Bank regulators mull adjustments to caps on dividends

DIVIDEND-focused investors in Singapore may have been excited by news reports this past week that the United Kingdom's Prudential Regulation Authority (PRA) will allow banks under its charge to begin paying dividends again.

The move comes as bank regulators around the world are reviewing restrictions they placed on dividend payouts and share buybacks earlier this year, when Covid-19 began jamming up global economic activity and threatening to trigger a cascade of defaults and bankruptcies.

On the face of it, regulators seem willing to allow the banks - especially the strongest ones - more latitude to set their own dividend policies. But they do not appear prepared to entirely let go of the restrictions currently in place.

This was certainly the tone of the statement on Dec 10 by the PRA. On the one hand, the regulator said UK banks are "resilient to a wide range of economic outcomes, including economic scenarios that are materially more severe than current central expectations", and that it is now up to their boards to determine the appropriate level of distributions.

On the other hand, the PRA asked the boards to operate within "temporary guardrails" when deciding on their dividends for FY2020. Specifically, the dividends should not exceed the higher of 20 basis points of risk-weighted assets as at end-2020, or 25 per cent of cumulative eight-quarter profits covering 2019 and 2020 after deducting prior shareholder distributions over that period.

At the end of March, UK-regulated banks suspended dividend payments and share buybacks until the end of 2020 at the behest of the PRA. The banks also withheld outstanding dividend payments for 2019 that had already been approved.

The move enraged the shareholders of banks such as HSBC and Standard Chartered. But the PRA was right in wanting to do everything possible to ensure that banks had as much capacity as possible to withstand a potential surge in bad loans in the face of Covid-19 and support their cash-strapped customers.

Other regulators took similar measures. In March, the European Central Bank (ECB) said banks under its regulation should not pay dividends for FY2019 and FY2020 until at least Oct 1 2020. The ECB also told the banks to refrain from share buybacks.

In July, the ECB extended this policy to January 2021.

In the United States, the Federal Reserve took a more measured approach, avoiding a total elimination of dividend payouts. In June, it capped Q3 2020 dividends to the amount paid for Q2, and tied them to a formula based on recent income. It also banned share repurchases by banks in Q3 2020.

In September, the Fed extended these measures until the end of the year.

The Monetary Authority of Singapore (MAS) adopted a similar position as the Fed. In July, it called on the local banks to cap their total dividends per share for FY2020 at 60 per cent of what they paid for FY2019. MAS also said the local banks should offer shareholders the option of receiving their FY2020 dividends in scrip in lieu of cash.

Shift in dividend caps?

Over the next few weeks, some major bank regulators are set to adjust their policies on bank dividends and share buybacks.

This week, on Dec 18, the Fed is scheduled to release its second round of bank stress tests. The dividend caps announced in June came after its first round of stress tests and sensitivity analyses.

Meanwhile, the ECB is reportedly mulling plans to lift the outright ban it currently has on bank dividends but maintain some form of cap on payouts going forward.

Top executives at some banks in Europe and the US have been lobbying for restrictions on dividends and share buybacks to be abolished, arguing that these rules, although temporary, are preventing the banks from properly compensating their shareholders and hurting their ability to garner decent market valuations.

At least one executive has publicly suggested that forcing the banks to hold too much capital might result in their customers suffering higher prices as the banks try to pad up their return on equity.

The obvious counter argument is that governments around the world are still actively shielding their economies from the fallout of Covid-19 through a wide range of fiscal support measures.

These measures encompass cash handouts and wage subsidies as well as tax cuts and government fee waivers. They also include quasi-fiscal measures such as the deferment of loan repayments and credit guarantees.

If the banks feel they have too much capital it might be because these unprecedented fiscal measures have helped prevent many businesses from being pushed to the wall, their employees from being put out of work, and collateral values from collapsing.

In my view, the banks should only be given full flexibility to set their own dividend policies and share buyback programmes when the Covid-19 economic support measures are fully unwound. This would ensure that fiscal spending meant to benefit ordinary people does not end up in the pockets of investors.

Big provisions by local banks

Singapore's three local banks - DBS, OCBC and UOB - have wasted no time preparing themselves for the day that all the support measures are rolled back. With their ability to pay dividends to their shareholders curtailed, they have front-loaded substantial bad loan provisions in 2020.

At each of the three banks, allowances for credit losses during the first three quarters of 2020 were higher than for the whole of 2019 by a long way. The increases were driven by sharply higher general provisions, or allowances for non-impaired assets.

At DBS, in particular, general provisions alone for the first three quarters of 2020 were almost S$1.5 billion, or more than twice the group's total provisions for the whole of 2019 of S$703 million.

To put the scale of the general provisions at DBS another way, they amounted to more than 40 per cent of the group's reported net profit for the first three quarters of the year. For OCBC and UOB, general provisions for the first three quarters of 2020 were equivalent to about 33 per cent of their reported net profits.

This provides the three local banks with a substantial cushion with which to cope with any deterioration in asset quality in 2021. It also positions them well to quickly flex their dividend paying capacity if MAS were to decide in the next few weeks to loosen or completely lift its cap on dividends.

The three banks are not as cheap as they once were though. DBS is currently trading at almost 1.26 times its net asset value (NAV). UOB is trading about 1 per cent above its NAV, while OCBC is trading 5.4 per cent below its NAV.

Assuming their dividends for FY2020 are exactly 60 per cent their payouts for FY2019, DBS is trading at a FY2020 yield of 2.9 per cent, while OCBC and UOB are trading at FY2020 yields of 3.2 per cent and 3.4 per cent, respectively.

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