As the interest rate outlook and growth becomes more uncertain in Asia, shareholder returns in the form of dividends and, in the view of analysts, share buybacks, are likely to be increasingly key in stock selection for banks.
According to a JP Morgan report dated April 18, banks’ ability to increase shareholder returns would depend on their capital buffer, internal capital generation capability and potential regulatory changes on capital management.
Hong Kong, Malaysian and Singapore banks have higher regulatory capital buffer than peers at status quo.
“We will mainly examine banks’ ability to increase shareholder returns by looking at their capital buffer, internal capital generation capability and potential regulatory changes on capital management,” JP Morgan says.
“Aside from examining banks’ current capital buffer, we will also assess banks’ ability to support future growth. Here, we calculate banks’ internal generation by looking at ROE excluding dividend and share buyback,” JP Morgan says. The formula is (ROE *(1-dividend payout ratio – Share buyback/profits)).
Using this formula, Singapore banks could well see “upside risk” on capital return as risk-weighted asset (RWA) growth is expected to be -5.8% y-o-y in 2024, JP Morgan estimates.
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Banks which are likely to experience RWA growth are likely to see limited dividend payouts and/or share buybacks. CET1 ratio is the ratio of common equity divided by RWA. RWA can increase or decrease depending on the risk weights for a bank’s loans and other assets. According to the report, Malaysian and Japanese banks may see higher RWA growth.
All three local Singapore banks have articulated clear dividend policies. United Overseas Bank U11 and Oversea-Chinese Banking Corp have announced payout ratios of 50%, and OCBC’s group CEO Helen Wong has said that she prefers to reward shareholders with dividends rather than share buybacks.
However, although OCBC has the highest CET1 ratio, and it has increased its dividend payout ratio to 50%-53%, JP Morgan prefers DBS Group Holdings as it has articulated a clear capital return policy through dividends. “We also prefer UOB vs OCBC given stretched relative valuation,” JP Morgan says. “The catalyst would be positive NIM surprise at UOB while a disappointment at OCBC [could arise] given higher rates sensitivity and bigger HIBOR exposure.”
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Separately, UBS says the higher for longer Federal Reserve stance on the Federal Funds Rate is likely to have a “twofold” impact on the local banks. First off, equity risk premium would probably rise as risk-free rates rebound. This has materialised in the US where equity prices have fallen on the back of higher yields on 10-year US treasuries.
On the other hand, the impact on earnings could be positive, UBS reckons as NIM would stay relatively resilient. While elevated interest rates would impact NIM positively, they are likely to have a negative impact on loans growth and possibly credit costs.
“We generally remain comfortable on asset quality given banks have around 70 bps of excess provisions to buffer asset quality stress; and several datapoints that we track closely are still not showing alarming trends yet. As such, we do not expect credit costs to be a drag for now. In terms of earnings sensitivity, we believe every 10bps increase in credit costs would have a negative 3- 4% impact on EPS,” UBS calculates.
Overall, UBS expects investors to be focused on NIM and asset quality. “We think there is a possibility that UOB surprises positively on NIM relative to peers given steps to lower funding costs (UOB lowered wholesale deposit rates in Q1); low bar for surprise following a disappointing guidance in 4Q2023; and its management appears to be more comfortable on the liquidity environment currently which could mean lower funding pressure ahead,” the Swiss bank says.
