The capital a bank holds is one of the metrics most closely watched by investors, ratings agencies and regulators in times of crisis like the Covid-19 pandemic.

Given the uncertain economic climate, the Monetary Authority of Singapore (MAS) has called on all locally-incorporated banks headquartered in Singapore to cap the total dividend per share for FY2020 at 60% of that of the prior year, and to offer shareholders the scrip dividend option.

The whole point of cutting dividends is to ensure that more net profit accretes to the banks’ Common Equity Tier 1 (CET1) and help support the banks’ total Capital Adequacy Ratios (CAR) so lenders can support businesses and the community.

In Singapore, banks are still able to pay dividends but at a reduced rate. Among them, the scrip dividend scheme of Oversea-Chinese Banking Corp (OCBC) is the most attractive.

OCBC is the only local bank to offer a discount for its scrip dividend in 1HFY2020 ended June. Whenever the bank issues its scrip dividend, its investors on average take some 70% of the dividend with scrip, which accretes to capital. Under MAS guidelines, the maximum dividend per share that OCBC can declare would be 31.8 cents for FY2020, or 60% of its FY2019 dividend of 53 cents. For 1HFY2020, an interim dividend of 15.9 cents per share has already been declared. This represents half of the maximum 31.8 cents dividend per share that could be paid out in FY2020.

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In terms of absolute dollars, OCBC’s total dividend payout is around $700 million, or around 49% of its net profit of $1.43 billion. If past trends are anything to go by, OCBC would be adding $490 million to its common equity, over and above whatever retained earnings the bank’s management and its board think fit to add to reserves.

Among the three banks, both OCBC and United Overseas Bank (UOB) have confirmed that some of their customers could suffer a ratings downgrade. In this event, higher risk weights are likely to be assigned to the loans of these customers, and this would add to the banks’ risk-weighted assets (RWA). RWA is the denominator in the CET1 ratio.

“RWA saw a fair bit of the increase because credit migration took place in 1H2020 and 2Q2020,” says Darren Tan, CFO of OCBC, referring to the 7% y-o-y and 5% h-o-h rise in RWA to $223.9 billion. “In terms of dividend, the payout takes place in the third quarter, and on experience the retention is 70% which would add back to the numerator but the net outflow of 30% means there would be a slight decline. That would be more than covered by earnings in the third quarter,” he explains.

OCBC reported net profit of $730 million in 2QFY2020 ended June. OCBC pays dividends every half year, so earnings in 3QFY2020 is likely to be retained, and will accrete to capital. “In the numerator, with dividend recaptured and earnings in 3QFY2020, we would think overall capital levels would be relatively strong,” Tan says.

Lee Wai Fai, CEO at UOB, also acknowledges there could be some ratings migration that would cause its RWA to rise although, as at June 30, UOB’s RWA had risen just 0.87% y-o-y and 2.5% since Dec 31, 2019. Lee says, “I don’t think it’s realistic to expect us to stick to [a CET1 ratio of] 14%. Between now to end-2021, there will be some deterioration and I suspect that’s one of the reasons why MAS came in with the restriction on dividends to preserve some of our capital, to allow banks to use that to grow. CET1 ratio will drop but we are quite confident that it will be above 12.5%.”

UOB should be able to maintain its CET1 ratio at 12.5% because of its hefty general provision (GP) levels year-to-date and net profit accretion to retained earnings. “We’d actually added a crazy level of GP so it’s not only capital that you’re looking at, it’s your GP,” Lee adds. In addition, banks are working with ratings agencies and regulators to mitigate the effect of an en-bloc downgrade of credit ratings. “In normal circumstances, when you do ‘accomodation’, the rule is to downgrade. But the guidance given across the world is to look through the pandemic as temporary and look at the longer term viability of industry,” he continues. Nonetheless, Lee expects more credit migration, double that of a mild recession.

In terms of dividends, for 2QFY2020, UOB is paying an interim one-tier tax-exempt dividend of 39 cents (2QFY2019: 55 cents). This works out to a total payout of $651 million which translates into a payout ratio of 41.8% compared to its 1HFY2020 net profit of $1.56 billion.

While OCBC and UOB pay their dividends every half year, DBS pays its dividends quarterly. In 2QFY2020 ended June, it had declared a dividend of 18 cents, compared to 30 cents in 2QFY2019. This translates to $457 million or a payout ratio of 36% compared to its net profit of $1.247 billion in 2QFY2020. UOB and DBS Group Holdings have also offered scrip dividends. UOB says a separate announcement will be made for its books closure date and pricing for the scrip dividend. DBS’s scrip will be priced at the closing prices of Aug 14 and 17.

Looking ahead, DBS CEO Piyush Gupta expects its CET1 ratio to stay within the range of 12.5% to 13.5%. “As we take up general provisions, we’re keeping an eye on our CET1 levels as well so that we can make sure that we keep within our operating range,” he says.

DBS CFO Chng Sok Hui adds, “I think the drivers of CET1 are likely to be credit costs as well as the risk-weighted asset migration. Those are not easy to estimate ahead but I think if the situation pans out in 2021 and it’s not prolonged and you don’t see a resurgence of the pandemic, we could then actually peak in 2021. But it’s very much dependent on whether the situation stabilises.”

Inevitably, dividends are a function of earnings. Banks have to maintain their CAR within certain regulatory levels, and in times of crisis, impairments and write-offs can impact CAR. Following the global financial crisis, the Basel Committee on Banking Supervision at the Bank of International Settlements provided regulatory guidelines for CAR and introduced other ratios such as CET1 ratio, the net stable funding ratio, and the leverage ratio.

As at June 30, HSBC Holdings’ CET1 ratio is at 15% while that of Standard Chartered Bank is at 14.3%. Both banks are regulated by the Prudential Regulation Authority, which is part of the Bank of England. The UK regulator has also strongly advised banks to withhold dividends and suspend share buybacks this year, and to use their capital to support businesses and the community.