As expected, UK banks’ first quarter results generated their fair share of gloomy headlines. While underlying profits came in slightly above consensus forecasts, loan loss provisions far surpassed analyst estimates, as lenders booked their first charges in response to rapidly deteriorating economic and credit conditions. Though they each remained profitable in the period, the five largest listed banks collectively booked £7.4bn in credit impairments, a five-fold rise on the first three months of 2019. Appropriately enough, below are five questions we think investors in the sector should be asking.
1) Are banks’ economic scenarios severe enough?
Even by the standards of the 2008 financial crash, some of the impairments were brutal. In truth, there is simply no way of knowing how accurate these estimates are – a point underlined by the differences between banks’ own economic modelling. In arriving at its £2.1bn provision, Barclays (BARC) forecasts UK GDP to contract by around half in the three months to June. Lloyds’ (LLOY) estimate for a decline of 7.4 per cent looks positively bullish by comparison, as does Standard Chartered’s (STAN) expectation that Asian-centred growth will lead the global economy out of recession later this year. In the words of one analyst, first quarter loan losses “could be a sign of prudence or greater concern”. For now, guesswork abounds.
2) How much of a threat are client collapses?
Breaking down its $3bn (£2.4bn) first quarter expected credit losses (ECL), HSBC (HSBA) singled out a “corporate exposure in Singapore” – believed to be scandal-hit oil trading firm Hin Leong – as the chief reason behind a $0.7bn rise in provisions in its Asian commercial banking arm. And while £1.2bn of Barclays’ expected losses relate to a shift in its “baseline economic scenario”, another £0.4bn was needed for “single name wholesale loan charges”. Clearly, the banks are going to struggle to adjust all write-downs smoothly. This means plenty of scope for one-off hits to compound pressure on capital and income.
Again, predicting when and where this might occur is a considerable challenge. HSBC, which expects provisions to rise to between $7bn and $11bn by the end of the year, acknowledges that its ECL models may fail to capture both specific corporate blow-ups and fraudulent activity. Given both types of risk are more likely in a times of acute economic stress, it seems likely that banks are in for some nasty one-off shocks.
3) Is profitable lending growth dead?
Evidently, debt markets have deteriorated in a big way since the start of the year, even as banks have responded to the call to extend cheap credit at a time of acute distress for households and businesses. Partly due to this emergency response, the world that emerges from the Covid-19 pandemic is going to be so loaded with debt that investors may question banks’ abilities to grow lending profitably. In truth, some unsecured lending was already starting to wane before the crisis struck, while investors should remember that UK mortgage lending grew throughout the depths of the GFC. But the damage to corporates’ balance sheets and risk appetites could spark a long recession in ordinarily-profitable lending lines for banks. With central bank rates set to remain on the floor, net interest margins offer little breathing room.
4) Will the WFH experiment accelerate cost cuts?
Even prior to this crisis, banks’ return on equity and balance sheet growth was anaemic. To executives, this created an incentive to bring down costs, as the now-paused restructurings of HSBC and Royal Bank of Scotland (RBS) show. The enforced (and apparently efficient) transition to home-working over the past two months, coupled with a surge in take-up in online banking, could therefore be read as an opportunity for lenders to re-consider their occupancy cost bases in the coming years. What a shift away from centralised call centres and expensive City real estate won’t do, however, is address the largest single expense line for banks, which is still staff.
5) Should we start to talk about value?
At a certain price, heavily-sold shares can start to look over-sold. Despite management’s pessimistic outlook, Barclays' share price rose after first-quarter results revealed a strong period for its securities traders. And with the stock more than 60 per cent below the group’s tangible book value, some may be tempted to view the group’s investment bank as a diversified and defensive perk rather than a drain on capital. For now, the current price implies almost no faith in chief executive Jes Staley’s belief that a 10 per cent return on equity is possible in the medium term, or that the journey to this target involves some truly staggering impairments. In the case of RBS, the pessimism is arguably more profound: the group’s £13.4bn market capitalisation is now lower than the lender’s total surplus regulatory capital.
