BTO's Exposure to Small Banks Weighs on Dividend Coverage

The John Hancock Financial Opportunities Fund's (BTO) net asset value (NAV), which reflects the value of a fund's assets less its liabilities, has contracted around 20% this year, largely thanks to a roughly 85% exposure to banks.

This large allocation to banks and the fund's small-cap tilt made the fund vulnerable to the industry's recent sell-off when solvency concerns abounded after the collapse of two regional banks, SVB and Signature.

Banking turmoil continues as rising deposit costs (pressure to raise interest paid to customers) and possible regulatory changes that could impact profitability continue to weigh on the industry's stock prices.

A slow recovery in the banking sector could be a problem for BTO's dividend, which is primarily funded through NAV growth (capital appreciation).

Following BTO's 18% dividend hike in early 2022 and the recent slump in banking stocks, the fund's $2.60 per share payout now consumes around 10% of NAV annually.

That's well above BTO's long-term average payout rate of 6% of NAV. To prevent further asset erosion and maintain BTO's dividend rate, NAV must compound by around 10%, a tough hurdle to meet given the financial sector's challenges.

With dividend support fading and the fund needing a robust recovery in banking stocks that could take time, we are downgrading BTO's Dividend Safety Score from Borderline Safe to Unsafe.

We estimate any near-term distribution cut would be closer to 25%, which would return the fund's dividend yield closer to historical levels. In 2008, during the great financial crisis, BTO reduced the payout by 35%.

If a cut occurs, BTO's 12% premium to NAV could also disappear, providing some downside risk for current investors to consider.

We will be keeping an eye on how BTO's NAV progresses and will provide updates as needed.