Concerned about the rising Non-Performing Loans and the attendant weakening and erosion of the capital base of Deposit Money Banks in the country, the Central Bank of Nigeria, through a recent Circular, barred the DMBs with NPLs above 10 per cent from paying dividends to their shareholders. In the same circular to banks and discount houses, the apex bank had observed that rather than grow their capital by retaining earnings, some banks were paying out a greater proportion of their profits as dividends to shareholders, regardless of their risk profile and the need to build resilience through adequate capital buffers. Consequently, it directed that “in order to facilitate sufficient and adequate capital build-up for banks in tandem with their risk appetite, any Deposit Money Bank or discount house that does not meet the regulator’s minimum capital adequacy ratio shall not be allowed to pay dividends”.
This directive by the CBN with respect to dividend payments by the DMBs serves to reinforce the provisions of Section 17(1) of the Banks and Other Financial Institutions Act 2004 and Prudential Guidelines for DMBs of 2010, which stipulate that no bank shall pay dividends on its shares until “all its preliminary expenses, organisational expenses, share selling commission, brokerage, amount of losses incurred and other capitalised expenses not represented by tangible assets have been completely written off; and adequate provisions have been made to the satisfaction of the bank for actual and contingency losses on the risk assets, liabilities, off balance sheet commitments and such unearned incomes as are derivable therefrom”.
Not surprisingly, shareholders of the DMBs are reported to be kicking against this directive on dividend payout from the apex regulator arguing that it was capable of eroding the value of banking stocks quoted on the Nigerian Stock Exchange. Already, the drop in the share prices of some tier-two banks in recent times could be traceable to this development and so, in a sense, their argument holds some water. However, the negative impact will only be short-lived. The simple reason is that if a company’s profits are retained and ploughed back into viable projects rather than paid out as dividends, chances are that the share price will appreciate. Evidence of this abounds even in the Nigerian stock market where share prices of companies have reacted to favourable announcements regarding seized investment opportunities. Where this is the case, shareholders of such companies having no payout can sell part of their shares to meet cash needs. In other words, they have the ability to make their own (homemade) dividends.
This was the thrust of the seminal paper by Franco Modigliani, Nobel Prize winner in Economics, and former University of Chicago Professor Morton Miller, who developed the Dividend Irrelevance Theory way back in 1961. Miller and Modigliani regarded dividend payment as irrelevant and argued that given the investment decision of a firm, the dividend payout ratio does not affect shareholders’ wealth. They contended that the value of the firm was a function of only the firm’s earnings or its investment policy and that the division of earnings between dividend and retained earnings had no effect on the firm’s value. The implication of the M&M theory is that shareholders should not bother about whether dividends are paid since they have the ability to make homemade dividends and substitute them for the corporate dividends if retained earnings are properly applied.
The argument of Myron Gordon and John Lintner to the effect that a return in the form of dividends is certain while a return in the form of capital gains is risky and therefore “a bird in hand is worth more than two in the bush” appears plausible. However, not when the “certainty of dividend” is threatened by huge non-performing loans and significantly eroded capital base.
Notwithstanding the drawbacks of the M&M dividend theory which revolve around some unrealistic assumptions, a number of empirical studies have shown that retained earnings represent an important source of growing a firm’s capital: they are not only easier and cheaper to source than external finance, they also help curtail financial risks as well as improve liquidity and profitability of the firm. So, the DMB shareholders should worry more about the earnings ability of their banks. It is a fact that many DMBs especially those in the Tier-2 category are still reeling from the effects of the recent slump in crude oil prices. Besides taking loans in foreign currencies before the naira depreciated in value mid-2014, many banks were over-exposed to the oil and gas sector which contracted following the collapse of international crude oil prices- a development that triggered loan defaults, deterioration in asset quality and rising NPLs in the banking industry.
At present, the precarious financial state of some DMBs is making them targets for foreign acquisition. Already, reports say a United States-based private equity firm, Milost Global Inc, has concluded due diligence on one of the Tier-2 banks in preparation for possible acquisition. Much as this is cheering news for the banking industry, the country’s economy would be better served if the bank was adequately capitalised with the controlling shares in the hands of Nigerians.
These same DMBs are up against a fresh challenge arising from the implementation of International Financial Reporting Standards which would have a significant impact on the size of their bad loans provisions. The aim of the IFRS 9 is to enhance financial stability by introducing a forward-looking expected loss impairment model that allows banks to make a provision when a financial asset is recognised. So, in line with IFRS 9, effective this year, the DMBs would be required to make provision for not only loans that have gone bad but also for those credit facilities that show signs of deteriorating.
In view of these emerging risks, shareholders of weak banks should welcome a conservative stance on dividend pay-out and support the CBN in ensuring compliance by the DMBs especially in view of the fact that it is not the first time such a directive would be issued by the regulatory authority. Apparently, a similar directive to the DMBs in October 2014 has been observed more in the breach necessitating this recent one. To this end, the CBN should enforce to the latter its directive that “banks shall submit their Board approved dividend payout policy to the CBN before the payment of dividend shall be permitted”. Doing so is obviously in the overall interest of not only the depositors but also the shareholders.
It goes without saying that the quantum of the NPLs especially in some Tier-2 banks poses a major threat to their corporate survival. For such banks where related-party lending and over-exposure to a single sector of the economy have been the order of the day, the shareholders should rise up to the challenge by demanding good corporate governance as well as ensuring through the audit committees that adequate systems are put in place to monitor such risks and minimise their adverse impact on the quality of the loan portfolio. Indeed, the DMB shareholders should join hands with the CBN in ensuring that the banking industry and by extension the financial system is stable and safe for all stakeholders. They should recognise that it is only a Going Concern (certainly not a dead bank) that is in a position to pay dividends to shareholders.
Punch
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