Banks currently enjoy a strong tailwind thanks to the aggressive interest-rate hikes implemented by central banks, which are doing their best to restore inflation to normal levels.
Rising interest rates greatly enhance the net interest margin of banks, i.e., the difference between the interest they charge on their loans minus the interest they pay on their deposits. It is thus natural that the financial sector has attracted the attention of many investors. However, the vast majority of investors is focused solely on U.S. banks.
There are some Canadian banks that offer much higher dividend yields than their domestic peers, with a wide margin of safety. Below, we will discuss the prospects of three Canadian banks that offer exceptionally attractive dividends.
namely The Bank of Nova Scotia (BNS), The Toronto-Dominion Bank (TD) and Bank of Montreal (BMO).
Dividend Yield at a 10-Year High
The Bank of Nova Scotia (BNS) , which is often called Scotiabank, is the third-largest financial institution in Canada behind the Royal Bank of Canada (RY) and the Toronto-Dominion Bank. Bank of Nova Scotia operates in four core business segments, namely Canadian Banking, International Banking, Global Wealth Management and Global Banking & Markets.
Bank of Nova Scotia has a different growth strategy from its peers in the Canadian financial sector. While other banks try to expand in the U.S., Bank of Nova Scotia is focused primarily on growing in high-growth emerging markets. It is a leading financial institution in the high-growth markets of Mexico, Peru, Chile and Colombia, which have a total population of about 230 million people and have under-banked markets. These markets have the advantages of higher population growth, higher GDP growth and wider net interest margins than the U.S.
The bank is taking advantage of the fragmented status of these markets and is likely to keep growing for several years. It is the third-largest bank in Chile, the second-largest card issuer in Peru and the fourth-largest bank in the Dominican Republic.
On the other hand, Bank of Nova Scotia has exhibited a somewhat volatile performance record. During the last decade, the bank has grown its earnings per share by only 2.9% per year on average, partly due to a stronger U.S. dollar.
The bank is currently facing a headwind due to highly volatile financial markets, which have led customers to reduce the frequency of their transactions. This means lower fees for the bank. In addition, due to the ongoing economic slowdown, the bank has lately increased its provisions for loan losses. On the other hand, Bank of Nova Scotia benefits from rising interest rates, which enhance the net interest margin of the bank. Overall, the bank is likely to grow its EPS marginally this year, to a new all-time high.
Moreover, Bank of Nova Scotia has grown its dividend for 11 consecutive years and is currently offering a nearly 10-year high dividend yield of 5.9%. It is also remarkable that the bank proved resilient during the Great Recession, which was the worst financial crisis of the last 90 years, and during the coronavirus crisis.
Given also the reasonable payout ratio of 48% of the bank, its dividend has a wide margin of safety. Therefore, investors can lock in the nearly 10-year high dividend yield of 5.9% of the bank and rest assured that the dividend will remain safe for the foreseeable future.
Score a ‘TD’ With This Bank
Toronto-Dominion Bank (TD) traces its roots back to 1855, when the Bank of Toronto was founded. The institution, which was formed by millers and merchants, has blossomed since then into a global financial institution with $1.4 trillion in assets and approximately 95,000 employees.
Toronto-Dominion Bank is the largest bank in Canada in assets, deposits and earnings. The bank has a 21% market share in the country, a network of 1,060 branches, and it is ranked #1 or #2 in most of its retail products. It is also the sixth-largest bank in North America in assets and deposits and the fifth-largest bank in North America by market capitalization.
Toronto-Dominion Bank has exhibited a strong performance record. During the last decade, the company has grown its earnings per share almost every year, at a 6.6% average annual rate. Management has stated that its goal is to grow the bottom line by 7%-10% per year on average. Thanks to its solid business model and its competent management, the bank has promising growth prospects ahead.
About a year ago, Toronto-Dominion Bank announced its intention to acquire First Horizon (FHN) , a premier regional bank with a focus on the attractive U.S. Southeast markets, for $13.4 billion, in an all-cash deal. If the deal materializes, it will help the bank accelerate its growth in North America. The company is paying 9.8 times the estimated earnings of First Horizon, after the effect of synergies has been taken into account. The deal is expected to close in the running quarter. Management expects the acquisition to be immediately accretive to the adjusted EPS.
Toronto-Dominion Bank is currently offering a 4.0% dividend yield. The bank has grown its dividend for 11 consecutive years, at a decent pace. It has grown its dividend by 6.2% per year on average over the last decade and by 8.0% per year on average over the last five years. It is also important to note that the company proved resilient throughout the Great Recession and the pandemic.
Given also its healthy payout ratio of 43%, its 4.0% dividend has a wide margin of safety.
Oh Canada! 10 Straight Years of Dividend Increase
Bank of Montreal (BMO) was formed in 1817, when it became the first bank of Canada. During the past two centuries, Bank of Montreal has grown into a global powerhouse of financial services, with about 1,400 branches in North America. In 2022, the company generated 64% of its adjusted revenue from Canada and 36% from the U.S.
The primary competitive advantage of Bank of Montreal is its long history and reputation as well as its large size. The company is the eighth-largest bank by assets in North America and one of the Big Six banks in Canada. Just like Bank of Nova Scotia and Toronto-Dominion Bank, Bank of Montreal proved resilient throughout the Great Recession and the coronavirus pandemic.
Bank of Montreal has exhibited a solid performance record. During the last decade, the company has grown its earnings per share consistently, at a 5.8% average annual rate. Even better, the bank is likely to accelerate its growth in the upcoming years thanks to its recent acquisition of the Bank of the West. Management expects this acquisition to be immediately accretive to EPS and be accretive by more than 10% in 2024.
Bank of Montreal has raised its dividend for 10 consecutive years. It has grown its dividend by only 4.0% per year on average over the last decade but it has accelerated in the last five years, with an average annual growth rate of 8.3%.
Thanks to its solid payout ratio of 40% and its proven resilience to recessions, the bank is likely to keep raising its dividend for many more years. Therefore, investors can lock in the current 4.3% dividend yield of the stock and rest assured that the dividend will remain on the rise for many more years.
Most U.S. investors dismiss Canadian banks, as they feel less familiar with these names. They also prefer to avoid the currency risk of these stocks, as a stronger U.S. dollar negatively affects the earnings of these banks and the dividends that U.S. investors receive.
On the other hand, the above three banks are offering much higher dividend yields than most U.S. banks, with a wide margin of safety. In addition, they have proved much more resilient to economic downturns than most U.S. banks. Therefore, investors should consider purchasing these high-quality banks around their current stock prices.