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Are UK banks on the road to recovery?

The UK banking sector had a torrid 2015, but how is it faring so far this year?
May 5, 2016

The headline fall in profits made by the UK's biggest banks unsurprisingly grabbed the lion's share of attention when these groups reported their first-quarter trading figures. Given the perfect storm of legacy provisions, low interest rates and loan defaults from the commodities sector weighing on the balance sheets of mainstream banks, the loss of profits on a year-on-year basis is hardly surprising.

The drop in earnings during the first three months of the year compared with 2015 was dramatic for most of the banks. Standard Chartered (STAN) and Lloyds (LLOY) suffered the largest fall in pre-tax profits, with drops of 59 per cent and 46 per cent, respectively, year on year. However, in the case of Lloyds, it was the buyback of some of its enhanced capital notes - issued in 2009 - that took a £790m chunk out of profits.

It should be noted that Royal Bank of Scotland's (RBS) loss of £968m was due to its final £1.2bn 'dividend access share' payment to the government, made as part of its bailout terms.

 

Global impact

For Asia-focused Standard Chartered, the threat of oil and gas companies defaulting on their loans still looms, although loan impairments stabilised at $471m and were down almost threefold on the final quarter of last year. Emerging market exposure persists as a thorn in the side of HSBC (HSBA), too. The bank's loan impairment charges increased by almost $700m to $1.2bn during the first quarter, primarily in its global banking and markets business.

Charges for bad loans increased by $300m for this business, as it was forced to take a hit on loans to the oil & gas and metals & mining sectors yet again. Meanwhile, the deterioration of economic conditions in Brazil, the United Arab Emirates and energy markets in Canada and Spain have driven delinquency rates and charges.

 

All doom and gloom?

Cost reduction and slimming down are two of the firefighting strategies being employed to get the all-important cost-to-income ratio down. On the first, progress is being made across the sector. Standard Chartered managed a 10 per cent reduction in its operating expenses, while Lloyds shrunk them by a consensus-beating 2 per cent to just shy of £2bn. Costs fell as a result of the group's simplification strategy, which has generated annual savings of £495m to date, which management expects to increase to £1bn by the end of 2017.

Simplification has become a buzzword for management strategy within the UK banking sector. Barclays (BARC) cut its operating expenses by 7 per cent to under the £4bn mark, albeit this reduction was less than expected by analysts. The bank's pre-tax profits were down by a quarter during the first three months of the year, but this is largely due to its bid to rid itself of what it deems non-core assets. Just last month, it announced it was in talks with Bob Diamond's Atlas Mara venture over a potential sale of Barclays Africa.