Dividends have come under extreme pressure in this downturn, we have seen companies with strong dividend record cutting their dividends, rarely have we seen a company increase their payouts to shareholders in the last 8 months. It’s all about capital preservation and survival for corporations. However people are still looking for the “safe” investment, a place to hide and get paid in the mean while. Many investors are asking themselves “who can keep up with their dividends?” Canadian banks the major dividend payers in the country are on top of the many investors list, but how much longer can they go before cutting?

Ian de Verteuil an analyst at Nesbitt Burns recently cut Scotia Bank (BNS.to) to an underperform which sent down the stock about 6% and being my largest bank holding put a dent into my portfolio.This downgrade made me a little worried about the banks dividends, so far no Canadian bank has cut or made any indication of cutting their dividend, but the high yields (as high as 10% on some) causes some worry.

This prompted me to do some due diligence and research a little more about possible dividend cuts. The banks are currently paying out between 55% AND somewhat over 65% in dividends; I think we all agree the bank earnings will continue to drop for the next few quarters. This brings up two important questions: how low will they go? And how low can they go before we see potential cuts? The first question is one that nobody can answer with any certainty, so I will focus on the second question.

How low till they let go?

According to Peter Rozenberg at UBS if the banks miss the 2009 estimates by 10% the payout ratio will be around 59% well above the 40-50% comfort level for the banks, however if they miss by 30% the ratio will be around 76%. Well for some banks like BMO 30% miss will bring up payout ratio to 97% on the other hand if same scenario is applied to TD the ratio is only 65%. Banks feel very strong about their dividends and even in the event of 20% miss and higher than usual payout ratio, it is very unlikely that they will cut dividends. This gave me some assurance that the dividends are safe, well unless we miss by 30%, but how likely is that? I would rule out the possibility, but I do not believe it to be very likely.

In this very chaotic environment information, research and due diligence is key to a better sleep. At least for now I can sleep at little better at night.

How do you feel about your dividend stocks?



Ray is an ex-financial adviser and the founder of Financial Highway. Currently working in the financial industry and working towards completing his Chartered Financial Analyst, CFA, designation.