Bank investors have a lot to look forward to if no black swans appear on the horizon. If FY2019 was a normal year, FY2020 is likely to go down as peak provisioning and a trough for earnings. FY2021 should be better than FY2020, but unlikely to match FY2019. Here is why.
A common theme running through the FY2020 ended Dec 31, 2020, results of the three local banks — and foreign banks — is that the impact of peak Covid-19 on the global economy is behind us. This suggests that credit costs and allowances for problem loans — be they through general provisions or specific provisions — are likely to have peaked.
Allowances for this year, their FY2021, are likely to be lower, with banks’ management guiding either the lower or mid-range of the ranges they guided last year. Hence, if pre-provisioning operating profit remains the same as FY2020, profit after tax and allowances is likely to beat last year’s levels. And this holds true for the three local banks.
But, even if net profit levels are likely to rise this year compared to FY2020, they may not get back to FY2019 levels unless the banks start writing back some excess provisions such as their management overlays. This may not materialise till FY2022 though. In sum, this year is likely to be better than last year, but not as good as FY2019.
The other area of focus for investors is dividends. Currently dividends are capped at 60% of FY2019 levels by the Monetary Authority of Singapore. “We were asked to hold dividends at this level for four quarters including the end of the first quarter. However, in several other jurisdictions, the regulators have started relaxing restrictions on returning capital to shareholders,” says DBS CEO Piyush Gupta, during DBS Group Holdings results briefing on Feb 10.
“It is possible the MAS might take that view as well, but it is equally possible that the MAS could maintain their prior guidance given that they had been relatively lenient on these restrictions as compared to other regulators. Nonetheless, we have always maintained that we have the capacity to pay more dividends,” he adds.
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DBS, which pays dividends quarterly, paid out 18 cents for 4QFY2020, taking full-year dividends to 87 cents representing a payout ratio of 46.8%. From 2QFY2020 onwards, DBS’s dividends have been capped at 60% of FY2019’s.
Samuel Tsien, outgoing CEO at Oversea-Chinese Banking Corp (OCBC), says that its final dividend is also governed by guidance from MAS. “We do not know when [the cap on dividends] will be lifted and we hope it will be lifted as dividends are a way to reward our shareholders,” he says adding that he is monitoring global jurisdictions.
For instance, HSBC Holdings which was asked to halt share buybacks and dividends by the Prudential Regulation Authority in the UK, has resumed dividends and share buybacks this year.
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“Dividend declaration and capital adequacy ratios (CAR) depend on growth. In the event there is a strong recovery as there was after the Global Financial Crisis, then we will look at how to deploy capital to take advantage of growth opportunities,” Tsien says. A portion of net profit accretes to capital, hence banks have a certain dividend payout ratio.
OCBC’s payout ratio for FY2020 is 39% and its full-year dividend of 31.8 cents is 60% of FY2019’s full-year dividend of 53 cents. Unfortunately, for the 2H2020 scrip dividend, OCBC’s board decided against giving a discount.
As at Dec 31, 2020, OCBC’s common equity tier 1 (CET1) capital was 15.2%, the highest among the local banks. Meanwhile, the CET1 of DBS and United Overseas Bank’s (UOB) stood at 13.9% and 14.7%.
Lee Wai Fai, group chief financial officer at UOB, points out that the banking group will resume a payout of 50% of profits once the regulatory cap is lifted. For FY2020, UOB announced a dividend of 39 cents in 2HFY2020, taking dividends for the full year to 78 cents, or a 45% payout ratio.
Lower allowances, higher profits
It is increasingly clear that the local banks have managed their portfolios diligently, and are now guiding for lower provisions this year. During DBS’s results briefing, Gupta guided on allowances for 2021. “We gave guidance last year that total allowances will be in the $3 billion to $5 billion range [for 2020–2021]. Assuming that we end up at the middle of our guidance, which is $4 billion, then we have already taken the majority of total allowances in 2020, which is $3.07 billion. So, this year we may end up taking another $1 billion of incremental provisions, which is what we do in a normalised year,” he said.
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In FY2020, DBS reported a 26% y-o-y decline in net profit to $4.72 billion, largely because allowances surged to $3.07 billion. However, profit before allowances rose 2% to a record $8.43 billion. If allowances decline significantly to $1 billion or lower this year and profit before allowances is maintained at $8.43, DBS’s net profit in FY2021 would be $2 billion higher than FY2020’s level.
Over at OCBC, Tsien guided that he expects total credit costs at 33 basis points of loans, or around $880 million, compared to the $2.043 billion in FY2020. Of this, $864 million was in general provisioning. “We expect over two years, total credit costs of 100 basis points to 130 bps. We would likely end up at the lower end of that range. We’ve taken 67bps last year, and have 33bps left,” Tsien says.
OCBC reported a full-year net profit of $5.586 billion for FY2020, down 26% y-o-y. Operating profit before allowances was $6.312 billion. Hence if operating profit remains the same, lower allowances would lift net profit in FY2021.
UOB reported a 33% y-o-y decline in net profit to $2.91 billion in FY2020. Operating profit before allowances for the year was $4.99 billion. UOB’s total allowances were $1.55 billion, of which $900 million was in general provisioning.
Wee Ee Cheong, CEO of UOB, says, “We are targeting a rebound in profits driven by high single-digit loan growth, double-digit growth in wealth management fees, lower cost-to-income ratios (CIR) and lower credit costs.”
Management overlays provide potential for write-backs
Stages 1, 2 and 3 of a bank’s ECL (expected credit loss) depend on macroeconomic variable (MEV) models. Hence the ECL framework tends to be pro-cyclical. Conservative lenders such as the three local banks can provide for management overlays, which are amounts set aside over and above what their MEV models indicate or dictate for ECLs. Banks could write back these into their profit and loss statements when MEV models turn more positive.
Write-backs are unlikely in 1HFY2021, or even FY2021 though. However, credit costs are likely to abate. For local banks, this is the first crisis they have experienced under International Financial Reporting Standard (IFRS) 9, and banks are reluctant to commit to write-backs. Under IFRS9, if any loans go into special provisioning, now known as ECL stage 3, 60% to 70% of the special provisioning comes from general provisioning, which are reversed out of general provisions. Some US banks chose to start writing back reserves in the fourth quarter on the back of improved macroeconomic conditions but they are on a different financial reporting standard.
“We opted not to do that. Our view was that we could use the fourth quarter to further fortify our balance sheet so that any potential vulnerabilities this year would have to be provisioned for in 2020. We thus increased our general allowance reserves in the fourth quarter,” Gupta indicates.
Over at OCBC, Tsien says: “We will have to look at market developments if as expected there will be lower credit costs. If the market performs better and the recovery is strong in the second half of this year, there is the possibility of that, but we do not want to make that forecast.”
Lee of UOB says, “Our stand for this year is we are optimistic but we’re still cautious. Our base case is not to reverse provisioning but to reduce credit costs.” He is guiding some 30bps in total credit costs this year, or around $870 million.
“We’ve a lot of management overlay, of $1 billion. We might have to take a look at that [for write-backs],” Gupta says. “There is scope for reversal but it’s not baked into our plans.”
Lee says UOB’s management overlay is more than $1 billion while OCBC’s management overlay is $405 million. OCBC has a further $874 million in regulatory loss allowance reserve (RLAR). UOB’s RLAR as at Dec 31, 2020, stood at $379 million. RLAR is a non-distributable reserve appropriated through retained earnings to meet regulatory requirements.
Return to growth
In the short term, the local banks look set to return to growth — with net profits rising because of reduced allowances, and the likelihood of income growth, from a rebound in loan growth, and the continued expansion in fee income.
Geographically, though the three banks have diverged. DBS, with the amalgamation of Lakshmi Vilas Bank (see sidebar), sees potential in India — both in its domestic market and the trade and investment flows between India and Southeast Asia.
DBS is also focused on its digital exchange, digitalising the supply chain including trade finance, its retail wealth management business, and leveraging on a recent Chinese securities joint venture.
OCBC and UOB view trade and investment flows between North Asia and Southeast Asia as continued growth opportunities. OCBC has an increasing focus on Greater China. Its profit has the least contribution from Singapore, at just 44% in 4QFY2020. OCBC Wing Hang, which it acquired in 2014, saw a 7% y-o-y rise in profit to HK$2.49 billion in FY2020.
Referring to OCBC’s CET1 of 15.2%, Helen Wong, incoming group CEO at OCBC, says, “It’s too early to talk about how we’re going to utilise our very strong capital. We do not have any M&A plan under review but would want to look at emerging opportunities in this region.”
“Although Hong Kong is facing a pandemic, it continues to be an international financial centre. Its financial services sector remains healthy and continues to be an important fund-raising centre for Chinese corporates as they embark overseas. The connect programme between Guangdong, Hong Kong and Macau will offer high potential. We are not going to change our Greater Bay Area strategy but will look to put in more resources and we’re looking at higher targets,” Wong adds.
UOB remains focused on Asean, and facilitating trade and investment flows between North Asia and Asean, and intra-Asean, through its FDI (foreign direct investment) Advisory offices in the region. According to Wee, UOB has helped more than 3,500 customers grow regionally through its FDI Advisory unit.
In addition, its digital-only bank TMRW launched in 2019 in Thailand, and last year in Indonesia, enabled it to garner an additional 300,000 customers, of which more than a quarter transact more than four times a month. “TMRW accounts for 26% of our retail base in Indonesia and 12% in Thailand,” says Wee of UOB
