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A look ahead to bank results next week

We look at what next week’s third-quarter results could hold in store for investors in Lloyds, Barclays and RBS.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Bank shares fell across the board after the referendum result. Since then performance has been mixed, with some companies recovering much of the lost ground but others still lingering 20% below pre-referendum levels.

Next week will see results for July to September from the UK’s three largest high street lenders: Lloyds Banking Group, Barclays and Royal Bank of Scotland. Below we explore why some banks have fared better than others.

The same...

There are two major headwinds facing the UK banking sector at the moment;

  • UK economy – Most UK banks are highly exposed to the domestic economy. A downturn would increase the number of bad loans and reduce businesses’ appetite to borrow.
  • Lower interest rates – Banks are forced to pass cuts on to borrowers, but struggle to do the same for savers. This squeezes margins.

But different...

Despite industry-wide challenges, some UK banks look considerably healthier than others. Below we take a look at what makes each of the UK’s financial giants unique.

Lloyds Banking Group

Lloyds’ UK exposure and large mortgage book make it particularly vulnerable to a UK recession. However, it also looks well-placed to weather any storm.

A market leading cost:income ratio (a measure of the difference between the bank’s costs and its income) and reasonable net interest margin (the difference between the interest it pays depositors and charges borrowers) help to insulate the bank against a downturn. Further cost-cutting is underway, with 200 branches and 3,000 jobs to go by the end of 2017.

That low cost base has helped to return the bank to profitability, and resume the dividend. Lower interest rates have had an impact though, with the bank reining in expectations for full-year capital generation (to 1.6% from 2%) at the half year. However, a Common Equity Tier 1 capital (CET1) ratio of 13% means that Lloyds still retains a comfortable capital buffer.

The bank has reiterated its commitment to a progressive ordinary dividend, and currently offers a prospective yield of over 6% next year (variable, not guaranteed and not a reliable indicator of future performance). However, lower capital generation might reduce the scope for the special dividends some investors had expected.

Overall, we feel Lloyds is well-capitalised and robustly profitable, able to weather any but the most severe storms. There are headwinds though, and while it might be in a better state than rivals, growth is still likely to be lower than expected earlier this year.

Lloyds Banking Group share price, charts and research

Barclays

Barclays has been streamlining operations of late, with plans to dispose of the African business and focus on UK Retail and Corporate banking. However, it also retains a sizeable investment bank and international credit card business.

That has proven a significant bonus since the referendum. Not only have the value of international earnings increased following the decline in sterling, but results from US investment banks suggest conditions in that part of the market have improved markedly.

Barclays has made progress in the wind down of its ‘bad bank’, with the sale of Barclays Egypt reducing risk weighted assets (liabilities against which the group must hold capital) by £2bn. Barclays Risk Analytics and Index Solutions was sold for a £535m pre-tax gain– proof the bad bank can occasionally throw up good surprises as well as bad.

However, Barclays still faces a number of hurdles. Although CET1 capital is reasonable, it’s hardly excessive, and that could limit the scope for increasing returns to shareholders. The bad bank continues to throw up writedowns while conduct charges have not yet gone away – including seemingly endless PPI fines.

The bank still has a long way to go before returning to robust health, but Barclays’ new simplified structure makes sense to us. The shares offer a prospective dividend yield of 1.7% (variable, not guaranteed and not a reliable indicator of future performance) which at least offers something for investors patient enough to wait out the recovery.

Barclays share price, charts and research

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RBS

RBS’s basic strategy is sound enough. It’s just making very heavy work of implementing it.

Like Barclays, the bank is looking to simplify its structure and focus on what it’s good at – commercial, private and high street banking, mostly in the UK. These parts of the bank have actually been performing quite well, but you’d never guess it from the share price.

That’s because bad bits keep on coming out of the woodwork. Capital Resolution, the pretty name for all the stuff the bank wishes would go away, is still spitting out huge losses (£1bn in the first half). On the bright side it’s being wound up quickly - more than can be said for Williams & Glyn.

RBS was told by the EU that it must split out and sell-off W&G in return for receiving state aid during the financial crisis. This was meant to happen by the end of 2017 at the latest, but that deadline keeps getting pushed back, and isn’t now expected to be reached until 2018. Meanwhile the whole process keeps sucking in money.

These aren’t the only problems RBS faces. As conduct costs fade into the background for other banks they keep mounting up at RBS. The scale of fines for mis-selling US mortgage backed securities are still unknown, but the Department of Justice does not have a reputation for leniency where European banks are concerned.

Despite progress in the core business, which is still aggressively cutting costs, analysts expect the bank to remain loss-making in 2017. Somewhere in RBS lurks a nice bank, generating nice returns. It’s lurking pretty deep though.

RBS share price, charts and research

The information in this article is not intended to be advice or a recommendation to buy, sell or hold any investment or currency mentioned, nor is it a research recommendation. No view is given as to the present or future value or price of any investment or currency, and investors should form their own view in relation to any proposed investment.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance. Investments can fall as well as rise in value so you could get back less than you invest. Past performance should not be seen as a guide to future returns.

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Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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