A triumphant decade: Pakistan’s banks win the dividend payout race

Commercial banks have dominated the country’s equity market in terms of the dividend mandate, offering the highest amount among all the 35 sectors on the Pakistan Stock Exchange (PSX) in the last decade.

In terms of total cash dividend amount or even payouts as percentage of profit, banks have led the way, doling out Rs823 billion (roughly $4.65 billion at today’s dollar rate) to their shareholders over the last 10 years with analysts expecting the princely run to continue.

The analysis does not take into account dividend as percentage of share price, and is not a reflection on the absolute returns offered to shareholders.

While absolute returns among these sectors vary, of course, an analysis of payouts from a shortlist of 211 (out of 546) listed companies that paid at least a tenth of their accumulated profits in dividends during the decade reveals the banking sector remained far ahead.

PSX's listed companies pay 'record' Rs500bn as dividends in 2021

Dividends for the financial year ending December 2021 are not yet available.

So why are banks so generous?

“Some big banks have been around for decades, they have had high retained earnings, which has enabled them to pay high dividends,” said Raza Jafri, Head of Equities at Karachi-based Intermarket Securities. Out of the 14 banks shortlisted for this report, 8 banks paid dividends in each of the 10 years under review.

Jafri said most of the large banks sit on capital buffers, much above the minimum Capital Adequacy Ratio (CAR) requirement of the central bank. These banks make huge profits from investment in government securities, which do not drag their CAR.

A gauge to assess banks’ financial strength, CAR shows how much capital is available to a bank as percentage of its risk-weighted credit. This regulatory requirement ensures banks have sufficient reserves to manage a certain amount of loss and avoid the risk of insolvency.

A higher CAR value allows banks more room to invest in risk-free government securities as well as comfortably maintain the minimum reserves requirement.

Jafri said lending to the private sector was about 70% of the banking sector’s deposit until 2008, but the equation changed after the financial crisis.

With the number of defaults on the rise, banks shifted focus towards risk-free Pakistan Investment Bonds, which were offering double-digit returns. In the last five or six years, more than half of banking deposits were parked in government securities — for some banks this number went up to even 70%.

While banks continued to invest in government securities, they also earned some bad press in the process – with the Pakistani government being their single-largest borrower back in 2017. Even during the period between 2016 and 2018 when interest rates dropped below 7% to a multi-decade low, CAR of large banks was 5 to 10 percentage points higher than the 11% required by the State Bank of Pakistan (SBP).

“If I look at the banks, such as MCB, whose dividends have historically been good, the biggest reason is strong CAR level and profitability growth,” said Umair Naseer, Associate Director Research at Topline Securities.

Naseer said banks’ profitability remained very strong even when interest rates were low. This was due to a healthy deposit rate growth, which remained in double-digits over many years, he said. “So, this is the main factor that drove a good payout.”

MCB Bank distributed Rs169 billion in dividends to shareholders, highest by any bank, and more than what any other (excluding HBL and UBL) earned in profit. Standard Chartered Bank (SCB) Pakistan was on top of the list in terms of payout as percentage of profit, giving 84% of its accumulated profit in dividends.

“If you ask me, Meezan Bank has been the best-performing bank,” Jafri said of Pakistan’s largest Islamic bank which witnessed exponential growth in the past decade.

The analyst said Meezan cannot invest in government securities because they don’t comply with Shariah, yet it is in the top 10 dividend-paying banks. Jafri disagreed that its performance was merely a function of being an Islamic bank.

“It focused on growth, increased branch network, improved service quality, and increased its share in auto and home financing markets,” Jafri said of Meezan Bank, which became the largest bank by market capitalisation last year.

Market analysts expect the banking sector’s stellar dividend performance to continue for at least another couple of years, but the recent regulatory push by the SBP may undermine their ability to pay strong dividends in the medium to long term.

In mid-2020, the SBP introduced a housing finance scheme and required commercial banks to lend at least 5% of their private sector credit to this scheme or face penalty.

Jafri said if banks do not comply, they may face higher tax rates, which could affect their ability to continue paying such high dividends. There are signs of it already, he said.

“We have seen MCB slightly miss our dividend expectations for the first time in 15 years in Jan-March quarter of 2021.” Another big risk is the implementation of IFRS9 rules, a new accounting standard that will require banks to book provision – recognise a loss on a loan – at the time of lending, not after a default.

“This could eat into their retained earnings and capital ratios.”

Naseer agreed the implementation of IFRS9 standards are a major risk to future dividends, but he said there are a lot of ifs and buts around it. "It might be implemented in phases, not at once."

The analyst said the banking sector’s overall valuations are attractive at the moment. “Even if payout ratios don’t increase, they will remain at the same level,” the analyst said, sharing his outlook for the next two years.

The writer is a Marjorie Deane International Fellow at City, University of London