Your Dividend Alternative in Banking

Many American investors are looking for a solid income investment in the banking industry, but this can be difficult in the current dividend environment.

With major banks like Bank of America and Citigroup yielding a fraction of a percent, and even better-off banks like Wells Fargo yielding under 3%, the search for higher yields is not an easy one.

But another group of banks has held up very well through the recession and has substantially higher yields than major American banks.

Source: Cheryl DeWolfe.

Northern neighbors
Unlike the largest American banks, which began to threaten the nation's financial system, Canada's banks did not endure the same slide. Yes, shares did temporarily drop along with the broader market, but they have rebounded and avoided much of the share dilution that hit American banks.

Dividend darlings
One of the major advantages of this banking stability, aside from investors being less likely to be wiped out, is the payment of higher dividends. Among Canada's largest banks, we can see some of the industry's best yields in the table below.

Bank Dividend Yield
Bank of Nova Scotia (NYSE: BNS  ) 4.2%
Toronto-Dominion Bank (NYSE: TD  ) 3.7%
Bank of Montreal (NYSE: BMO  ) 4.3%
Royal Bank of Canada (NYSE: RY  ) 4%

With many of these banks yielding over 4%, the dividends begin to approach those of lower yielding preferred stocks while still offering the upside potential of common shares. Although economic conditions can change, the performance of these banks through the last recession and through previous recessions establishes Canadian banks as among the safest in the worldwide banking industry.

Tax considerations
Like many countries, Canada has a dividend withholding tax of 15% applied to dividends paid to non-Canadian shareholders. Fortunately for American investors, a tax treaty worked out between the U.S. and Canada prevents double taxation by allowing investors to count that 15% withholding tax toward their American dividend tax.

For many investors, this means no net additional tax burden from Canadian bank dividends. But these tax treaties are not done on the same terms with every country. So, before purchasing investments from a foreign country, investors should always consult an appropriate professional regarding dividend tax laws.

Overvaluation?
When comparing Canadian banks to their American counterparts, Canadian banks look expensive on a price to tangible book basis. With Citigroup selling below tangible book and many other American banks selling for only a small premium to that value, some investors see Canadian banks as expensive, with many trading at over twice tangible book value.

But much of this has to do with the cheap valuation placed on American banks right now. After a recession involving a bunch of shadowy securities held by American banks, investors are understandably hesitant to take American bank book values at face value.

Keeping this in mind, it is perfectly reasonable that Canadian banks would trade at a premium. A better handling of the recession gives investors the likely correct impression that Canadian banks are not hiding as many toxic assets as their American rivals.

Whether the American banks are good investments based on their book values is another debate. But the cheap valuations of American banks should not be seen as a negative toward investing in high-yielding Canadian banks.

More stability and higher yields
Canada's banks offer a way for financials investors to collect yields greater than those seen among American banks. Additionally, the response of Canadian banks to the financial collapse further demonstrates a more long-term, stability-oriented investment. While I can certainly see the bullish arguments for investing in undervalued American banks, investors looking for high yields should consider Canadian banks in their investment decisions.

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