During the peak of the COVID outbreak last year, MAS imposed dividend caps on the three banks, where they are allowed to pay only 60% of their FY2019 dividends per share. Fast forward to today, investors are starting to anticipate the easing of restrictions on the Singapore banks’ dividends.

Ferlyn Tan |  Published on 02 Jul 2021

• During the peak of the COVID-19 outbreak last year, MAS imposed dividend caps on the three banks to ensure that they have sufficient capital to weather through an economic downturn.

• However, at the beginning of this year, some regulators have announced their plans to relax the restrictions placed on their banks’ capital return programmes. 
• In light of these events, we believe there is a good chance that the dividend restrictions may be lifted as soon as this year. 
• Looking ahead, we also believe that the trio remains in a good position given the brighter economic outlook ahead. 
• We maintain our positive stance on the Singapore banking sector. We favour OCBC (SGX:O39) and UOB (SGX:U11) over DBS (SGX:D05) given their more attractive valuations. 
During the peak of the COVID-19 outbreak last year, the MAS imposed dividend caps on the three largest local banks to ensure that they have sufficient capital to weather through an economic downturn. The three banks were requested to cap their FY2020 dividends per share (DPS) at 60% of their FY2019 DPS and offer their shareholders the option of receiving scrip dividends instead of cash.  
This is not uncommon, given that regulators in other countries have also urged their banks to cut dividends and suspend share buybacks during the same period. 
However, at the beginning of this year, some regulators have announced plans to relax the restrictions placed on their banks’ capital return programmes. For example, the European Central Bank has allowed European banks to resume dividend payouts and share buybacks, albeit with limitations. Meanwhile, the Fed announced that it will allow large US banks to increase their dividend payouts and share buybacks as long as they pass the annual stress test. As of 25 June 2021, all 23 large US banks subjected to the stress test have easily passed, which means that the additional restrictions put in place during the COVID-19 crisis will be lifted, paving the way for banks to return capital to their shareholders.

Will dividend restrictions on Singapore banks be lifted soon?

In light of these events, investors are starting to anticipate the easing of dividend restrictions on Singapore banks. As of 30 June 2021, it was reported that MAS is currently conducting additional stress tests on the three banks to assess whether dividend restrictions need to be extended.
In general, we believe there is a good chance that dividend restrictions may be lifted as soon as this year. The three banks had already front-loaded a huge amount of allowances for loan losses in 2020. Therefore, we can expect to see strong earnings recovery as loan loss provisions normalise in the next two years, a development that will support the banks’ capital positions, which is a key indicator that determines whether they have sufficient capital to return to pre-COVID payout levels. 
If they were to resume back to pre-COVID common dividends levels, it will only shave off approximately 90bps to 110bps from the banks’ current CET1 capital base. Based on their latest capital positions, it is clear that the three banks have adequate capital to resume their pre-COVID dividend levels (Table 1).
Therefore, given the brighter economic outlook and coupled with the fact that various central banks are also relaxing their dividend restrictions, we believe MAS could gradually ease its dividend restrictions on Singapore banks.

Singapore banks remain in a good position given the brighter economic outlook

Looking ahead, we believe that Singapore banks remain in a good position given the brighter economic outlook. Firstly, we believe that interest rates should start to increase in the coming two years. While the Fed has initially guided for no rate hikes until at least 2024, it surprised investors in the latest Fed meeting by raising its inflation forecast and bringing forward its timeline for an interest rate hike.
The Fed now sees two rate hikes in 2023, according to its dot-plot projections, and there was also an increasing number of Fed members expecting the central bank to hike rates as soon as 2022. As more than 50% of the three local banks’ revenue still come from net interest income, which is closely correlated with the interest rate environment, an interest rate hike will be a strong earnings driver.
Secondly, as discussed in our previous article, the three banks are expecting a mid-single-digit loan growth on average this year. This will further support their net interest income (Chart 1). Besides, we also see room for upgrades in Singapore’s GDP estimates as the current social distancing measures are lifted. An acceleration in vaccination rates and loose monetary conditions will also support economic activity in Singapore, which will in turn, drive further loan growth for the three banks. 

Chart 1: Loan growth for the three banks in the next two years 

Finally, we also see room for growth in the banks’ fee income (non-interest income), particularly wealth management fees and card fees. Given how the wealth management industry in Asia-Pacific is projected to maintain a robust pace of growth, coupled with the fact that the three banks are focused on building up their AUM, we believe wealth management will continue to be a key growth driver for the banks. Meanwhile, consumer spending is also expected to return as Singapore’s economic recovery picks up steam, which will support the banks’ card fees. 

Decent upside potential for the Singapore banks

At this juncture, investors should be aware that another spike in COVID-19 cases will likely cause another shock to the economy and the banks’ share prices. When that happens, tighter social distancing measures will likely be imposed again, and this will inevitably weigh on Singapore’s economic recovery. Many companies may not be able to withstand another shock as they have already been struggling to stay afloat amidst the current challenging business environment. In the worst-case scenario, loan loss provisions may surge again, and this will hurt the banks’ earnings. 
While we keep in mind this potential risk, we believe that the three banks are in a good position to ride out the COVID-19 crisis as the world continues to make steady progress in vaccination roll-outs. We maintain our positive stance on Singapore banks, as they are expected to see strong earnings recovery in the next two years, led by lower credit costs, higher loan volumes, growth in fee income, as well as potentially higher net interest margins. 

We favour OCBC (SGX:O39) and UOB (SGX:U11) over DBS (SGX:D05) given their more attractive valuations. We maintain our target price for the two banks, which have an average upside potential of about 11% in the next two years. Should MAS revisit its previous decision to cap dividends, investors can also expect higher dividends ahead, with OCBC and UOB potentially offering dividend yields of about 5%.

Declaration:
For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.