With the current crisis, many companies may cut the dividend with justifiable explanations of what they plan to do with the cash
After months of being locked down, Bangladeshi citizens are well aware of the toll it has taken on the economy: rising unemployment, SMEs failing left, right and centre, broken supply chains and rising social unrest amongst the lower income groups. All these factors could mire the Bangladesh economy into a deep, prolonged recession.
A major threat to the economy, however, lurks in the balance sheets of big banks, and if not handled well could be cataclysmic. The banking sector was struggling prior to Covid-19 from skyrocketing NPLs, declining margins with a capped interest rate regime, government directed restructuring of shabby loans, deteriorations in efficiency indicators, and declining demand for loanable funds, etc.
The pandemic has put the sector in further stress. As the funds from the stimulus package are distributed through the banking channel, both credit and collection risk will lie with the banks. Most banks are overburdened with nonperforming assets and require mitigation of credit risk before disbursing any fresh aids.
With a high cost to income ratio of 78 percent, cost rationalisations and layoffs in the banking sector may come up with an endeavour to increase efficiency but if executed poorly under a weak governance framework, it will leave the sector in shackles. The City Bank Ltd recently announced a 10 percent pay cut for most of their employees, and many are fearful of other banks following suit in the wake of the decision of the Bangladesh Association of Banks.
The revenue stream of the insurance industry is also in jeopardy due to the pandemic, with the fire and marine insurance premiums expected to take the biggest hit. These two components consist of roughly 77 percent of non-life insurance companies' total premium income.
On May 11, the central bank instructed banks to not disburse any cash dividend to both sponsors and investors until September to ensure that the banks have adequate reserves on hand to absorb the strain on their capital base. This had already created heatwaves amongst the 2,574,491 active B/O account holders who were expecting some sort of relief through their invested capital. Banks and NBFI's occupy the largest chunk of the market capitalisation within the Dhaka Stock Exchange and such a declaration would have further plunged investors' confidence, potentially driving away foreign investment.
The 30 banks and 23 NBFIs listed with the capital market provided cash dividends amounting to Tk1,670 crore in 2018. In order to maintain the "A" category status, a company should disburse a minimum of 10 percent dividend in the form of cash, stock or a combination of the two.
Although top-level management in most banks would try to justify their actions of not being willing to pay dividends via referring to the policies implemented by the European Central Bank (ECB) and the Bank of England (BoE), would the ordinary shareholders of the 30 listed banks understand the reasons behind such decisions?
When it comes to corporate responsibility, there is one fine line that many shareholders suggest should never be crossed: the dividend.
However, this is where virtually everyone misunderstands the elementary finance principles – it is the total returns, not just dividends, that matter. Paying dividends does not benefit investors because a dividend of Tk1 simply reduces the stock price by Tk1 – similar to withdrawing from an ATM. You do get cash in your pocket but have less remaining in your bank account.
It is true that dividends provide liquidity, allowing shareholders to fund their obligations. But shareholders can alternatively create liquidity themselves by selling their shares.
Nevertheless, it is only the bonus/stock dividend that is adjusted in the Bangladeshi capital market. Most investors also witness a decrease in stock price that seems to include the cash dividend disbursed, but the opening price is actually not adjusted for cash dividend in both the DSE and CSE unlike what many are used to globally.
Another fallacy about dividends can be seen clearly when stock buybacks enter the equation. Dividends and buybacks are both forms of paying out shareholders. Companies like Apple and Amazon utilise buybacks frequently to increase shareholder value.
Buybacks have a huge advantage—they are highly flexible. Management can implement a buyback scheme one year, decrease the number of outstanding shares such that the earnings per share is higher than what it would have been, and shareholders receive a higher denomination of the earnings as dividends. Management can continue to do so next year, or even the years after and suffer no stock-price hit.
In contrast, the dividend policy at the Dhaka Stock Exchange is stringent and inflexible. Forcing most companies to pay out a chunk of their profits as dividends hampers the growth of many small-scale and medium-tier companies going forward. If such ventures cut their dividend due to a temporary crisis or project expansion ambitions, the stock price can plummet drastically.
The consequences of this situation can be quite substantial. Firstly, companies will tend to focus more on maintaining the level of dividend on pen and paper and might take short-term actions to preserve it, rather than focusing on the business itself. According to a journal paper titled "Payout Policy in the 21st Century", CFOs admitted that they would even cut out profitable investments to maintain the dividend.
Secondly, shareholders may occasionally overpay for dividends and tend to develop a reliance on dividends for liquidity via demonstrating a passive investment approach. The world's greatest investor, Warren Buffett, is known for his nonchalant yet nefarious approach of cashing in massive dividends year-on-year. Under such circumstances, shareholders can sit back and finance their obligations with dividends each year, without the need to figure out which companies to sell.
So, what is the solution? One remedy is to change the rules of the game. During 2013-14, Marico paid a special onetime silver jubilee dividend of 175 percent to commemorate its 25 years since inception in addition to the 175 percent dividend announced earlier. Promoting the culture of special dividends can boost promoters' confidence since they already view it as "one-off", and investors can understand the notion of being flexible without panicking.
With the current crisis, many companies may cut the dividend with justifiable explanations of what they plan to do with the cash. The authorities should not come up with abrupt policy changes and companies should not exploit the opportunity to reset the equilibrium to one where no or low dividends become the norm.
Promoting this idea will only hamper investors' returns if the floor price mechanism was to be removed abruptly since many investors would resort to selling their stakes. If paying dividends are a matter of concern, companies should stress that it will pay out after the cash leftover is utilised for specific profitable investments. That money will recirculate within our economy when the investors utilise it to purchase essential items, keeping the economic cycle afloat.
It is debatable if capping the rate of dividends that could be paid for this fiscal year by the central bank was necessary at all. The retail investors have hardly witnessed any capital gains in their portfolios over the years. If the 30 listed banks manage to pay out the bare minimum to the shareholders who are suffering, it certainly would not add to the existing ills of the banking sector, which is already diagnosed with a plethora of financial ailments.
Sayeed Ibrahim Ahmed, an experienced investment analyst, is currently a Senior Lecturer of Finance at American International University Bangladesh (AIUB). He can be reached at email@example.com