quarterly payouts during the pandemic, but haven’t been able to raise them. That’s because the main banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), imposed restrictions on the banks in March, 2020, when pandemic-related lockdowns began and the economy went into a tailspin.
OSFI wanted to ensure the banks had enough liquidity to keep lending and handle a potential wave of loan defaults if the economy continued to struggle. So, the banks couldn’t raise their quarterly dividends or buy back their own shares.
The good news for everyone: The economy is recovering, the lending taps are open and defaults (so far) have been less than expected.
The great news for investors: The cautious approach over the past year has left the banks holding enormous amounts of excess capital above what regulators require.
Some of this cash will likely flow to shareholders in the form of higher dividends when the pandemic subsides and OSFI gives the go-ahead. During the fiscal second-quarter reporting season this week, some bank executives dropped tantalizing hints about what these higher dividends could look like.
“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,” Dave McKay, RBC’s chief executive officer, said during a conference call with analysts on Thursday.
He added that various operational tailwinds “give us confidence in our core earnings and our ability to move that payout ratio back up to the top end of the range.”
The underlying numbers suggest dividend increases could be big. RBC has been paying a quarterly dividend of $1.08 a share, or $4.32 annually, throughout the pandemic. Analysts estimate, on average, that RBC will generate a profit of $11.20 a share in 2021. Comparing the current distribution to the estimated profit means that today’s payout ratio is under 40 per cent.
If RBC boosted the distribution to the top end of its payout ratio – or 50 per cent, as Mr. McKay suggested – the annualized distribution would rise to $5.60 a share if profit estimates rang true. That implies an increase of $1.28 a share, or nearly a 30-per-cent boost to the current dividend.
Under this hypothetical scenario, RBC’s dividend yield, which compares the annual distribution to the share price, would rise from 3.5 per cent to 4.5 per cent.
Other banks are in similar situations, given that excess cash is a sector-wide issue.
“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,” Louis Vachon, National Bank of Canada’s CEO, said during a call with analysts on Friday.
Though National Bank’s payout ratio is just 34 per cent right now, Mr. Vachon would like to raise the dividend to return the payout ratio to a range between 40 per cent and 50 per cent. Based on 2021 profit expectations, that implies a dividend increase of 49 cents a share on a current annualized distribution of $2.84 a share.
That’s a 17-per-cent boost to the dividend, and it only lifts the payout ratio to the low end of National Bank’s target range.
The question about when dividend hikes will resume remains open. But the question about what these hikes will look like is getting the answer investors should applaud.
Full disclosure: The author owns units of the BMO Equal Weight Banks Index ETF.
With a file from James Bradshaw
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