Dividends Aren’t Always a Reliable Guide to Bank Health

Investors need to look beyond the cash when restrictions are lifted on shareholder payouts from European banks

By Rochelle Toplensky

Dividend policies for European banks are likely to diverge in the coming months. 

Investors shouldn’t take a resumption of generous payouts as a sure sign of relative strength.

Bank regulators that banned dividends during the spring lockdowns are expected to announce this month whether they will allow them again. Among other options, they could wait until stress tests are completed next summer, allow capped payouts on a case-by-case basis or remove all restrictions. 

There will be useful signals in what officials decide, and how lenders respond. But there are other things to consider before following the cash.

European bank shares have rallied since the mid-November vaccine news but are still down more than 15% on the year. The ban on payouts helped build sizable capital buffers—about 40% of market capitalization, calculates Barclays. 

Most lenders are lobbying hard for a green light to restart payouts they hope will boost stock prices, and take some of the sting for investors out of the big bonuses that banks will pay after a banner trading year.

Vaccines have ignited recovery hopes, but great uncertainties remain: how we will work, what credit losses will be once government-support programs end, what economic scars the downturn will leave. Generous shareholder payouts next year could leave some lenders susceptible. 

Officials will look at capital adequacy, profitability and risk, but will also consider factors beyond banks: their regulatory risk appetite, the importance of dividends to local investors, the range of banks in their jurisdiction and the signal the policy will send.

Switzerland has the lightest touch of the big European jurisdictions, allowing 2019 dividends to be paid, albeit in two installments rather than one. Both big Swiss banks received permission to pay their second tranche and UBS seems likely to resume share buybacks next year too. They have been helped by a relatively strong domestic market, with gross domestic product down an annualized 1.6% at the end of September.

Likewise, the U.K. regulator never actually banned dividends. Rather, officials wrote sternly worded letters to British bank bosses recommending that payouts be canceled. 

It worked: No dividends were paid. But pressure has been mounting to ease the tacit restriction, given that British investors are unusually dividend-focused.

Payouts are expected to restart from early next year, but investors should be cautious. 

The U.K. has struggled with high Covid-19 infection rates and reported a 9.6% drop in annualized GDP for the end of September. There are tough times ahead: Britain switching from European Union trading rules to new deal terms in 2021 is expected to take 2.1% off GDP, or as high as 3.1% if there is no new trade deal, says the Institute for Fiscal Studies, a think tank.

In contrast, eurozone officials officially banned banks from paying dividend and bonuses earlier this year. They are also likely to be cautious in easing the restrictions. 

Regulators cover a range of economies, from Germany to Malta, and banks must contend with negative interest rates. However, annualized GDP was down a more modest 4.4% in the year to September and any Brexit impact is expected to be less significant than in the U.K.

Investors are in line for sweeter returns next year. While a Swiss decision to allow dividends seems a reliable all-clear signal, eurozone reluctance and British eagerness risk misleading those that don’t pay closer attention.

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