In response to the exceptional circumstances brought about by Covid-19, the Prudential Regulation Authority (PRA) at the Bank of England has written to UK banks asking them to ‘consider’ appropriate action regarding the payment, accrual and vesting of variable remuneration (i.e. bonuses) for senior staff, together with any dividend payments or share buyback plans.
Not surprisingly, the PRA does not guide towards a reduction in Additional Tier 1 (AT1) coupons, which are governed by the maximum distribution allowance (MDA) rules, and nor does it include Nationwide’s Core Capital Deferred Shares, as we anticipated on Monday. We think this is a prudent and sensible approach by the UK regulator and is consistent with the actions of others such as the European Central Bank and the Swiss National Bank. Bond investors like ourselves can take comfort in such actions.
We think this is another illustration of how this current economic shock will reverberate through the major risk sectors. The banks have been requested to curb distributions to conserve capital, so they have greater capacity to lend to the wider economy. Likewise, those corporates who access government support grants or subsidised loans will almost certainly see any future distributions (such as share dividends or buybacks) come under close scrutiny from regulators or government authorities. Dividend income in general will be heavily curtailed during COVID-19 related shutdowns, and we see this persisting in the aftermath while the economy starts on the road to recovery.
Despite the contagion and volatility recently seen in the credit sector, the fixed coupon distribution available from bonds should see strong technical support over the medium term as investors look for income in a world where equity distribution remains curtailed.
We are not saying that credit is immune from future volatility, but the added certainty of coupon income and defined maturity can offer investors considerable medium term comfort in this uncertain environment.