DRP discounts offered to save cash

A trend is surfacing among large financial corporations to actively encourage shareholders to participate in dividend reinvestment plans (DRP), offering shares at a discount.

On Thursday, CIBC announced a 3% discount on DRP reinvestment, and extended the plan to preferred shareholders. The discount applies to the “dividend reinvestment option” of the plan, but not the “share purchase option.”

National Bank announced similar changes to its DRP, with a 2% discount for shares purchased via its DRP.

Sun Life announced enhancements to its DRP on May 12, offering shares issued from treasury at a 2% discount, with an option to increase that discount to 5%. Canadian-resident preferred shareholders can opt to have their dividends reinvested in common shares of the company.

In all three cases, the discount applies to shares issued from the corporate treasury, with no discount on shares the company acquires on the open market for its DRP.

Jonathan Wellum, CEO, CIO and portfolio manager at AIC, says DRP programs are largely aimed at individual investors, but that his funds will occasionally take advantage of them if the stock’s valuation is attractive.

“In most cases, we take the cash, but if the discounts become large, then it makes sense to look at it,” Wellum says. “Our opinion will be influenced quarter by quarter.”

As an investor, Wellum says the discount, combined with the absence of transaction costs, could make the DRP attractive. He says the uptake on DRP programs tends to run in the high 40% range.

“As the discount gets bigger, the amount of participation in the DRP program increases,” says Scott Lamb, vice-president at AIC. “You can look at that discount as a barometer of how anxious the banks might be for people to participate.”

Banks and insurers are generally very reluctant to cut their dividends, because doing so could be interpreted as a sign of weakness. By enticing more investors to reinvest their dividends, the companies are able to reduce their cash payouts without cutting the dividend.

“Canadian banks would be loathe to cut a dividend, so this could take off any market pressure,” says Lamb. “There’s talk that pay-out rates are pretty high, but if most of that is coming back to your capital base, then it might relieve some of that talk.”

He says the DRP discounts probably indicate that the firms want to slowly build their capital base in an efficient manner.

“To do a secondary offering, there would be fees associated with that,” he says. “This is just a nice way, every quarter, to slowly add to your capital base, while giving some benefit back out to the investor.”

Wellum points out that it’s also a far more subtle way of building capital than a bought deal.

“The environment is very unusual,” says Wellum. “There are long-term challenges out there. No one’s afraid to walk around with a little more capital these days.”

(05/28/09)