Amid dividend cuts, income investors can still find safety

John Heinzl was kind enough to quote me in his recent piece Amid dividend cuts, income investors can still find safety:

James Hymas, president of Hymas Investment Management, said the risk of banks cutting dividends is “so small that it cannot be quantified.”

“The saving grace in all of this is that after the credit crunch the regulators really went to town, insisting on higher capital levels,” Mr. Hymas said in an interview. “So the banks have an enormous shock absorber … in terms of their capital and their size and their protection from competition.”

8 Responses to “Amid dividend cuts, income investors can still find safety”

  1. skeptical says:

    Here’s the absolute worst case imagined by the Bank of Canada guys to ensure the CET1 doesn’t drop below 8%:

    GDP Decline 8.2%
    Recession duration: 7 quarters
    Unemployment rate increase: 6.4%
    Peak unemployment 12.6%
    House price correction: 40.9%

    It’s almost as if they did not test it hard enough…

    I think GDP decline will probably overshoot, at least temporarily. If things don’t recover in a jiffy, we’ll see GDP decline of 6 to 8% easy.

    Duration of recession- I think things should recover before then. Hard to predict.
    Unemployment rate increase: Already blown past that. Way past that.

    Peak Unemployment: Already way past that, numbers should reflect that soon.

    House Price correction: 40.9%. I don’t think this number will materialize. Even AB which has been battered badly over the last 5 years has seen price go down by no more than 15% or so on average. But individual properties can definitely fall by that much. Perhaps, that’s why they have the CMHC waste bin for those mortgages.

    We’ll find out if the adverse scenario was bad enough.

  2. peet says:

    Quite frankly, I don’t find a 2019 BOC exercise that has nothing to do with the present crisis, helpful, nor speculation [ because that’s all it is] on how it will all turn out. Here is what the 2019 BOC exercise dealt with:

    This exercise considers a three-year adverse scenario … The scenario begins with an escalation of global trade tensions, which leads to a decline in international trade and global productivity and a period of persistently above-target inflation. To stabilize inflationary expectations, some major central banks tighten monetary policy at a faster-than-expected pace. This is accompanied by an unexpected and disorderly repricing of risks. Global financial conditions tighten significantly, setting off downturns in the housing market and credit cycle. Consequently, global economic activity weakens markedly, and the deflationary pressures induced by the recession prompt accommodative monetary policy in later years … An important factor in the magnitude of these losses is the sharp rise in long-term interest rates

  3. skeptical says:

    And now we have an additional interesting international twist here. UK and Europe regulators have asked their banks to suspend their dividends till this crisis is over.

    And for all intents, the UK banks have stronger balance sheets than their Canadian counterparts with CET1 reaching about 15% vs the 11 to 12% levels for the Canadian banks.

    And all the banks in Europe and UK have so far complied. How can you say no to someone who keeps you alive?

    So even if the banks are fundamentally sound, it could soon become a game of optics.

    Are Canadian regulators going to do the same and ask the regulators to do the same?
    After all, how would it look when people are losing homes, can’t pay mortgages, are defaulting on rent, can’t pay their bills and on the other side of spectrum we have filthy rich bankers paying themselves bonuses and showering dividends on their shareholders. It will be a very tricky situation, to say the least.

    And for the suffering preferred guys, whose sole motive in life is to clip coupons, would that privilege be also temporarily withdrawn?

    These are questions worth reflecting.

  4. peet says:

    Keep in mind the rationale of the ECB and BOE which said that the capital conserved could be used to support the economy, households, small businesses and corporate borrowers, as well as to absorb losses on existing exposures to such borrowers. The big British banks [who are also worried about the likely Brexit chaos by the end of this year] quickly took this opportunity to announce suspension. Also stopping for 2020 are Societe General, ABN Amro, ING, Rabobank, UniCredit, as well as numerous smaller financial institutions in the Euro zone.

    However, Swiss UBS and Credit Suisse have said they are NOT suspending [ although getting some “flak” from the Swiss regulator].

    So, keeping the above rationale in mind, consider that RBC had $3,509 million net income for Q1 ending Jan 31 2020, and paid out $1,496 million in dividends to common shareholders. While that is a big chunk, preferred share payout for Q1, by comparison, was small change at $65 million.

    So any temporary reduction of the common dividend would certainly be a big event, but of no concern to preferred shareholder who have to be paid as long as a penny of dividends is paid to common shareholders.

    And, from a policy point of view, a suspension of RBC’s $ 65 million in preferred dividends is not only irrelevant to cash flows but would do nothing to address the broader, economic and liquidity, concerns of the sort raised by the ECB or BOE. Same comment for the other 5 banks.

  5. skeptical says:

    All good points and I concur with most of what you say. As fixed income investors, since our returns are so meager and potential for loss so enormous, our job is to ensure that capital doesn’t get destroyed.

    Given this backdrop, the question that needs to be asked is this: Are the bank dividends really that safe that they can get away with sub 6% returns for perpetuals? When insurance companies and solid utilities are trading between 6.5 to 7%?

  6. skeptical says:

    The flow of wonderful news continues unabated. This time we have the cute Kiwis:

    Interestingly, the hybrid capital notes are spared.

    I think they’ll keep the preferred dividends flowing, if for no other reason, than just to keep the market going.

    Otherwise, we’ll have a deep stigma associated with bank fund raising forever.

    But we are getting ahead of ourselves, aren’t we?

    Never thought 2020 would be, as the Chinese say, interesting 🙂

  7. baffled says:

    the biggest danger seems to be coming from the governments ordering the banks to suspend the dividends to conserve cash…today i read ..”The Reserve Bank of New Zealand ordered all local banks to suspend dividends to bolster their cash stockpiles.”

  8. jiHymas says:

    Some more discussion on April 2.

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