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3 Reasons Why Bank of Nova Scotia (TSX:BNS) May Cut Its Dividend

Bank sign on traditional europe building facade
Bank sign on traditional europe building facade

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) has been a terrific dividend stock. So terrific, in fact, that investors have grown unaware of the growing risks. The company is incredibly far from going out of business, but it might not take much for the bank to cut its 4.9% dividend.

Long regarded as a safe and reliable payout, income investors should take caution when trusting this stock. Here’s why.

Oil declines

Scotiabank is a $91 billion behemoth with exposure across dozens of industries and several continents. While energy accounts for roughly 3% of its loan book, regional pressures could create unforeseen hurdles.

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Most of the bank’s loan book is centred around Canadian-specific exploration and development. According to Bloomberg, the last few years have been “the worst pricing environment in the history of Canada’s oil industry.”

The biggest issue is structural. While oil and gas production continue to explode throughout the country, pipeline and transportation infrastructure lag far behind. Last year, regional pricing fell more than 50% due to a supply glut.

With production set to rise through 2030 and beyond, this systemic issue won’t be going away anytime soon. New pipeline capacity may take years to get online, and by the time relief comes, new supply growth may reinstate the problem shortly thereafter.

If a 3% exposure sounds minimal, think again. Even at their most conservative, banks are levered bets. Small impairments across a limited segment of the loan book can have far-reaching effects.

Real estate frenzy

According to Fool contributor Matt Smith, Canadian banks all face “stricter mortgage regulations, heavily indebted households, and a saturated domestic financial services market.” I’d add a potential real estate bubble to that list. While the current exuberance is far from the U.S. subprime mortgage meltdown, there’s still plenty of reason to worry.

From 2013 to 2019, several cities in Canada have seen home and property prices increase more than 300%, which is one of the fastest rates in the world. Meanwhile, housing availability continues to struggle, and cities like Vancouver are trying to clamp down on vacant units.

While a sudden collapse is improbable, it’s likely that over the next few years Canada will see a normalization of its property markets. As we’ll see, even a small normalization could have severe effects.

Crazy credit

Famed investor Steve Eisman recently shorted several Canadian banks, betting that they’re not prepared for even a slight slowdown in the economy. “Canada has not had a credit cycle in a few decades,” he said earlier this year. “I don’t think there’s a Canadian bank CEO that knows what a credit cycle really looks like.” Eisman thinks there’s at least 20% downside in large Canadian bank stocks.

“At this stage in the credit cycle, what you should be seeing is increasing levels of reserves that increase faster than impaired loans, because essentially what you want to do is build money for a rainy day,” he adds. “You did not see that at all in Canadian banks. In fact, what you saw was reserves were basically flat.”

If the credit cycle normalizes, impacts from both the energy and real estate sectors could be magnified considerably. The odds of a near-term dividend cut are still low, but investors should know that Scotiabank stock may not be as reliable as you’d expect.

More reading

Ryan Vanzo has no position in any stocks mentioned. Bank of Nova Scotia is a recommendation of Stock Advisor Canada.

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