Which Canadian Bank Could Raise Dividends the Most?

Ruth Saldanha: Canadian banks have continued to stay resilient through the COVID-19 pandemic. And now with the economy reopening, and vaccines leading to some hope for return to a pre-pandemic life. What does this mean for the big banks? Morningstar analyst Eric Compton is here today to share his thoughts. Eric, thank you so much for being here today.

Eric Compton: Thanks for having me.

Saldanha: As the summer progresses, and more restrictions lift in Canada, what is likely to be the impact on Canadian banks?

Compton: So long story short, we think the impact is going to be very positive. And when the economy does well, banks also do well. There were some worries in Canada, Canada got off to a bit of a slow start when it came to vaccinations, but they have caught up at this point. And, you know, based on some of the latest numbers I've been looking at, they've even surpassed the United States, for example, when it comes to vaccination rates. So we think, the vaccination story has caught up and even become a strong one in Canada, you're seeing some of the more stringent lockdown measures being lifted in Canada. You even saw the reopening of the Canadian border with the U.S. So we think that the economy is going to be coming back in a big way in Canada, that's going to be beneficial for the banks, it's going to be beneficial for things like credit cost, loan growth, fee growth, all of the above. So we think the economic outlook is very positive.

We also think, currently, you know, capital markets have been very strong for the banks, we think that's also going to continue with the resumption of activity, investment banking pipelines remain quite full. And kind of the final catalyst, you know, once you get a resumption of loan growth and a recovery in the economy and the labor market. Currently, the the Bank of Canada thinks they're going to be able to start raising rates potentially even as soon as the second half of 2022. So, we think its really kind of full steam ahead for Canada as the economy continues to reopen and recover. And all this is good for the Canadian banks.

Saldanha: Well, that's good news. Now, at the start of the pandemic restrictions on the banks led to a freeze on dividend increases, do you think that's likely to be removed now? What's your outlook on Canadian bank dividends going ahead?

Compton: Yeah, so you're correct. The the bank regulators, they did put a restriction on capital returns. So the banks have not been allowed to raise their dividends or to do share buybacks. Those restrictions currently remain in place. But you know, with the recovery underway, we do think it's only a matter of time before they are lifted. Right now I'd say it's probably pretty realistic to think that they might get lifted sometime in the second half of 2021, potentially towards the end of 2021. As the recovery gains steam, and as the regulators just become even more confident that things are going to be fine. The regulators in the U.S. have actually already lifted these restrictions. Everyone's heading in that direction. So we think it's just a matter of time in Canada before that happens. When it does happen with the earning strength of the Canadian banks, with just the fact that they haven't been able to raise dividends for a little bit, now, we do think it is realistic to expect an initial bump once the restrictions are lifted. So we think it is pretty realistic to see high-single-digit to low- to mid-double-digit percentage growth in dividends once the restrictions are lifted, in conjunction with some share buybacks.

We do think that for BMO, and Toronto-Dominion will probably be on the higher end of that range. BMO has seen a lot of strong earnings growth. Toronto-Dominion also we think has a little more room for some dividend growth. We think Scotiabank will probably be on the lower end of that range, more exposure to Latin America and their earnings growth hasn't been as strong. So we think bit less dividend growth from them. And the rest of the banks are probably somewhere in the middle.

Saldanha: So right now, what's your favourite Canadian bank pick and why?

Compton: Yeah, so we don't see a tonne of easy value among the Canadian banks at current valuations. We had a tonne of calls in 2020, but they've recovered quite well since then. So we think a lot of the easy money has been made at this point, and we do expect returns to be much more normal going forward. That said, there's always you know, relative value within the group. So we do like Scotiabank actually is kind of contrarian pick among the group. They have not done as well as far as earnings growth compared to peers. A lot of that comes down to the exposure to Latin America. So they just haven't done as well, the market doesn't love them quite as much right now and as a result, their multiples and just valuation is a little less demanding compared to peers. However, we do think eventually you'll see a recovery in these international markets. And so we do see, you know, there's a narrative for a potential catalyst for some of that story to turn around for them and drive some earnings growth in the future. So, right now, we think the valuation is less demanding than some peers. And there's a reason to believe that eventually, some of that growth might turn around in the future. So for those willing to wait for that, we think Scotiabank could make some sense.

Saldanha: Well, thank you so much for joining us today with your perspectives, Eric.

Compton: Thank you.

Saldanha: From Morningstar I'm Ruth Saldanha.