From growth stories to dividend plays

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By:
Rob Dwyer
Published on:

The mood among bankers attending Felaban’s annual conference in November was conspicuously relaxed. Why relaxed? Well, business is good

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The collapse in the number of bilateral correspondent banking relationships in recent years – driven by anti-money laundering and compliance and a key focus of the Latin American banking federation (Felaban) meetings – has now stabilized. 

It may have thinned out some of the delegations to the annual get-together from the smaller banks in the smaller markets, but those that still come seem comfortable about the emergent status quo.

More to the point, the business environment for the region’s banks is increasingly healthy. Funding options remain cheap, and there is abundant liquidity thanks to the continued strong appeal of emerging markets to international investors. 

Profitability is also up from already high levels, and even the region-wide need to improve digital platforms is being contained in terms of operating expenses. Provisions have peaked and asset quality is improving.

Revenues are also set to rise. Economies are growing across the region, driven by recoveries in Brazil, Argentina and, to a lesser extent, Peru and Colombia. Mexico remains positive, too, despite the negative impact of big political risk.

Banks in the region will face growing demand for credit next year as GDP improves. They are well placed to take advantage because across the region the banking systems are highly concentrated. 

In Peru, the top five banks make up 91.2% of the system’s loan portfolio; in Colombia it is 78.8%; in Chile 76.7%. Brazil’s largest five banks enjoy a 76.5% share and Mexico’s 70.4%. Only Argentina has something close to plurality: its top five banks ‘only’ have a market share of 47.5%.

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Relaxed, and why not?

Linked to this concentration – and perhaps the most telling trend in the region this year – has been the emergence of the leading banks as dividend stocks. 

Only in Argentina will banks seek to increase their capital next year – for investments and M&A opportunities. Elsewhere, many of the banks are sufficiently provisioned and capitalized to have begun returning capital to shareholders to optimize their equity structures (building up too much equity dilutes the return ratios).

In Mexico, Banorte has accelerated its share dividend plan and may issue another special dividend of Ps10 billion ($535 million) in 2018 (on top of a planned Ps9.4 billion), which would take next year’s total payout ratio to 83%, or a dividend yield of 5.9%. That is a dividend stock in anyone’s book.

The same is true of Peru’s Credicorp. Last month, it paid out an extra dividend worth NS15.70 ($4.85) a share. Next year’s pay-out ratio could hit 50%. 

In Brazil, Itaú has increased its dividend payouts by an average of 3.6% over the last three years and the yield is expected to be 5.8%. Even Bradesco, which is lagging its main private-sector competitor in this metric, is expected to have a dividend yield of 4.9% by 2021.

This is an important development. As UBS notes, historically emerging market banks have been growth names rather than income plays because of the low credit penetration and the structural growth opportunities across developing countries. 

However, the build up of capital in anticipation of Basel III has been compounded by the late-cycle slower growth in risk-weighted assets, and now many of the EM banks offer investment opportunities based on capital distribution to shareholders.

It is not even clear that when credit portfolio growth picks up this dynamic will break down. The profitability of the large EM banks should lead to surplus internal capital generation, even when credit demand is growing, and therefore the potential will remain for higher and special dividend payouts.

If this persists and EM banks become a dividend play throughout a cycle, it will have big implications for investors and managements alike, lowering share-price volatility as long as managements play along with their new dividend responsibility.

And management should be able to maintain dividend policies in the absence of any great competition. One particularly instructive statistic is that across the region, the participation of foreign banks has fallen sharply in the previous decade – from 20.9% market share in 2008 to 12.8% in 2016 – and continues to fall. 

What about the fintechs?

The only cloud on the horizon on the march of EM banks to permanent dividend investments status is the rise of fintechs. 

No wonder in Brazil the central bank launched a consultative process at the end of August in an attempt to simplify the regulations of startups and enable a lower cost of compliance to help disrupt financial systems. 

The aim is to enable digital platforms to offer lower-cost credit and spur competitive forces.

However, it is likely it will take more than regulation, although this will undoubtedly help. It will also require cultural shifts: among consumers and among these challengers. 

Presently, many fintechs seem to meekly enter big banks’ versions of tech incubators. A report by Goldman Sachs on the Brazilian fintech industry commented about the surprisingly collaborative nature of Brazilian financial startups with the main banks. 

It seems the banks are more likely to absorb fintechs than lose much in the way of business to them.

As one senior retail banker in Brazil says: “We don’t think the future of Brazil is one of the rise of the fintechs, rather the rise of technology for the financial institutions.”