The primary demand from policy makers to banks is to preserve capital to maintain a constant flow of lending to the real economy and minimise the depth of disruption caused by this crisis. Investors will likely not be expecting much of a payout given events of the past few weeks, but withholding dividends under cover of widespread supervisory pressure and peer-group action will be easier to deal with.

Withholding dividends as a result of supervisory pressure goes beyond the question of investor expectations. In a letter to ECB Supervisory Board chair Andrea Enria widely reported in the media, the European Banking Federation noted that decisions by banks to suspend 2019 dividends should take into account investor perceptions of the solvency of the European banking sector. This is a critical point.

The ECB’s steer, however, is crystal-clear. In its FAQs on supervisory measures being taken in reaction to coronavirus, the Bank said: “the relief banks get from the measures adopted needs to be used to finance the economy and absorb possible losses, not to increase remuneration or the distribution of dividends”. The ECB is not formally requiring banks to suspend or reduce dividend distributions or buy-backs, but it is expecting banks “to take prudent decisions in light of the deteriorating economic outlook”. This guidance has been supplemented by similar communications from banking supervisors across Europe.

"In an 11 March report (COVID-19 impacts on European banks: pre-existing health conditions matters), Scope touched on the emerging issue of dividends: “The heightened level of uncertainty may cloud the outlook for dividends and buybacks, which had emerged as a pivot in the bank equity story in recent months,” wrote Marco Troiano, deputy head of financial institutions at Scope. “We expect the recent leeway some banks gained with respect to increased capital distribution (via buybacks and higher dividends) may be reduced, at least while the emergency is ongoing”.

Unintended consequences

But there could be a flip side. Some investors will focus on the long-term ability of banks to return capital so will look through any temporary payout suspension if they believe long-term returns are sufficient. But others may view withholding returns as undermining the investability of banks – just when banks most need support in their equity and AT1 capital. Depriving institutional investors of returns could divert the flow of capital to other investment sectors, especially institutions that depend on investment returns to meet pension, insurance and other liabilities.

“We expect banks to be very careful with capital distributions in this environment. However, steady returns on capital – AT1 securities in particular – are an important factor in reducing the cost of capital of a utility-like banking sector with very low growth prospects, and thereby facilitating access by businesses and households to bank lending,” said Dierk Brandenburg, head of the financial institutions team at Scope Ratings.

A utility-like sector like banking might reasonably be expected to offer utility-like constant returns. But in the face of crisis-induced dividend suspensions, banks will have no option but to hold out instead the prospect of future returns. In this regard, rising credit spreads and a yield curve that has steepened ahead of massive government bond issuance could be good for future bank earnings and therefore future investment returns. The pessimistic scenario is that imploding inflation expectations will lead to Japanification – that is, stagnant returns today and in the future.

European banks are reviewing their positions on dividend payments. Santander said its board had agreed to consolidate any dividend from 2020 earnings into a single final proposed dividend, to be submitted to the AGM for approval in 2021. The November 2020 interim dividend was scrapped.

Commerzbank and Aareal Bank have said they will continue with their annual dividend proposals, though they could yet be scrapped before the respective AGMs later this year. Svenska Handelsbanken’s AGM approved the board proposal that no resolution regarding the dividend be made but be postponed until after the summer. An EGM will be held in November at which the dividend will be addressed.

SE-Banken said the board will analyse the situation before evaluating a dividend proposal for 2019. Danske Bank said that its 2020 AGM will be called when possible, and the board will monitor the situation closely and reassess what it will propose for payment of dividends.

Caixabank is reducing its proposed 2019 fiscal year cash dividend from 15 cents to seven cents, while the 2020 dividend policy is being altered from a cash pay-out of more than 50% of reported earnings to a cap of 30%. The bank pointed out that a large part of its dividend goes to La Caixa Foundation, whose welfare projects conduct medical research and research into the well-being of the elderly. The board said it intends in future to return capital above a 12% CET1 ratio in the form of special dividends and/or buybacks, subject to a prior return to economic normality, but not before 2021.

Author: Keith Mullin: k.mullin@scopegroup.com