What to look for in Q1s for Lloyds, Barclays, RBS & HSBC

At the same time, sector share prices have remained battered, further deepening sharp discounts to book value. As a result, there is a disconnect between the large write-downs anticipated by the market and the regulatory disclosures made to date.

That should change next week, when the UK’s five largest lenders by market capitalisation will open their books for the three months to 31 March. From Tuesday, investors will have the first real view of the damage done and yet to come for the sector, as well as signs of how it is managing in an economy on life support.

Shifting focus

This time around, earnings will not be the main event. In part, that is because the first quarter of 2020 included at least seven weeks when Covid-19 and its effects was barely on the agenda, especially for domestic-facing lenders Lloyds Banking (LLOY) and Royal Bank of Scotland (RBS). Even for Standard Chartered (STAN) and HSBC (HSBA), both of which were exposed to the crisis when it was confined to China, the hit to first-quarter revenues is unlikely to be large – judging by the comments made by respective management teams at full-year results season at the end of February.

When it comes to income generation, investors also have very little clarity on what to expect, or what reference points to use. The range of analyst forecasts already point to wildly differing predictions for lenders’ earning potential in 2020. While consensus estimates guide for a collective 39 per cent decline compared with last year’s reported numbers, this average includes some expectations for higher earnings in the case of Barclays (BARC), HSBC and Standard Chartered. Apparently, some analysts are simply yet to process recent events, and what they might mean for bank income statements.

At the other end, some City number-crunchers think earnings will be wiped out or even turn negative this year. The exception to this pessimism is RBS, despite consensus that the state-backed lender is the most sensitive among peers to lower interest rates, given its already-thin net interest margin.

Lessons from America

But while many companies have abandoned guidance in recent weeks, bank investors are right to expect greater clarity from companies whose reputations and equity stands or falls on their ability to quantify and price risk. The focal point here – and the headline to which shareholder eyes should be directed next week – will be detail on capital levels and balance sheet strength.

Estimates are likely to be highly provisional, it being still a matter of weeks since this crisis began to rock asset prices and credit quality. But banks are under pressure to publish two important estimates: provisions against bad debts and expected drawdowns from existing customers.

On the first point, recent numbers from Wall Street’s six largest banks suggest expected impairments could be substantial. Added together, the first-quarter loan loss provisions booked by Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley came to $25.4bn (£20.7bn), a 350 per cent year-on-year increase and a clear indicator that US lenders are witnessing the sort of credit distress last seen in the 2008-09 financial crisis.

The process of arriving at these provisions is a complicated one, and must now be based on accounting rules that factor in the lifetime value of a loan. Expected credit losses are therefore highly reliant on lenders’ own macroeconomic assumptions, the adoption of which have enormous implications for banks’ own capital levels.

“Uncertainty is multiplicative,” wrote Berenberg analyst Peter Richardson in a note to investors this month. “The outcome of uncertain loan loss rules during an uncertain economic shock and considering uncertain policy effects is therefore problematic for investors.”

While first-quarter results should provide some insight around those assumptions, bankers are unlikely to have much more clarity on the economic outlook than the rest of us. The Office for Budget Responsibility’s “coronavirus reference scenario” models a 35 per cent contraction in GDP in the second quarter of 2020, followed by a huge rebound in activity. Major banks will be compelled to make finger-in-the-air guesses, too.

At a minimum, UBS estimates that each of the five largest lenders’ cost of risk will at least double this year, before receding in 2021. Across the group, impairments are also forecast to more than double in 2020.

Others are guiding for material but manageable headwinds from non-performing loans. Berenberg’s own estimates – which use recent UK bank stress test data and factor in an economic shock equivalent to three-quarters of the hit seen in the global financial crisis – suggest loan losses could range between 110 and 170 basis points of common equity tier one (CET1) capital.

Hungry mouths to feed

The second important metrics concern lending volumes, and how much support banks are having to provide to existing customers with stand-by credit lines and overdrafts.

Berenberg estimates that up to 47 per cent of the cash committed via corporates’ revolving loan facilities had been drawn down by listed and unlisted global corporates at the end of March, up from just 8 per cent at the end of 2019.

This appears to be corroborated by Federal Reserve data showing a $400bn rise in US commercial bank lending by volume in the two weeks to 25 March, which implies a 20 percentage point hike in unused commitments. The use of such facilities by clients of JPMorgan Chase “already dramatically exceeds what happened in the global financial crisis”, according to the bank’s executive chairman Jamie Dimon.

Investors in JPMorgan’s UK counterparts will therefore be eager for both absolute figures and for commentary on how this will impact CET1 capital. Although this is likely to be manageable at present, there could be trouble ahead if corporate clients are forced to max out their credit lines over the course of 2020.

Capital adequacy?

Taken together, the shocks are broadly assumed to be serious, but digestible. This month, the European Banking Authority (EBA) appeared to shrug off the deep uncertainty implied by the sector's share prices in a report that concluded lenders will “sail through the corona crisis with sound capital levels”. Good asset quality, high capital buffers and supervisory measures were all cited as reasons for confidence. “Sound capital positions should enable EU banks to weather expected upcoming impacts stemming from the coronavirus crisis and to provide lending to the economy at the time of need,” surmised the EBA.

The recent cancellation of dividends and share buybacks means that capital levels are stronger than they otherwise would have been. In fact, UBS estimates that fourth-quarter dividends and buybacks would cover more than a year’s worth of ‘normal’ loan losses on their own.

The Prudential Regulation Authority also admitted that the savings from the cancelled distributions weren’t necessary “to maintain adequate capital positions”, although this may be of scant consolation to income-seeking investors. Compared with their North American peers, the capital buffers of UK banks – RBS in particular – look resilient.

CET1 ratios look healthy

As such, don’t expect first-quarter results to contain any mention of plans to raise equity. Especially so soon after the enforced cancellation of dividends, bank bosses would likely be sorely punished by the markets if they so much as mention the possibility of boosting capital levels further.

But with the scale of the current predicament still barely visible, there is an argument that banks should vaccinate themselves against a deep economic downturn. Whether lenders could find deep-pocketed investors willing to take a bet on an unloved, margin-depleted low-return sector with a utility-like role in financial markets is a million-dollar question. But if the price of financial security and more time is further equity dilution, then it may be worth paying. Financing will only get harder should loan losses and defaults start to seriously mount.

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