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DBS, UOB forecast to cut dividends this year as OCBC resorts to script in bear case, says Morgan Stanley

Goola Warden
Goola Warden • 6 min read
DBS, UOB forecast to cut dividends this year as OCBC resorts to script in bear case, says Morgan Stanley
The Covid-19 pandemic has changed many aspects of our lives. Since banks are central to the way we live — the way in which banks are perceived have also changed. Take as an example dividends. Local investors have over the past 10 y
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SINGAPORE (Apr 17): The Covid-19 pandemic has changed many aspects of our lives. Since banks are central to the way we live — the way in which banks are perceived have also changed. Take as an example dividends. Local investors have over the past 10 years been able to look forward to rising dividends from our local banks. Now, banks’ ability to pay dividends will be seen as a sign that regulators are comfortable with their capital levels and their ability to pay these dividends. Such banks will be the best banks to invest in.

“With the outlook for bank sector earnings uncertain and dividends likely to be increas-ingly rare, we think banks that maintain div-idends will trade at premiums,” says Morgan Stanley in a report dated April 14. “This is partly because income funds will need these dividends but also because continued payment of dividends will be seen as a sign of regulatory comfort with capital levels,” the US investment bank confirms. Around 16% of Asia-Pacific dividends came from financial in 2019. The local banks have been one of the best dividend paymasters in recent years.

On March 31, the UK’s Prudential Regulatory Authority threw a spanner in the works by asking banks including Standard Chartered and HSBC Holdings, both of which are listed in Hong Kong, to cancel their final 2019 dividend payments and stop share buybacks to conserve capital. The Monetary Authority of Singapore has since clarified that it will leave it up to the local banks to decide their dividend policy, but it has discouraged share buybacks, recommending that banks keep the capital for lending purposes.

Morgan Stanley says regulators are concerned about banks’ dividends because of three main reasons. First, banks need to maintain sufficient capital buffers to resist any credit stresses. Secondly, banks to have sufficient capital to be in a position to support borrowers over the next few months. MAS and other regulators have introduced loan moratoriums and other schemes such as loan guarantees or relaxation of lending rules to ensure the flow of credit. Third, regulators including MAS have intro-duced measures to free up bank capital, in-cluding lowering counter-cyclical buffers, and allowing regulatory reserves to be used as capital so that banks can support the real econ-omy, rather than to be earmarked for share-holders via dividends and share buybacks.

Stimulus affects credit costs and capital

Regulators are focused on stimulus — otherise known as, forbearance — measures to ease the pain and economic slowdown from lockdown, circuit breakers and attempts to stop the spread of Covid-19.

Some of these forbearance measures, including in Singapore, involve deferment of interest payments on loans for a period of time, and in some cases, deferment of repayment of principal.

Banks are encouraged to support SMEs, where the government will share the risk with the local banks. SMEs would be able to de-fer principal payments on their secured term loans up to Dec 31, subject to banks’ assessment of the quality of the SMEs’ security. SMEs will also be able to extend the tenure of their loans by up to the corresponding principal deferment period if they wish.

The impact of these forbearance measures are twofold — impact on the profit and loss account based on expected credit loss definitions, and on capital, because SME loans, and loans to troubled companies carry higher risk weights causing banks’ risk-weighted assets (RWA) to rise. This would cause common equity tier 1 (CET1) ratio to fall. Since these forbearance measures are im-posed by the government, they are unlikely to have an impact on the banks’ expected cred-it loss (ECL) models this year.

For instance if SMEs and other groups helped by the stimulus plans fail to make interest payment on loans, the loans are unlikely to be restructured because of forbearance measures announced in the Temporary Measures Bill.

In normal circumstances banks would have to make provisions for these restructured or troubled loans and eventually classify them as non-performing loans or NPLs. In 2020, because of the forbearance measures, they won’t have to do so. MAS has asked banks to take government stimulus into account for their ECL macroeconomic variable models, and not require transfers to their regulatory loss allowance reserves (RLAR). These measures will keep credit costs down and preserve capital. As such, banks will also not need to classify restructured or problem loans as non-per-forming loans this year.

Despite this, analysts are pricing in higher credit costs for 2020, than the banks’ 2019 credit costs, which ranged from 20 basis points to 25 basis points. “Assuming no revenue growth, this translates to +60bps for credit costs, a similarly negative scenario as the GFC,” UBS says.

Aakash Rawat, analyst at UBS, says there are two scenarios that could emerge. “In a scenario where activity remains subdued for longer (or more than 6 months), asset quality deterioration might get delayed to 2021, giv-en forbearance this year.” If the recession is short, and banks are able to “kitchen sink” their problem loans as was the case in 2017, share prices could recover a lot faster, Rawat suggests.

In the meantime, news that Hin Leong, one of the largest local oil trading companies has had its banks freeze credit to it. Bloomb-erg reported that banks are owed US$3 billion ($4.3 billion). According to news circulating around the financial sector, HSBC is owed US$600 million, DBS Group Holdings US$290 million, Oversea-Chinese Banking Corp US$230 million, Rabobank US$230 million, United Overseas Bank US$200 million, Natixis US$130 million, and Credit Agricole CIB US$86 million. It is unclear whether Hin Leong qualifies for the forbearance measures.

Expect some dividends this year

Nick Lord, an analyst at Morgan Stanley, ex-pects DBS and OCBC to continue to pay their planned dividends this year and next, although OCBC could re-introduce its scrip dividend which is very popular.

“In our base case, we see DBS’s payout peaking at 72%. UOB pays its dividend ac-cording to a 50% payout ratio, and thus we have lowered our 2020 [forecast] dividend to $1.00 and 2021 dividend to $1.10,” Lord says in the report. “In our bear case, we have low-ered dividend per share estimates for DBS to reflect our view that banks will be required to demonstrate more prudence if matters worsen materially. We assume DBS cuts its dividend to $0.65 for both 2020 and 2021. At OCBC, given its use of the scrip option, we assume the same as base case. For UOB we see a dividend of $0.64 in 2020 and 2021 in our bear case,” he suggests.

Despite flat or falling dividends, the Singapore banks could still be the best banks to invest in.

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