Bank of England gives mixed signals on bank dividends, SME debts and market risk-taking

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Banks will be able to start announcing dividend plans alongside their half-year results at the end of the month after the Bank of England lifted its ‘guardrails’, but analysts said investors should not expect a huge windfall yet.


The BoE’s Prudential Regulation Authority this morning said its guidance on UK bank shareholder distributions has returned to normal, which fed expectations that the likes of Lloyds Banking Group PLC (LON:LLOY), Barclays PLC (LON:BARC), NatWest Group PLC (LON:NWG) and peers can emulate the recent actions of their American cousins and sanction “super-sized shareholder returns” by releasing excess capital build up through the course of the coronavirus crisis.


READ: Lloyds, Barclays, HSBC and other UK banks move higher as dividend ban lifted


However, while the central bank’s Financial Policy Committee (FPC) approved of the lifting of the curbs, its half-yearly pronouncements on the state of the UK’s financial system contained a number of cautious statements.


Noting that corporate debt vulnerabilities have “increased modestly” in the first half of the year, but more so among small and medium-sized enterprises (SMEs), the FRC said it expects banks to use “all elements of their capital buffers” to support the economy through the recovery.


Increased risk-taking in global financial markets was also flagged up by the FPC, with risky asset prices continuing to increase and levels of high-yielding corporate bonds at its highest level in a decade, evidence of loosening underwriting standards, especially in leveraged loan markets.


“Asset valuations could correct sharply if, for example, market participants re-evaluate the prospects for growth or inflation, and therefore interest rates,” the committee said.


The lifting of dividend curbs for the banks has removed “a key plank of uncertainty” surrounding the banks, said financial analyst Danni Hewson at AJ Bell.


“The relaxation of these restrictions is also an acknowledgement that the sector is in pretty solid financial shape and marks an interesting contrast with the European Central Bank which signalled caution on a quick return to big dividends in the Eurozone.”


Gary Greenwood at broker Shore Capital said: “we believe this will open the door for the UK banks to announce further shareholder distributions alongside their interim results which are dye to be published during the last week of July and first week of August. We expect this news to be welcomed by the market and should act as a positive catalyst to share price performance for a sector that has weakened off in recent weeks.”


Hewson added however: “some protections are being kept in place to ensure banks still have extra capital put by just in case and, in order not to make regulators twitchy, the sector may be wary of going too far, too fast on capital returns.


“We’ll find out very soon just how generous UK banks are prepared to be, with first half results season commencing at the end of July. The guardrails may have been removed, but the Bank of England will be expecting companies to act responsibly.”


UBS analysts forecast that most banks will wait until the end of the year before announcing the payment of any special dividends, given the ongoing uncertainty.


“Though all banks under coverage could afford excess capital distributions, we assume that substantial payouts will wait for FY21 announcements, pending a reduction in mobility restrictions, increased vaccination coverage, an end to furloughs, substantial start to Bounce Back Loan repayments, stress test results and full year audit processes,” UBS said in a note last week.


However, just knowing that banks are able, should they wish, to pay out a growing pile of excess capital that stood variously at 6-27% of market cap at the end of the first quarter “should generate broader appeal for the shares, we think”.


However, given the precarious nature of several areas of the economy, some commentators said it was definitely too early to lift dividend curbs for the FTSE 100 lenders or the challenger banks.


“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,” said Simon Youel, head of policy and advocacy at Positive Money.


“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.”


KPMG’s Karim Haji said relaxing rules on dividend payments whilst also giving the green light for banks to use their capital buffers to the fullest extent, with a decision to hold the countercyclical buffer ratio at 0% until 2021, was a cautiously optimistic approach from the BoE.


“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.”


He said the FRC’s warning about increased risk-taking in financial markets, “means firms need to ensure they have robust risk controls and governance around asset valuations and credit standards”.


The absence of a warning about potential short term inflation “could be overly optimistic given the many compounding pressures that remain in light of the pandemic and Brexit”, said Haji.

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