The release of second quarter results for the quarter ending April 30th, 2011 by the Canadian banks saw both National Bank (NA-T) and Royal Bank of Canada (RY-T, RY-N) raise their dividends by 8% on the back of stronger results. When combined with further increases by the two smallest banks, Canadian Western Bank (CWB-T) and Laurentian Bank (LB-T), this means that four out of the Big Six banks and six out the eight Canadian banks have increased their dividends over the last six months, three of them (National, Canadian Western and Laurentian) twice. This leaves Bank of Montreal (BMO-T, BMO-N) and CIBC (CM-T, CM-N) as the only Canadian banks not to have raised their dividends in the past year.
Gerry McCaughey, the CEO of CIBC, did indicate during his conference call that bank’s directors were seriously considering he possibility, even though CIBC’s Q2 earnings were felt to have been the most disappointing of any of the banks that have reported. But he explained that, as any review of the big Canadian banks would have shown, its distribution rate (dividends as a percentage of net earnings) needed to be lower before any increase could occur. Both CIBC and BMO, whose U$4.1 billion takeover of Marshall and Ilsley Bank has been approved by regulators and Marshall’s shareholders, have distribution rates above the 45-55% range that they have indicated is the highest level they feel comfortable with.
While it was initially a little surprising to see Royal Bank raising its dividend with its distribution rate still above 50%, its subsequent announcement of the sale of its sub-scale and loss-making US retail operations to PNC Bank (PNC-N) for U$3.65 billion last week made it clear why the directors were comfortable doing so. The capital freed up can be reassigned to more profitable operations such as asset management and capital markets, and brings an end to an unsuccessful attempt to build up a US retail presence in the fast growing south-eastern US markets of the Carolinas, Georgia and Alabama. Having lost $3 billion in operating losses over the last decade, and taken an additional U$1 billion writedown on its investment, most onservers felt that getting PNC to pay it the reduced book value of the former RBC Centura busienss was a good outcome. The problem for Royal was that it was not even amongst the Top 5 banks in any of the states it operated in, with the exception of North Carolina, where it was No. 5. As TD’s US expansion has indicated, in the US retail market, you need to Go Big or Go Home, and TD’s US operations now have more branches than its Canadian business, although they are less profitable at present. Similarly BMO’s takeover of Marshall & Ilsley doubles the size of its US business, which is No. 3 in Chicago and the surrounding areas, and makes it the leading bank in the adjacent state of Wisconsin, giving it both size and geographical concentration. Canadian banks have the advantage of size and an oligopoly in their domestic market, which has enabled them to surmount the finacial crisis (a healthy housing market helped as well) and become as profitable as they are. When they are outside their home country, the same benefits do not apply, and management has to have a clear vision of their strategy and competitive advantages to succeed.
(A slightly different version of this article appeared in the June edition of The Income Investor).