Shareholders look for a combination of growth, income and total shareholder return. Year to date, DBS’s share price has gained 17.5% versus Oversea-Chinese Banking Corp’s 8% and United Overseas Bank’s 6.9%. It is difficult to say how much DBS’s share price will adjust, once the stock goes ex-dividend on May 3.
Chng Sok Hui, group chief financial officer at DBS, says core dividend will rise to $1.20 a share for FY2018, representing a payout ratio of around 54%. DBS’s earnings would have to grow to $5.8 billion to meet that payout ratio. The bank’s largest shareholder is Temasek Holdings with 29%.
By comparison, UOB declared a special dividend of 20 cents a share and a final dividend of 45 cents a share, taking its total dividend to $1 a share for FY2017. It will be paying out about $1,661 million in dividends compared with $1,135 million in FY2016, an increase of 46% and a payout ratio of 49%. The increase is large, but nothing as spectacular as DBS’s, and shareholders can opt for scrip if they so choose. UOB’s major shareholders are the families of Wee Cho Yaw with 18.13% and the late Lien Ying Chow with 5.15%. UOB has guided for a core dividend of 80 cents a share for this year.
OCBC’s final dividend was the most parsimonious of the local banks. It raised its final dividend by a mere cent, and its payout ratio was 37%, making it the lowest among the banks. It will be paying out $1,548 million, up 2.86% y-o-y. Yet, OCBC’s net profit rose 19% y-o-y to $4,146 million for FY2017.
In order of net profit growth, OCBC’s was the highest for FY2017, followed by UOB, which reported a 9% rise in net profit to $3.39 billion, while DBS’s net profit rose 4% to $4.37 million. As a comparison, HSBC Holdings on Feb 20 announced that its final dividend would remain unchanged. It paid total dividends of US$10.5 billion ($13.8 billion) in FY2017, representing a payout ratio of more than 100%. Its reported profit attributable to shareholders for FY2017 was US$9.68 billion. (The comparison with FY2016 is not meaningful because of the write-offs and one-off charges in that year.) Seen in that respect, DBS’s dividend payout ratio is not remarkable.
DBS’s (gross) loan growth for FY2017 increased 7.3% y-o-y to $327.8 billion. It now has the largest market share in mortgages at 30% of the local market. Its housing loans, which are largely Singapore-based, grew almost 14% y-o-y to $73.3 billion. Last year, DBS consolidated the retail business of Australia and New Zealand Banking Corp, which it acquired in 2016, and that helped to boost loan growth.
OCBC reported loan growth of 7.8% last year, while UOB’s loan growth came in at 4.6%. Both banks have an expanding regional footprint. OCBC has subsidiaries in Indonesia and Malaysia, while UOB has wholly-owned subsidiaries in Indonesia, Thailand and Malaysia. Both banks were also awarded foreign banking licences in Myanmar in 2015. Last year, UOB received a foreign-owned subsidiary bank licence in Vietnam.
UOB, OCBC conserving capital for growth
The CAR gives an indication of banks’ capital levels, and their vastly different payout ratios probably speak volumes about growth plans and use for capital over the next few years.
UOB has the highest “fully loaded” Common Equity Tier 1 (CET1) ratio among the local banks, at 14.7%. “That’s a good problem to have,” says Wee Ee Cheong, CEO of UOB. He plans to use the bank’s excess capital for growth this year. “We just opened our Vietnam office and a digital branch. Vietnam is a country that is growing [strongly]. We set up a total digital concept to enter the Vietnamese market. It has the youngest population base [in the Mekong delta]. They are digitally quite savvy, so we thought this is one way for us to enter the market,” he says.
On the wholesale banking front, UOB is planning to attract Vietnamese companies as customers and to enable cross-border flows from regional companies and MNCs going into Vietnam. “The cost of operating in Vietnam is more competitive compared with China. As a regional bank, we started our Foreign Direct Investment Advisory offices in 2011 to capture this regional footprint. The result has been very encouraging,” Wee elaborates. “From 2011 to now, we have been able to attract 1,600 companies with a deposit flow of $90 billion. These companies [are from] China, Japan, Korea and different parts of the world. They are talking to us because of our Southeast Asia footprint. They want to talk to one bank that can provide a regional solution. The traction is getting quite good and quite encouraging. And, especially with China’s Belt and Road Initiative, I believe the momentum is likely to [increase].”
Regional growth also forms an integral part of OCBC’s growth trajectory. In 2014, OCBC completed the acquisition of Wing Hang Bank. For FY2017, Wing Hang Bank reported net profit of $425 million, up 18% y-o-y, while loans rose 11% to $31 billion. “Wing Hang Bank’s earnings have been increasing, which is within our expectation, and 2017 was a good year for it in fee income,” says Samuel Tsien, CEO of OCBC, at a recent results briefing. “In the next three years, Wing Hang Bank will be our core business through which we will drive our business in the Greater Bay Area [GBA], which is the Chinese authorities’ term for nine cities in the Pearl River Delta plus Macau and Hong Kong.”
The Chinese authorities aim to turn the GBA into a more robust economic region to spur China’s growth, utilising the financial prowess of Hong Kong and the technological capabilities of Shenzhen and Guangzhou. “We are using Wing Hang Bank to be a core player in the GBA. That means we have to shore up its treasury, commercial banking and wealth management capabilities,” Tsien says.
Stable, sustained dividends
OCBC’s aim is to ensure stable, sustained dividends for its shareholders, and its dividend policy is a payout ratio of 40% to 50% of core earnings, Tsien notes. Also, the payout needs to be viewed in the context of total shareholder return, including retaining capital for growth. “We always [ask]: Do you need to have the capital to support the growth of the company and how do you see growth opportunities? We continue to see significant growth opportunities in each of our businesses in Singapore and overseas. Market opportunities will continue to be available and we would like to keep the capital to support those opportunities,” Tsien explains.
He goes on to elaborate that the need for capital depends on two factors. First, are there growth opportunities to deploy capital, at a return that is acceptable to investors? “Our view is there is enough organic opportunity in the market to allow us to deploy that capital efficiently for our shareholders.”
The second factor is whether you still see your business as a growth business such that you will look for additional opportunities. “For all of our business pillars — banking, wealth management and insurance — we see them as a growth business and we want to retain capital so that we can grow our franchise and give even higher returns on a consistent basis to our shareholders,” Tsien says.
In a nutshell, OCBC and UOB want to keep their capital to support growth. The next time the stocks in your portfolio pay a hefty dividend, it is worth questioning their objectives.
OCBC promises growth and dividends to shareholders
The capital adequacy ratio (CAR) and Common Equity Tier 1 (CET1) ratio are numbers closely watched by rating agencies and the investment community. During the global financial crisis, it turned out that several global banks had insufficient capital for the risks they took and had to be rescued by their governments. During the period when the US government implemented TARP, or the Troubled Asset Relief Program, and the European banks had to shore up their capital with rights issues and inflows of capital from sovereign wealth funds, the Singapore banks managed the come through relatively unscathed. Only DBS Group Holdings had a rights issue in 2009 (announced in December 2008) to raise $4 billion.
The comfort zone for CET1, according to Darren Tan, chief financial officer of Oversea-Chinese Banking Corp, is between 12.5% and 13.5%. Higher levels of CET1 mean that capital is not being efficiently deployed, Tan says.
No need to tap shareholders for growth
“For dividends, the approach we’re suggesting is one where they are sustainable and steady. Whether a company declares dividend or not goes back to the basic question of whether it can deploy the capital in an efficient manner and whether it can deliver returns to its shareholders with that capital,” Tan points out.
Another reason dividend has to be stable and measured is that OCBC would not want to tap its shareholders for additional capital should a growth spurt appear. The bank has guided on a loan growth of high single digits. “We’ve guided for a payout ratio of 40% to 50%, which translates into risk-weighted asset [RWA] growth of 6% to 7%, implying growth in underlying assets [including loans] at 10% to 12%, which would enable us to grow without tapping capital,” Tan elaborates.
“The answer to the question is we believe we can deploy capital more effectively to build up our business. The return [on equity] we delivered in the past year of 11.2% is more attractive and higher than that of 10% in the previous year. The ability to deploy capital in a more attractive manner for our shareholders is the dominant reason why we believe we do not need to declare any further dividend,” he says.
CET1 components
OCBC’s CET1 ratio rose 1.1% to 13.1% as at Dec 31, 2017, from 12% a year ago. Roughly half of the increase came from a decline in RWA for Bank of Singapore. The change to an “internal ratings-based” (IRB) system of assigning risk weights lowered RWA.
The other half of the 1.1% gain in CET1 was from Great Eastern Holdings. For 2018, OCBC also resolved the capital contribution for its 88%-owned subsidiary, which at one point was a concern among analysts, as OCBC was viewed as having to put up more capital for it.
The impact to capital contribution from Great Eastern Holdings is twofold. The first part is that the capital arising from Great Eastern will not be included in OCBC’s capital calculations. (Great Eastern’s CAR is in excess of 200%.) The deduction of Great Eastern’s capital from the OCBC group’s capital is based on the cost of the investment itself, so long as OCBC does not increase its investment in Great Eastern.
The second part of the Great Eastern impact is that the corresponding RWA from Great Eastern is also taken out of the OCBC group. “[This is] why when you look at the details of the financials in terms of capital, it’s a decline despite earnings increase, and in terms of RWA, there is a net reduction (see table). The net effect is the capital deduction for the [banking] group as a whole will not change, as long as there is no increase in [the investment in Great Eastern],” Tan explains.
In addition, foreign subsidiaries are not likely to be a drag on capital. Previously, the foreign exchange used for banks’ overseas operations would carry risk weights and require additional capital; now, that foreign exchange will not be considered part of RWA.
In the next two years or so, OCBC is likely to shore up its CET1 further. Wing Hang Bank is likely to move towards the IRB approach from what is now termed a standardised approach (SA). Capital requirement for credit risks under the IRB system can be decreased if the company shows that its actual risk level is lower than what was indicated under SA. Once Wing Hang Bank moves towards the IRB approach, its RWA could decline and the OCBC group could save more capital. “What may be on the horizon is the IRB for Wing Hang Bank, but that may not happen for 12 months,” Tan says.
Retained earnings are also a major component of CET1. “The capital we manage is from organic growth, which would allow us to capture growth opportunities without tapping capital inorganically,” Tan says.
Shareholders of OCBC should be content that theirs is a growth stock, despite being disappointed that dividends rose a mere one cent a share.
