CA - Buffett Says Make Money In Your Sleep 2 Dividends For A Dream Retirement

2023-12-01 09:30:00 ET

Summary

• Success in investing comes from tapping into the talents around us for financial gain. We like to achieve it passively through dividends.
• Warren Buffett's portfolio has always been over-allocated to banking institutions as he sees it as a "forever" industry.
• Load up on big sustainable dividends from Scotiabank and U.S. Bancorp at these massive discounts.

Co-authored with "Hidden Opportunities."

Billionaire Warren Buffett's portfolio has almost always been over-allocated to banking institutions and other financial services companies. This is because banking is a "forever" industry. There will always be the need for a safe place to place our savings, a platform to make transactions and investments, and support our quest for cars and homes. Companies are always going to need banks to conduct business to enable growth.

And Mr. Buffett hasn't shied away from panic in the sector. He has often used the fear as an opportunity to load up on quality firms at cheap valuations. The Oracle of Omaha initially purchased shares of American Express ( AXP ) during a scandal-infused panic in the banking sector in the 1960s, and M&T Bank ( MTB ) was purchased during the Savings and Loan Crisis .

"Widespread fear is your friend as an investor, because it serves up bargain purchases." - Warren Buffett

The banking sector is typically one that is generous with dividend payments at modest payout ratios. This means, they retain a healthy portion of the profits and only distribute a sustainable amount to shareholders. We will now discuss the two well-managed banking leaders who have delivered dividends to shareholders through some of the toughest times for the financial services sector.

Let's dive in.

Pick #1: BNS - Yield 7%

Canada has the fastest-growing population among G7 nations, and the country's banking system functions as an oligopoly. The Big 5 (Toronto-Dominion ( TD ), Canadian Imperial Bank of Commerce ( CM ), The Bank of Nova Scotia ( BNS ), Royal Bank of Canada ( RY ), and Bank of Montreal ( BMO )) offer pretty much the same products and services to all of their clientele and tightly coordinate fee increases. A newcomer to Canada will likely open an account or obtain a mortgage and other products from one of these financial institutions.

BNS , commonly known as Scotiabank , is one of Canada's oldest and largest banks, with a long history of delivering dividends to its shareholders. The banking institution paid its first dividend in the year 1833! Scotiabank has consistently been rated as one of the safest banks globally, with current placement at #26 (behind Royal Bank of Canada at #10 and Toronto Dominion Bank at #21). Notably, none of the big U.S. banks have made it to the top 50 in recent years.

Note:

• All figures discussed in this section are in Canadian Dollars.

• Scotiabank declares and pays dividends in CAD, and U.S. investors receive an amount that fluctuates based on the exchange rates.

• U.S. investors will experience a 15% tax withholding on dividends from Canadian corporations (Retirement accounts are exempted).

74% of Scotiabank's residential mortgage is uninsured (meaning the borrowers put down at least 20% down payment towards the purchase), and the total portfolio has a Loan-To-Value ratio of 51%, indicating substantial equity owned by the borrowers and lower risk to the bank. Moreover, the residential mortgage portfolio exhibits solid credit quality, with over 86% of the uninsured loans issued to customers with a credit score of 720 or higher and a total portfolio average FICO score of 801.

Most importantly, the mortgage maturity schedule is staggered, with more maturities for 2025 and 2026 (thanks to the home build spree in 2020-21). With the Bank of Canada close to the end of its rate hikes and steep political pressure around the affordability of homes in the current economy, we can expect rates to drop from mid-next year, making renewals less painful for homeowners. Source .

Office property loans represent <7% of the CRE portfolio, with ~2/3rds being investment-grade facilities, primarily to prominent, diversified proponents.

Scotiabank ended Q3 with 9% higher deposits, a 7% higher loan portfolio, and a CET1 ratio of 12.7% (up from 12.3% in Q2). Consistent with other banking institutions, Scotiabank's Provision for Credit Losses increased to $819 million from $709 million in the previous quarter (and $412 million a year ago). 94% of the bank's loans are secured by assets (primarily mortgages, auto loans, and lines of credit).

Scotiabank recently raised its quarterly dividend to $1.06/share, a 7% annualized yield. This dividend comes at a modest 58% payout ratio. The bank's senior debt carries A+ credit ratings from S&P and similar ratings from leading credit agencies. Scotiabank continues strengthening its capital and liquidity metrics while growing its deposits and loan portfolio amidst market uncertainties. The company has navigated challenging conditions successfully and is well-positioned to continue the same while delivering growing dividends to shareholders.

Pick #2: USB Preferreds - Up to 8% Yields

U.S. Bancorp ( USB ) is the fifth-largest bank in the United States by total assets, with $664 billion in Assets Under Management. USB has been in business since 1863 and currently operates branches in 26 states.

USB continued to improve its capital ratios, reported a CET1 ratio of 9.7%, and further strengthened its balance sheet by adding $95 million to the loan loss reserve. The bank continues to grow its deposit base (+3% YoY), and while its credit quality metrics reflect some strain from monetary tightening, they remain stable and below pre-pandemic levels.

USB's $54.2 billion CRE loan portfolio had 1.3% under non-performing status, weighed down by the office portfolio. Source .

On the residential mortgage side, metrics look healthy, with borrowers having a weighted average credit score of 771 and a weighted average Loan-To-Value of 72%.

As of Q3, there were no non-performing loans within the credit card portfolio. Despite the sequential rise in delinquencies, metrics remain well below pre-pandemic levels. And USB's $46.4 billion retail loan portfolio had no material change in delinquencies or non-performance. Source .

USB has been steadily growing its common stock dividend since 2009. For Q3, the bank declared a $0.48/share dividend. Investors may have expected a modest annual raise, but the bank is closely working on preserving liquidity. When the Fed's plan becomes more evident, the bank will likely continue raising its common dividend. The bank has not filed its 10-Q yet, but based on its diluted EPS reported for Q3, we estimate a ~50% YTD payout ratio.

USB's preferred shares are all investment-grade rated and offer excellent current income at deeply discounted prices. The trading post-call date, Floating Rate Series B Non-Cumulative Perpetual Preferred Stock ( USB.PR.H ) is our top choice. This security currently presents an attractive 7.9% yield and 26% upside to par value. This is a very attractive current yield for an investment-grade rated security issued by a bank that continued paying its non-cumulative preferred dividends through GFC and the COVID-19 pandemic.

We'll estimate the YTD spending numbers since we don't have a 10-Q filing yet. The bank spent ~$276 million on preferred dividends and ~$2.2 billion on common stock dividends. These shareholder commitments enjoy adequate coverage by the $4.59 billion net income (before preferred dividends).

USB-H has a 3.5% minimum coupon at par value. If, for some reason, we return to a near-zero interest rate economy, USB-H would yield 4.4% at current prices. That would be quite a lucrative coupon from an investment-grade security in a yield-less market. Hence, any drop in interest rates is enough to send the security toward par value, and investors will realize up to 26% capital upside.

USB continues to operate cautiously and works towards optimizing its credit quality and maintaining liquidity and capital levels, and the common and preferred dividends enjoy adequate safety. The Fed has the market believing rates will remain elevated for longer. Even if that were to happen, USB-H's floating-rate coupon will ensure our income remains elevated for longer.

Conclusion

Consumers work hard to earn a living and spend to cater to their needs and a little beyond that. Whether it is discretionary or non-discretionary expenses, they buy products or services from one or more global corporations. These companies are managed by highly qualified leaders and run by hard-working professionals. Dividends are my way of tapping into the talents of the skilled workforce around us.

As an investor with a highly diversified portfolio of income stocks, my dividends are omnipresent. They are in your mortgage payments, car payments, vacation spending, and even those gas refills during your road trip. There is a small cut for me in almost every place you spend your hard-earned money. Day or night, someone out there is always working hard to pay my dividends.

At our Investment Group, we've curated a comprehensive portfolio of over 45 dividend-payers, strategically aiming for an impressive overall yield of +9%. Our mission is to help investors enjoy a fruitful retirement financed passively. By generating income while you sleep, these investments align with Mr. Buffett's sage advice, giving you the financial freedom to savor your retirement years without worrying about working for the rest of your life.

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