SINGAPORE (May 15): The three local banks have taken slightly different approaches to pro-visioning and dividends. Credit costs are allowances or provisioning for both impaired and non-impaired loans. The relationship between how these allowances are calculated and the economy, also affects risk-weighted assets (RWA). Allowances affect earnings which is part of the numerator in the common equity tier 1 (CET1) ratio, while RWA is the denominator.  

First the provisioning. United Overseas Bank’s (UOB) general provisions of $61 million in 1Q2020 looks very low compared to Oversea-Chinese Banking Corp and DBS Group Holdings.

UOB’s credit costs in 1QFY2020 was just 36 basis points compared with OCBC which announced 86bps of credit costs. DBS’s total credit costs shot up to 1.08% compared to its specific provisions of 20bps in FY219, when it had a write-back of $58 million in general provisioning.

DBS started the quarter with $2.5 billion in expected credit loss (ECL) general allowance. Since DBS had a very good quarter of trading income and gains from sale of securities (+39% y-o-y) its management decided to boost its general allowances.

“Operating profit before allowances rose 20% from a year ago to a new high of $2.5 billion, which allowed us to to pre-emptively set aside $700 million of general allowances to fortify our balance sheet against risks arising from the ongoing Covid-19 pandemic. The charge increased the amount of general provision reserves by 29% to $3.23 billion, or 1.08% of assets under regulatory definition,” says DBS CFO Chng Sok Hui (see chart 1). “As this exceeded the minimum 1% regulatory requirement, regulatory loss allowance reserves (RLAR) are no longer needed.”

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Heightened general allowances, management overlays

Piyush Gupta from DBS also pointed out that of the $3.2 billion, over $1 billion comprised of management overlays. ECL provisioning is guided by macro-economic variable (MEV) models. Management overlay is the amount of general provisioning a bank puts aside over and above what the MEV model requires you to have.

OCBC’s general allowances rose significantly in 1Q2020 to $382 million. In 4Q2019, OCBC wrote back $64 million and had a general provision of $17 million in 1Q2019. Hence the impact was noticeable on net profits.  

During 1Q2020, the macro economy changed completely from what it had been in 4Q2019. Hence banks like OCBC had to put aside a lot more general provisions. During 1Q2020, OCBC increased its total cumulative allowances (including specific allowances) by $632 million q-o-q. OCBC started the quarter with a general allowance of $1.05 billion for non-impaired assets, and ended the quarter at $2.314 billion in general allowances, including RLAR of $874 million (see chart 2).

UOB’s total allowances in 1Q2020 was $286 million of which only $61 million was set aside as general allowances for non-impaired loans. UOB started the quarter with around $2 billion in general allowance coverage of which $750 million comprised management overlay.

“We ran the MEV model. The MEV outlook darkened, so we added $300 million of general provisioning to our base model which went from $1.3 billion to $1.6 billion, and we kept a management overlay of $400 million, above what the MEV model requires,” a UOB spokesman explains (see chart 3).

During 1Q2020, UOB also added $260 million to RLAR (see chart 3). Hence UOB ended the quarter with $2.77 billion of general allowances including RLAR.

In effect the three banks have been very prudent, putting aside a significant amount of general provisions in the event that Covid-19 impacts the economy in unforeseen ways.

Outlook for dividends

DBS announced it is maintaining an elevated dividend of 33 cents in 1Q2020, up from 30 cents last year. Its payout ratio works out to be 70%.

“We do not think of dividends in terms of the payout ratio. I would say we could live with the 70-80% range. The principal guidance is the stability of the dividend rather than the payout ratio,” Gupta says. As for the rest of the year, Gupta says: “we will continue to keep a watchful eye on our fi-nancial performance every quarter. Fortunately, since we pay a quarterly dividend, it gives us the capacity to be nimble.”

OCBC and UOB pay dividends semi-annually and do not have to make a decision yet.

On dividends, OCBC CFO Darren Tan says, “the outlook is still highly uncertain and we will make decisions closer to the time which during the half year results [in Aug] and dur-ing final year results [in Feb 2021].” In addition to net profit, RWA determines how much dividend a bank would want to pay. “In RWA there are two principal factors. The first is the borrower’s cash flow itself. If it is negatively impacted because of a weaker obligor rating, it will result in a higher RWA. The second factor is the industry the borrower is in. In a situation where we are currently, certain industries have been downgraded. Once we downgrade industry, the RWA of the companies in that sector will automatically increase,” explains OCBC CEO Samuel Tsien.

OCBC currently has the highest CET1 ratio among the banks, at 14.3%, followed by UOB with 14.1% and DBS at 13.9%. Gupta says DBS is comfortable going towards 12.5%. UOB’s management indicated that its AA rating is important and hence it will maintain a CET1 ratio to be commensurate with its rating. In Feb, UOB’s management had indicated it is comfortable with a 50% payout subject to a minimum CET1 ratio of around 13.5%.

With earnings under downward pressure, and RWA under upward pressure, investors may need to lower dividend expectations. On the other hand, if economies recover by early next year, the impact of that recovery would manifest itself in the banks first. Hence they are important components of any local portfolio.