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Topsy turvy

16 December 2020 By Liam Proud

The European Central Bank has turned dividend investing on its head. New guidance, unveiled late on Tuesday, could allow well-capitalised lenders like Nordea and KBC to offer tiny shareholder returns compared with riskier peers. While the limits are intended to be short-lived, the danger for investors is that the Covid-19 fallout causes them to last longer than expected.

The central bank’s supervisory boss Andrea Enria in March asked lenders to halt dividends and buybacks, because of the huge uncertainty over how severe loan losses would be during the pandemic. But a reversal now seems fair, since the sector’s pre-provision profit this year will be almost double the expected level of bad-debt charges, based on Refinitiv median estimates for the Euro STOXX Banks Index.

Enria is keeping lenders on a tight leash until September, however. Banks can pay out the lower of 20 basis points of their common equity Tier 1 ratio or 15% of aggregate earnings for 2019 and 2020 – excluding goodwill and other adjustments. One result is that lenders with high capital ratios and above-average valuations can only return a small amount of cash relative to their market capitalisations.

The maximum yield on offer for investors in Belgium’s KBC and Finland-based Nordea, for example, is about 0.8% and 1% respectively, according to Breakingviews calculations. Both have chunky CET1 buffers and trade at a premium to the sector’s average multiple of 0.6 times tangible book value. Spanish minnows Unicaja and Liberbank, which trade at a huge discount, could offer over 3% yields.

The bizarre outcome is partly a function of market values, over which the ECB has little control. But it’s also because Enria linked payouts to earnings and risk-weighted assets, rather than excess levels of CET1 capital. That’s prudent, since doing otherwise would have allowed well-capitalised banks to use their buffers to pay shareholders, rather than lend. But the message for investors is odd: they’re now incentivised to avoid some of the safest banks with high excess capital, in favour of arguably riskier lenders.

The recommendations only apply until Sept. 30. But shareholders will fear further restrictions if, for example, corporate insolvencies are worse than expected when governments start to withdraw guarantees, or if vaccines take longer to roll out. For investors wary of bank stocks, Enria’s latest move is unlikely to prompt a rethink.


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