For banks, the relationship between earnings growth, net profit, capital ratios, use of capital and Basel III reforms impacts dividends, capital management and share price.
Notwithstanding Asia’s reaction to the US elections, as at Nov 8, the local banks are up 29.5% on average in share price performance since the start of the year. Along with their generous dividends, banks have returned 36.8% on average this year. At the close of Nov 8, DBS Group Holdings, United Overseas Bank U11 (UOB) and Oversea-Chinese Banking Corporation (OCBC) returned 46.1%, 32.8% and 31.4%, respectively.
Among the analysts, UOB is the favourite with a rating of 4.33 out of five, comprising 13 “buy” calls, five “hold” calls and no “sell” calls. DBS has a rating of 4.11 with 10 “buy” calls, eight “hold” calls and no “sell” calls, followed by OCBC, rated 3.89 with nine “buy” calls, nine “hold” calls and no “sell” calls.
All three banks have articulated a dividend payout policy of at least 50%, returning some net profit to shareholders and retaining some net profit for growth and black swans. Additionally, banks have a share buyback programme, mainly to provide shares for employees’ share option schemes. For this purpose, when banks buy back their shares, they are not cancelled but redistributed.
On Nov 7, DBS announced its board had established a new share buyback programme of $3 billion. Under the programme, shares will be purchased in the open market and cancelled. The buybacks will be at management’s discretion and subject to market conditions. Share buybacks that result in cancelled shares should be earnings accretive and improve return on equity (ROE). Nonetheless, DBS is trading at an all-time high, with the highest market capitalisation for any Singapore company.
Next year, UOB celebrates its 90th anniversary. For its 80th anniversary in 2015, UOB announced a special dividend of 20 cents per share. When asked about a special dividend during 3QFY2024 ended September results briefing on Nov 8, deputy chairman and CEO Wee Ee Cheong smiled and said UOB’s 90th anniversary is unique, adding, “I hope so”. UOB’s dividends are a board decision. Although representatives of the Wees and the Lien family, the bank’s largest shareholders, are on the board, seven out of 10 are independent directors.
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At any rate, UOB’s net profit for 9MFY2024 ended September, including the impact of Citi integration costs, is up 5% y-o-y to $4.522 billion. This compares with UOB’s FY2023 net profit of $6.06 billion. Lee Wai Fai, UOB’s group CFO, has said the integration costs for the bank’s 2022 acquisition of Citigroup’s retail business in Malaysia, Thailand, Indonesia and Vietnam are tapering off, with Vietnam yet to be fully integrated.
The taper was felt in UOB’s 3QFY2024 results, with net profit, including integration costs, rising 13% q-o-q and 16% y-o-y to $1.61 billion. If this momentum is maintained, UOB’s dividends should continue to rise.
B3R and dividends
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The fully phased-in Basel III reforms (B3R) focus on the denominator of the capital ratio. This refers to the risk-weighted assets (RWA) that measure a bank’s risk positions, especially in credit, market, counterparty and operational risk.
The Basel II Accord implemented in 2006 enabled banks to move towards internal ratings-based (IRB) approaches. The internal models allow banks to estimate the risk themselves. IRB programmes are tailored to individual banks and enable risks to be measured more accurately. They allow banks to calculate parameters such as the probability of default (PD) for a loan within the tenor. The more risks a bank has, the more capital it needs to compensate for higher RWA.
After the Global Financial Crisis, regulators such as the Basel Committee on Banking Supervision (BCBS) believed that the same risk positions were valued too differently by the banks’ internal models compared to valuations made using comparable standards. So, under B3R, a capital floor has been recommended to limit capital savings from internal models.
Before July 1, UOB had the highest RWA density, followed by DBS, then OCBC. Similarly, pre-floor, UOB has the highest RWA density, followed by DBS and then OCBC implying that UOB is closest to the post-floor RWA, analysts suggest.
In 1HFY2024, UOB announced a dividend of 88 cents compared to 85 cents in 1HFY2023. The dividend for 2HFY2024 is likely to be 88 cents or higher, given that UOB’s Common Equity Tier-1 (CET-1) ratio is based on fully phased-in B3R at 15.2% compared to its transitional 15.5%.
In 3QFY2024, OCBC’s pre-floor CET-1 was 17.2%, and CET-1 based on fully phased-in B3R was 15.6%. DBS’s pre-floor transitional CET-1 in 3QFY2024 was 17.2%, and its fully phased-in B3R was 15.2%.
Lee explains: “Banks have their models. Basel wants us to standardise to avoid big variations [in risk weights]. Basel sets a floor based on standardised prescriptive parameters. If you’re very aggressive, your RWA will be lower, and the final phased-in [reform] has a floor at 70%. You must move your RWA [higher] if you are below that. We are probably more conservative in the models and have been positioning them for this new regulation, so we are less affected.”
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Mathematically, UOB’s FY2024 dividends should be at least $1.76 per share compared to $1.70 in FY2023, assuming it shows some net profit growth this year. A decade ago, UOB’s anniversary dividend was a modest 20 cents, while UOB’s interim and final dividends were 35 cents per half year or a total of 70 cents.
Lee says UOB has excess capital of around $2.5 billion “to grow and partly return to shareholders”. With this, UOB’s anniversary dividend could be around 40 cents or more.
Such a special dividend would cost around $669 million.
OCBC’s excess capital
During OCBC’s results briefing on Nov 8, management was asked about its capital management initiatives. Based on its Pillar 3 disclosures for 3QFY2024, its fully phased-in B3R CET-1, its transitional CET-1, and its 1HFY2024 CET-1 ratio of 15.5%, OCBC is likely to have excess capital of more than $3 billion if it plans to keep its CET-1 ratio “minimally at 14%” and assume no net profit growth. OCBC’s 9MFY2024 net profit grew 9% y-o-y to $5.9 billion.
In February 2023, group CEO Helen Wong changed OCBC’s dividend payout ratio to 50%. In 1HFY2024, OCBC announced an interim dividend of 44 cents per share. Based on its 3QFY2024 profit growth, OCBC should announce a final dividend of at least 44 cents, barring a black swan event.
“We have always been saying that we want to have our CET-1 at about 14% minimally over the medium term. This is because that was the expectation conveyed to us by rating agencies for AA-rated banks. We want to maintain our AA rating,” says Goh Chin Yee, group CFO, OCBC.
“Capital planning is to have enough capital to support our franchise growth. As outlined in our corporate strategy, we have many growth ambitions and several exciting plans in the pipeline on how we can use capital going forward,” Goh elaborates. Additionally, she cites uncertainties. As it is, global tensions may further ratchet up over trade wars and tariffs.
Goh also points out OCBC’s inorganic moves in the past year or so, such as the use of capital. These include its acquisition of PT Bank Commonwealth in Indonesia, Great Eastern Holdings G07 ’ acquisition of AmMetLife Insurance and OCBC’s acquisition of Great Eastern.
“Share buybacks and cancelling the shares is one of the capital management tools that can be used alongside delivering dividends. For us, looking at share buybacks depends on the situation. We have a share buyback programme, but it is to meet our employee share plan,” Goh says. CEO Wong has gone on record as saying she prefers dividends to share buybacks.
On Nov 7, Chng Sok Hui, DBS’s group CFO, was quick to point out that DBS can well maintain its 54 cents dividends per quarter even if net profits don’t grow. This is because the 3QFY2024 payout was 50%, which can be raised by a few percentage points.
Is DBS likely to announce a special dividend versus share buybacks? Gupta says: “We have choices. And as we go forward, we still have a lot of capital to return. We have from $3 billion to $5 billion or more of capital to return even after this. We will use all three engines, step-up dividends, special dividends and buybacks, to the extent we can. A couple of quarters ago, we even used the bonus issue to return some dividends to shareholders.”
Analysts often prefer share buybacks to dividends and ask management of big-cap companies, including REITs, about them. Why does this happen when institutional and retail investors prefer dividends?
“Long-term investors may prefer share buybacks. Investors outside of Singapore may have to pay withholding tax on dividends. We have to look at the interests of all our institutional and retail investors,” Lee says. As a case in point, US investors have a 30% withholding tax on dividends.
Minimum global tax
On Nov 7, DBS announced that its FY2025 net profit may not match its FY2024 net profit because of a possible $400 million tax charge. “The net profit is likely to be slightly lower because of implementing the global minimum tax of 15%. If we factor that in, we might see a bit of a drag on the bottom line,” Gupta acknowledges.
The minimum global tax compliance starts on Jan 1, 2025, for countries with tax rates below 15%, as their tax rates will have to be raised. According to Goh, the three countries relevant to OCBC are Singapore, Macau and the UAE. “There are incentives in Singapore, depending on activities. We have the financial services incentive. Because of the blend of our revenue mix and countries that we operate in, the impact will not be overly significant when this takes effect,” she explains.
In Singapore, tax rates under the financial incentive scheme range from 5% to 10%. On a blended basis, OCBC’s tax rate is around 14%. UOB operates in jurisdictions with higher tax rates than 15%; hence, the new tax regime is unlikely to affect its net profit.
Credit costs
Each of the local banks had idiosyncratic issues in 3QFY2024. UOB had a problem in Thailand with the integration of the Citi portfolio. Some customers had multiple cards. When UOB changed the billing cycle, the unfamiliarity caused some defaults. In addition, Thailand increased the regulatory minimum payment from 5% to 8%. “We have stabilised Thailand. However, we deviated some resources to look at customer surveys rather than to chase payment, and some backlog started to build up. We’ve addressed customer issues, and we have fully recovered. Customers are paying on time,” Lee says. As a result of the Thai integration, In 3QFY2024, UOB’s specific allowances rose to 36 basis points (bps). However, Wee expects total credit costs for the full year to be within the 25 bps to 30 bps range, suggesting that the worst provisioning and write-offs are behind it.
OCBC had to make a provision for a property which Wong says was largely secured with a loan-to-value of below 50%. “We have reduced exposure to the Hong Kong office sector by 50% since September 2023. This is due to actively engaging clients and advising them to deleverage much earlier,” Wong says.
DBS, too, had a couple of issues. “We saw an increase in new NPA formation [from] two lumpy cases. One reflected an auto sector client where there was some misstatement of warranted financials. We’ve pretty much written that one-off. The other reflected prudential moving of a particular case into a non-performing loan [NPL],” Gupta acknowledged.
2025 outlook likely benign
The banks have learnt to balance the interest rate cycle, loan growth (or lack thereof), their own securities book, high-quality liquid assets (HQLA) and fees from their non-interest income business to ensure they can record some annual growth.
During the 2022–2024 interest rate cycle, banks leaned on their asset-liability management (ALM) to raise earnings. As interest rates turned volatile, banks were able to increase customer flows from their treasury and market operations. In 3QFY2024, trading income was derived from customers and the banks’ proprietary trading.
Gupta summed up the outlook as succinctly as the current global uncertainty allowed: “If there are fewer rate cuts, it could be that the Trump regime is more inflationary, with tariffs and deficit spending. If that is the case, then the Fed monetary policy might stay tighter than is currently being projected, and that helps our NIM,” Gupta says.
There might be some upside from DBS’s fixed asset book, which could get repriced higher, helping overall net interest income. At any rate, the banks have been conservative on loan growth, with UOB and DBS pointing to mid-single-digit growth next year.
“If rates stay high, loan growth might be a tad less in general, though sensitivity shows that we benefit more from the interest rate than we give up on the balance sheet, and when you put all of that together, I think higher interest rate environment is generally better for DBS,” Gupta says.
Perhaps that is where the outlook for banks stands, better than expected in 2025, but 2026 is anyone’s guess, as none of the CEOs have tiptoed into a Trumpian future.
