Canadian banks can officially resume dividend increases and share buybacks after the country’s financial regulator lifted a moratorium put in place last year. Anthony Okolie speaks with Monica Yeung, Global Financials Analyst, TD Asset Management, about how lenders are likely to react.
First of all, a long awaited announcement, very positive development for the Canadian banks. At a high level I think it really reinforces the idea that the Canadian banking system is strong, resilient and OSFI made it very clear that now was the time to lift these restrictions. They pointed to three key reasons. Firstly, Canadian banks have weathered the storm, remained quite resilient through the COVID pandemic. Secondly, capital levels have remained very strong over the last 18 months, and finally, they were confident that bank management teams and boards of directors would act responsibly in making capital distribution decisions. Now, as you'll know, the Canadian banks did lag global peers, U.S. peers, in terms of this capital decision around lifting restrictions. The Fed lifted those restrictions in June of this year. I think part of the reason why OSFI waited so long is our tradition of being a very conservative and prudent regulator that speaks to the strength of our financial system. It speaks to why Canadian banks have done so well through financial crises in the past and really is part of the reason why I think they waited until now to make that decision.
OK, so now that they have the green light, how are banks likely to deploy their massive stockpiles of excess cash?
First thing that comes to mind are dividend increases. So Canadian banks have not had the ability to raise their dividends for more than two years. And I think it's reasonable to expect that we'll see sizable catch up dividend bump sometime in the next few weeks or months. To give you some context around that. Canadian banks typically target dividend payout ratio between 40 to 50% of their earnings. If we use that as a guidepost. Our expectation is that on average, the Canadian banks can raise their dividends in the mid-teens, high-teens, upwards of 15%. And two key winners that I'd really point out here National Bank, BMO. We expect that they could raise their dividend upwards of 25%, even 30% in one fell swoop.
OK, now, when the Fed lifted restrictions on the US financial institutions back in June, some banks announced some big stock buybacks. Do you expect the same thing to happen here?
I do expect buybacks to be a bigger part of bank capital allocation strategies going forward. Pre-COVID, in a typical year, Canadian banks might buy back 1%, 1.5% of their shares outstanding. What's different now is that Canadian banks are sitting on large piles of excess capital. To put some numbers around that, in aggregate, the Canadian banks hold about 60 billion dollars of capital over and above regulatory minimums. That amounts to 8% of their market cap. So very reasonable, in my view, that we could see some banks come up with announcements with buybacks, maybe 3%, 4%, 5%, 6% of their shares outstanding. Something more akin to what we've seen in the U.S., so definitely watch out for some announcements on that end.
Bank stocks have had an incredible run year to date of up about 30% in Canada. Does this sector still have a long way left to run?
I often liken banks to a coiled spring. They're very leveraged to the economic recovery, and all of that upside will really come to head in my view next year as we see upside from loan growth really come through the system, also upside in terms of higher rates. And so banks really stand to benefit from that angle. What I would say is, in terms of the thesis for community banks, really, if it was kind of a two act play, we're somewhere in the intermission right now, looking forward to the second half. What's really helped year-to-date has been the credit story, with banks really beating on credit, releasing loan loss reserves. And I think what's going to help going forward is seeing loan values come back and then also higher net interest margin. So net-net, taking that into account, with valuations trading around 10, 11 times over P/E at the low end of their historical range really keeps us positive, constructive on the Canadian bank sector.
Monica, thank you very much for joining us.
Thanks for having me.