China’s Massive Banks Are Facing a $42 Billion Dividend Trap

(Bloomberg) --

As dividends are slashed around the world, the $42 billion in promised payouts by China’s biggest banks have a powerful defender -- the Communist Party.

Industrial & Commercial Bank of China Ltd. and its three biggest peers are returning more than 30% of their 2019 earnings to shareholders, implying an average dividend yield of more than 6%. That’s nearly double what’s offered by their competitors in the U.S.

But with the banks facing trillions of yuan of potential credit losses from the impact of the coronavirus, there’s a growing debate on whether China’s mega lenders should maintain payouts to keep investors, especially their government owners, happy at the cost of their own deteriorating capital strength.

“Maintaining a high dividend payout is part of Chinese banks’ social responsibilities, especially now when the fiscal budget is tight,” said Nicholas Zhu, an analyst at Moody’s Investor Service in Beijing. “The virus fallout will erode their capital slowly and gradually, therefore any dividend reduction will come as a step-by-step process rather than a shock treatment.”

Banks in the U.K. and Denmark scrapped dividends to meet demands from regulators, while payouts were hit in Switzerland and Australia as watchdogs there encouraged lenders to preserve capital. In the U.S., its eight giant banks, including JPMorgan Chase & Co., are for now sticking to payouts, but have canceled share buybacks to support clients and the nation during the pandemic.

Ultimately, any dividend adjustments will come at the direction of Beijing, where there’s often a tug-of-war among regulators and departments with different priorities. The Finance Ministry and China’s sovereign wealth fund control more than two-thirds of shares of the so-called big-four banks, and are keen on maintaining payouts. The banking regulator, just like its counterparts overseas, is typically more focused on capital buffers and financial stability.

Regulators haven’t asked the big banks to adjust their dividends at present, said people familiar with the matter. One major bank, however, listed a lower payout as one of the ways to help it improve its financial strength in a recent survey by the regulators, one of the people said, asking not to be identified discussing private matters.

The CBIRC didn’t immediately respond to a request for a comment.

China’s biggest banks have reduced dividends before. In 2015, they cut their ratio to 30% from 33%, also at a time when they were battered by a rise in bad loans and stagnant profit growth as China’s economy slowed. ICBC and China Construction Bank Corp., the no. 2 lender, reported profit growth of below 1% in 2015.

ICBC’s shares tumbled 17% in 2015 and added to losses the following year.

The situation is even more dire now. UBS Group Inc. has forecast that China’s banking industry could suffer an unprecedented 39% slump in profits this year, even with government support on absorbing bad loans. Take that backing away, and their earnings could tumble as much as 70%. Analysts at S&P Global Inc. have predicted that a prolonged health emergency could add 5.6 trillion yuan in bad debt.

Rainy Day

A worst-case stress test last year by Chinese authorities showed that 17 of its 30 biggest banks failed to keep capital at adequate levels with economic growth slowing to 4.15%, a situation that now looks wildly optimistic as the pandemic upends the global landscape. The world’s second-biggest economy shrank 6.8% in the first quarter and could grow less 2% this year, according to a Bloomberg survey.

“With the rising credit risks, there’s room for Chinese banks to plan for rainy days,” said Richard Zhu, a partner at PricewaterhouseCoopers. “For a listed bank, maintaining stable operation is as important as keeping stable dividend payout.”

The biggest state banks so far have been able to keep their capital above minimum requirements and were able to deliver some profit growth in the first quarter. ICBC’s earnings grew 3% in the first three months, the slowest since the end of 2018. Bank of Communications Co., which posted the weakest quarterly profit gain in three years, said in an emailed reply that it has no plan to cut dividend at present and will try to maintain continuity and stability on the payout.

Chinese regulators have signaled that there could be a let-up in the pressure to pay dividends. Zhou Liang, vice chairman of the China Banking and Insurance Regulatory Commission, said recently that banks should now count more on internal capital generation, in addition to issuing bonds, preference shares and common equities.

CBIRC’s comments “sent a signal that regulators are inclined to have lenders keep more earnings to themselves, so we expect Chinese banks to cut their payout ratio in the near term,” said Chen Hao, an analyst at CIB Research.

Trading at an average 45% discount to their forecast book value, it’s also nearly impossible for China’s big banks to raise common equity because regulators generally require share sales to price at at least 1 time book value. As a result, retaining earnings is the only way to improve core capital buffers.

That may be easier said than done. Zhang Qingsong, president of Agricultural Bank of China Ltd, in March acknowledged the challenges. Being a state-run bank determines its most basic business model as providing credit to help the economy, meaning it will need continuous capital replenishment even as it keeps paying dividend, he said.

So scrapping dividends for 2019, set to be paid in July, is off the table, according to Jefferies Financial Group Inc. “But we see a rising chance that they reduce the 2020 dividend payout considering the potential profit decline,” Shujin Chen and Alfred He, analysts at Jefferies in Hong Kong, said in a note this month.

©2020 Bloomberg L.P.

With assistance from Bloomberg