Helen Bradshaw, portfolio manager at Quilter Investors, suggests banks will be cautious about handing dividends to shareholders while the pandemic continues, after restrictions have been lifted today.
“The banking sector bore the brunt of the dividend collapse since the start of the pandemic as the regulator ordered banks to freeze dividends as an insurance policy against spiralling loan losses.
“In December, the PRA gave the banks the option of resuming dividends, but with some very large caveats or ‘guardrails’ in that dividends could not exceed either 20 basis points of risk-weighted assets, or 25% of cumulative eight-quarter profits for 2019 and 2020.
“Now the ‘guardrails’ have been removed the banks face no regulatory barriers to resuming dividends at levels they desire. The ‘guardrails’ were always intended to be a stepping-stone back to normality, but quite what ‘normality’ now looks like is a whole other story.
“While the banks have the green light to resume dividends, it is likely that caution will remain, and indeed guidance encouraged them to do so. While there is more certainty on the economic backdrop versus last December, we are not out of the woods just yet and precisely what happens after ‘freedom day’ remains a big unknown.
“In addition, as the government starts to withdraw its support packages, cracks may begin to show and a number businesses could struggle to find their own feet once again. This could lead to a tick up in defaults that the banks will need to absorb. While the lifting of restrictions is a positive development, the road back to normality could be bumpy. Dividends will remain under scrutiny.”
Simon Youel, head of policy and advocacy at Positive Money, argues it’s too early to lift dividend curbs, given the state of the economy:
“As ordinary people and businesses across the country have suffered the worst economic effects of Covid-19, banks have continued to rake in profits from government-backed loan schemes.
British banks have proved time and time again that they can’t be trusted to make sensible decisions to support the public interest, and will instead prioritise short-term returns to shareholders over communities and the real economy.
With unemployment expected to rise and a high level of economic uncertainty, it is concerning that the Bank of England has decided to pander to bankers and shareholders instead of preserving capital for lending to support the recovery.”
Experts have been ploughing through today’s Financial Stability report from the Bank of England.
Karim Haji, EMA and UK Head of Financial Services, KPMG, says the BoE seems cautiously optimistic about the health of UK banks, while worried about risk taking in the markets.
“The Bank is cautiously optimistic, relaxing rules on dividend payments whilst also giving the green light for banks to use their capital buffers to the fullest extent if that’s what it takes to keep supporting UK businesses. The decision to hold the countercyclical buffer ratio at 0% until 2021 – which with the implementation lag means the end of 2022 – will help ensure this remains a reality.
“After more than a decade of being told to build buffers, the instruction to use them has seemed a drastic shift but in reality few banks have needed to make a dent in their reserves. The scale of banks’ capital supports the confidence demonstrated in today’s report, with UK banks remaining resilient to more drastic hits to the economy than those forecast. That said, it seems notable that there is no warning of potential short term inflation in today’s report, this could be overly optimistic given the many compounding pressures that remain in light of the pandemic and Brexit.
“The evidence of increased risk taking in financial markets is clearly a significant concern to the Bank of England, which means firms need to ensure they have robust risk controls and governance around asset valuations and credit standards. The use of third party ‘critical’ technology providers is also firmly on the watch list and whilst it’s broadly recognised that a cross sector, cross border approach is needed, the realities of achieving that will be challenging to say the least.”
BoE: Housing demand may continue after stamp duty holiday ends
The Financial Stability Report also flags up that the UK housing market was its hottest in a decade in the last six months, saying:
House price growth and housing market activity during 2021 H1 were at their highest levels in over a decade, reflecting a mix of temporary policy support and structural factors.
Official data shows that house prices jumped by around 9% in the year to April, although more recent data from Halifax shows they dipped 0.5% in June.
Recent high levels of activity are likely to reflect in part a temporary boost provided by the stamp duty holiday, as shown by the peak in housing transactions completing in March 2021 ahead of its original deadline. They may also partially reflect structural factors such as households prioritising additional space to accommodate flexible working arrangements and increased savings accumulated during the pandemic, as well as the continued low interest rate environment. There are similar trends in some other advanced economies.
Other, timelier indicators of house prices than the UK HPI remain strong, suggesting that some of that strength in demand may persist beyond the end of the stamp duty holiday in September.
China’s export jump calms growth worries
Shares in mining companies are also higher this morning, after stronger-than-expected trade data from China calmed worries about an economic slowdown.
The 32.2% surge in exports in June (compared to last year), and the 36.7% jump in imports indicates the Chinese economy is faring better than analysts had feared.
Anglo American (+1.5%) and Rio Tinto (+1.1%) are higher, tracking a rise in commodity prices amid expectations of higher demand for coal, iron ore, copper, nickel etc.
Sophie Altermatt, economist at Julius Baer, says:
Trade data came in better than expected, with export growth rebounding as global demand stayed strong and imports moderating less than expected.
Exports will likely remain a growth driver for the Chinese economy in the near term. With a higher base, trade growth is likely to level off from over the coming months, but the global recovery and fiscal support in developed economies remain supportive for solid exports, although demand will likely start to shift towards domestic services consumption.
The unexpected acceleration of export growth—despite the expected drag from supply shortages and delays at some ports in the Guangdong province, due to local Covid-19 outbreaks—implied that global demand remained strong, supporting Chinese exports.
BoE governor: Highly leveraged firms at risks from shocks
The Bank of England’s top officials were also asked about whether they’re concerned about the boom in private equity takeovers, which often leave companies severely indebted, following leverage buyouts.
Governor Andrew Bailey said the bank doesn’t take a view on private equity, but there are general concerns about corporate leverage, particularly in terms of their ability to withstand shocks like the Covid crisis.
He told reporters this morning:
“Companies that increased their leverage beyond levels that are safe and sustainable are of course in a much less resilient position when a shock comes along and we’ve had a very big one.
And so I think that very clear message should be to companies: Leverage matters.
It matters … from the point of view of the resilience of your own financial position and therefore you need to have regard to it. That’s not a point, per se, about private equity, it’s a point about leverage.
If you are a highly leveraged company you’re going to be more exposed to the sorts of shocks that I’m afraid can happen.”
Bank shares rally
Andrew Bailey has acknowledged how reliant banks have become on cloud services to run core parts of the banking system [as flagged earlier].
While he understands that the model is opaque (assumedly to protect the system from hackers), he says regulators needs to know that cloud providers are prepared for risks:
“We have to balance that, but as regulators and as people concerned with financial stability, and as they become more integral to the system, we have to get more assurance that they are meeting the levels of resilience that we need.”
Bailey insists dividend curbs were ‘very appropriate’
The BoE governor tells reporters:
“A year ago we were in an unprecedented situation. I think it’s very important not to apply judgement of hindsight.
“That was a very appropriate step to take….we mustn’t forget the emergency situation we were in a year ago.”
[Reminder: at the end of March 2020, Britain’s banks scrapped nearly £8bn worth of dividends, to help them weather the economic downturn]
Deputy governor Sam Woods also weighs in, explaining why the Bank lifted its restrictions on dividend payments today.
We’ve always been clear that we wanted to come back to our normal approach to capital setting and dividends.
We described in December the guardrails we put in place as temporary and as a stepping stone to normality and said we would come out again now in July, informed by the stress tests, so [that’s] where we find ourselves today”.
This tool allows the BoE to adjust the resilience of the banking system, by changing the ‘cushion’ of capital that banks need to hold in case of potential losses.
Andrew Bailey says the decision to raise the CCyB will rely on a “range of factors” , including the “evolution of the economic recovery, prevailing financial conditions and the outlook for banks’ capital.”