Will Canada’s Big Banks Cut Their Dividends?

Canadian dividend stocks are under substantial pressure to cut dividends with even the big six banks particularly vulnerable.

office buildings

Image source: Getty Images

Canadian dividend stocks are under considerable pressure to cut their dividends. In a shock announcement, Dividend Aristocrat Suncor slashed its dividend by a whopping 55% after reporting a devastating $3.5 billion loss. Many banks, retailers, REITs and oil stocks were under considerable financial pressure before the pandemic.

Poor 2020 earnings and weak economic data indicates that the worst is far from over. To shield themselves from the pandemic and ensuing economic fallout, companies are cutting costs in a desperate attempt to preserve their financial position. This indicates that the dividend carnage isn’t over.

Weaker economy

Dividends paid by many Canadian companies are unsustainable if the economy worsens. April 2020 job numbers, which were the poorest of modern times, caused unemployment to spike to a worrying 13%.

Canada’s first quarter 2020 gross domestic product (GDP) shrank 2.6%. Canada’s economy is expected to contract by 6.2% for 2020.

Ottawa’s economic stimulus has done little invigorate growth. The shuttering of non-essential businesses, closure of entertainment venues, social distancing, travel bans and restrictions are weighing on the economy, applying significant pressure to corporate earnings.

Declining corporate earnings

While oil stocks will be responsible for a large portion of the dividend cuts, Canada’s banks could be next. U.S. first-quarter bank earnings were poor. Profits fell by half or more compared to a year earlier and this occurred before the full economic impact from the coronavirus was felt.

Because of their crucial role in providing credit and other financial services, banks are an economic barometer, rendering them particularly vulnerable to economic downturns, which means that any economic slumps hit their earnings hard.

The worsening economic outlook for Canada indicates considerable pain ahead for the big banks. A sharp deterioration in earnings may force them to cut or even suspend dividends, despite claims that bank dividends are rock-solid.

The problem isn’t limited to declining earnings, but also the growing likelihood a Canadian housing bust.

Deteriorating credit quality

Canada’s heavily levered households, which are among some of the world’s most indebted, are especially exposed to external economic shocks. This will be responsible for a marked uptick in loan defaults, delinquencies and credit losses, further impacting earnings and bank balance sheets.

A forecast sharp decline in credit quality was responsible for U.S. and Australian banks boosting the cash held on their balance sheets. No one wants a repeat of the 2007 financial crisis, when many commercial banks nearly collapsed because of an unprecedented spike in loan losses and a lack of provisions as well as cash.

Major banks, especially those deemed too big to fail, started hoarding cash to build a coronavirus buffer. In response to the anticipated economic fallout two of Australia’s big four banks, ANZ and Westpac suspended dividends and NAB cut its payment by 64%.

While Australia’s banks historically had high dividend payout ratios compared to Canada’s banks, it doesn’t make the big six immune. They currently have payout ratios of around 50%, the lowest being National Bank of Canada’s 42% and Bank of Nova Scotia’s 52% the highest compared to over 80% for Australia’s big banks pre-coronavirus.

It would take a greater than 50% decline in bank earnings to force a dividend cut. While such a large fall is unthinkable, it could happen. A perfect storm of sharply weaker housing prices, growing loan defaults and a marked drop in earnings is feasible.

The banking regulator and policy makers will exert pressure on banks to retain sufficient capital to absorb growing loan losses so as to ensure the stability of the financial system.

The most vulnerable bank

Dividend cuts by the big banks appear unlikely but they could happen as Canada’s economy worsens and credit quality heads south. The most vulnerable are Scotiabank and Canadian Imperial Bank of Commerce because they have the highest payout ratios of 52% and 51%, respectively.

Scotiabank faces a sharp deterioration of earnings on two fronts, Canada and Latin America. Its rapid expansion into Mexico, Colombia, Peru and Chile sees international banking responsible for over 42% of Scotiabank’s net income. Latin American will be one regional economy most sharply impacted by the pandemic.

For these reasons, Canadian bank investors should brace for the possibility of dividend cuts.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Matt Smith has no position in any of the stocks mentioned. The Motley Fool recommends BANK OF NOVA SCOTIA.

More on Dividend Stocks

Dividend Stocks

2023 TFSA Contribution Time: 2 Dividend Stocks to Buy With $6,500

Buy these two great dividend stocks in your TFSA as a part of a diversified portfolio if you haven't already.

Read more »

Construction work on a site
Dividend Stocks

Canadian Infrastructure Stocks: Building the Future and Your Wealth

These two Canadian infrastructure stocks are highly defensive and offer excellent long-term potential, making them ideal for this uncertain market.

Read more »

Dividend Stocks

Dividend Investors: Top Canadian Utility Stocks for June 2023

These three top utility stocks could be excellent buys for income-seeking investors.

Read more »

A tractor harvests lentils.
Dividend Stocks

Why Nutrien Stock Is Still a Great Buy on the TSX Today

Nutrien (TSX:NTR) stock has gone through major ups and downs thanks to outside influences, but its bottom line remains incredibly…

Read more »

Businessperson's Hand Putting Coin In Piggybank
Dividend Stocks

Build Your Retirement Fortune With These Top TFSA Stocks

Here are two top Canadian dividend stocks you can add to your TFSA to build wealth for retirement.

Read more »

Path to retirement
Dividend Stocks

Invest in These Stocks for a Worry-free Retirement Income Stream

Are you looking for an income stream that can pay you throughout your retirement? Then invest a portion of your…

Read more »

Dividend Stocks

Is BCE Stock Still a Top Telecom Investment in Canada?

Canada’s telecoms can provide growth and income in a defensive shell. Let’s see if BCE is still a top telecom…

Read more »

Dollar symbol and Canadian flag on keyboard
Dividend Stocks

2 Canadian Dividend Stocks I’ll Be Buying Hand Over Fist in June 2023

These two beaten-down Canadian dividend stocks could help you earn handsome returns on your investment in the long term if…

Read more »