Before we discuss why the Canadian regulator OSFI should lift its cap on dividends as soon as possible, we would like to highlight the recent launch of the Hamilton Enhanced Multi-Sector Covered Call ETF (ticker: HDIV), an equal weight portfolio of seven established covered call ETFs with a sector mix broadly consistent with that of the S&P/TSX 60. HDIV utilizes modest 25% cash leverage to support higher potential long-term returns and yields and to mitigate the yield/return trade-off inherent in covered call strategies.

HDIV has a targeted yield of 8.5%, paid monthly and seeks to track the returns before expenses, of 1.25x the Solactive Multi-Sector Covered Call ETFs Index (the “Index”). The Index has an annualized (unlevered) five-year total return of 9.7%, higher than that of the S&P TSX 60 Index at 9.4%[1]. For more information on HDIV, please visit HDIV’s web page and refer to the Questions and Answers on HDIV”.


Now to dividends and OSFI. It has been our position for two quarters that OSFI should allow dividend increases. However, given OSFI has not yet made any announcements, it appears likely the banks will not increase dividends next week (coincident with Q3 reporting), and that investors will likely have to wait until year-end reporting in November/December, unless the banks announce mid-quarter (which is not typical). At this point in the recovery, we believe there is no compelling policy reason to continue with the cap. In fact, as time goes by, the cap seems less and less logical.

The two most critical measures of financial strength – earnings and capital – have never been higher for the Canadian banks. Last quarter, the banks made over $14 bln in aggregate earnings, or ~17% more than the last quarter before the pandemic. The world’s most important capital ratio – CET1[2] – is at an all-time high for the group. Moreover, the banks have set aside over $20 bln of reserves/allowances against performing loans, which is gigantic and forms a formidable cushion against unexpected challenges. As reserves normalize lower, we expect another ~$4 to $6 bln to be released back through earnings and into capital, further supporting the sector’s ability to pay dividends. Loan losses continue to be low and are likely to remain so for several quarters, which will also support capital generation.

In fact, it is difficult to find a single item in bank results that supports the ongoing moratorium on dividend increases. It is possible OSFI is taking a highly cautious stance, looking to the rising COVID cases and the virus’s looming seasonality. However, with over 64% of Canadians having been fully vaccinated, the country is well prepared to cope. We believe an equally strong case for lifting the cap would be to support the large number of Canadians who rely on bank dividends for income and help alleviate some financial challenges relating to the pandemic.

We believe the time to lift the moratorium was last quarter, and hence OSFI should lift its dividend restrictions now. The case for allowing a resumption of dividend increases is overwhelming – consider the charts below as supportive evidence. On the bright side, the longer OSFI waits, the larger the eventual increase will be.

To capitalize on the strong fundamentals of the Canadian banks, investors should consider the Hamilton Enhanced Canadian Bank ETF (HCAL). Supported by modest cash leverage (25%), HCAL offers potential for higher long-term returns and a higher dividend yield (currently 5.10%[3], paid monthly). Alternatively, investors could consider the Hamilton Canadian Bank Mean Reversion Index ETF (HCA), which seeks to replicate the returns (net of expenses) of the Solactive Canadian Bank Mean Reversion Index and has a yield of 4.11%[4] (paid monthly). For those investors with a full allocation to Canadian banks, we would recommend they consider the Hamilton Australian Bank Equal-Weight Index ETF (HBA), which has a yield of 5.25% and whose holdings, we believe, represent fraternal twins to their Canadian peers, while offering added diversification (see “Australian Banks: Outperformance vs Canada (akin to Canadian Bank #4) for more detail).


Recent Notes:

Globe & Mail on HDIV: Canadian ETF tests conventions with high yield on a portfolio of quality stocks (July 21, 2021)

Press Release: Hamilton ETFs launches Hamilton Enhanced Multi-Sector Covered Call ETF (July 20, 2021)

Canadian Banks: Reserve Releases Dominate Results; Q2-21 Takeaways (in Charts) (June 2, 2021)

Canadian Banks: Catalyst #2 (Reserve Releases) Approaching (April 30, 2021)

Canadian Banks: Are Analysts Underestimating the Recovery (Again)? (April 16, 2021)

Press Release: Hamilton ETFs Announces Name Change for HCAL (April 1, 2021)

Video: “Canadian Banks – Three Catalysts for 2021” (February 17, 2021)

Fintech/Cdn Banks: Can Standalone Digital Banks Disrupt the Incumbents? (January 14, 2021)


A word on trading liquidity for ETFs 

Hamilton ETFs are highly liquid ETFs that can be purchased and sold easily. ETFs are as liquid as their underlying holdings and the underlying holdings trade millions of shares each day.

How does that work? When ETF investors are buying (or selling) in the market, they may transact with another ETF investor or a market maker for the ETF. At all times, even if daily volume appears low, there is a market maker – typically a large bank-owned investment dealer – willing to fill the other side of the ETF order (at net asset value plus a spread). The market maker then subscribes to create or redeem units in the ETF from the ETF manager (e.g., Hamilton ETFs), who purchases or sells the underlying holdings for the ETF. 

[1] Compound annual growth rate from July 31, 2015 through August 19, 2021.
[2] Common equity tier 1.
[3] As of August 19, 2021
[4] As of August 19, 2021

Hamilton ETFs:

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