Traditional safe havens can disappoint


Savvy investors look for safe places for their money in uncertain times.

Canadians consider large companies that pay generous dividends as reliable and safe.

Are traditional safe-haven investments likely to perform well this time?

Some Canadian companies have paid dividends continuously for more than one hundred years.

Bank of Montreal paid dividends since 1829, Bank of Nova Scotia since 1832, Toronto Dominion Bank since 1857 and Royal Bank since 1870. BCE has paid since 1881 and Imperial Oil since 1891.

Taking the largest bank, Royal Bank, as an example, its shares peaked at $109 in February and bottomed at $72 on Monday with an expected dividend of 6 percent.

Since banks have paid dividends for at least 150 years, can we count on them as investments in these uncertain times?

In a Globe & Mail column titled “Amid dividend cuts, income investors can still find safety”, John Heinzl opines that Canadian banks are “unlikely to cut their dividends given their strong capital levels, although the relative safety of their dividends should be balanced against the possibility that the bank stock prices could fall further if the pandemic worsens.”

The article quotes an RBC Dominion Securities bank analyst, Darko Mihelic, saying “dividend reductions are “very unlikely,” given the banks’ financial strength.”

This analyst says that Canadian banks enjoy a Common Equity Tier 1 (CET1) capital ratio of 11.5 percent, above the minimum. “This indicates that the banks are in a strong position to absorb credit losses and ride out the crisis.” Banks would have to incur losses of $130 billion before CET1 would breach 8 percent, and that amount (of losses) is “almost unfathomable”.

In June 2019 I spoke to a large group of Canadian bankers in Toronto. I cited a note written by Bank of Canada economists, titled “Assessing the Resilience of the Canadian Banking System”.

The BOC suggested that banks would have to cancel their dividends in a severe recession, if capital levels dipped below 8 percent, after estimated losses of $115 billion in consumer and business loans.

The BOC stress test assumptions:

  • CET1 capital was 12 percent before the recession starts
  • Decline in real GDP peak-to-trough 8.2 percent
  • Recession duration 7 quarters
  • Unemployment increase trough-to-peak 6.4 percent
  • Peak unemployment 12.6 percent
  • House price correction peak-to-trough -40.9 percent

The paper concluded that bank losses would total $116 billion, representing about 4 percent of loan balances. With capital levels starting at 12 percent, higher than today’s level, CET1 would fall below 8 percent in about one year after the recession starts.

Dividends would be automatically restricted by regulators once that capital level is breached. Earnings would have to replenish the capital before regulators allow dividend payments to resume, which could take another year or two.

Before investors say “I can live with that” they might want to read the report’s fine print. BOC staff assume that most of the losses come from business and consumer credit loans, and mortgage losses are minimal as borrowers continue to make mortgage payments, even with a 40 percent decline in house prices. This is nothing short of delusional since, in Canada, personal bankruptcy wipes out all debt.

Canadians should expect that the recession started in late 2019 and will set records for severity and loan defaults.

During the week of March 16-22 almost one million Canadians applied for EI.

Banks will see losses well beyond what is contemplated by the stress test, and many borrowers will fail to make their payments.

Traditional safe-haven investments, especially those in the business of lending to households, will perform poorly in this unprecedented situation.


Hilliard MacBeth


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