UK banking sector – earnings roundup and outlook

Broadly speaking, profits were a mixed bag. On the one hand, higher interest rates meant banks improved their net interest margins. This is the difference between what banks pay out in interest on deposits and what they charge in interest on loans.

In practice, when rates rise banks are quick to up their charges on loans. But they raise the rates paid on deposits a little slower and a little less. That offers the chance for banks to make more money.

On the other hand, with inflation running rampant and a cost-of-living crisis that looks likely to accelerate into next year, banks have been preparing for some trouble.

Despite their best efforts, not all bank loans end up being repaid. So banks must make estimates for loans they expect customers to struggle paying back, known as bad debt. As the economic outlook looks set to deteriorate, the major banks have increased their estimates for bad debt. This passes through the income statement as an impairment change, reducing reported profit.

It can work the other way too though. When times look better than previously expected, provisions set aside for bad debt can be unwound, giving a boost to profit. That’s what we saw in 2021, the negative figures on the chart below show a reversal of charges taken by the banks in 2020 as they reacted to the pandemic. As it turned out, finances of individuals and businesses weren’t affected as badly as first feared, so these provisions could be unwound in 2021.

Impairment charges

Scroll across to see the full chart.

Source: Third quarter results for Lloyds (27 October), HSBC (25 October) and Barclays (30 September).

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Lloyds – UK in focus

Third quarter results were dominated by a 17% drop in underlying profit before tax, which came in at £1.7bn. The drop was driven entirely by higher impairment charges, coming in north of £650m, as the group prepares for a weaker UK economy.

Lloyds is taking steps to diversify income streams, but for now it’s especially exposed to the UK economy, with 95% of its assets based domestically. It’s also very reliant on traditional lending, especially mortgages, which make up around 65% of its loans to customers. If conditions in the UK continue to sour, that focus could put the group in a particularly exposed position. However, there are benefits.

Interest income accounted for 74% of total income in the third quarter, coming in at £3.4bn. That was 19% higher than the previous year, as the group’s net interest margin (NIM) benefited from the higher rate environment. NIM guidance has been raised, it’s expected to come in above 2.9% at the full-year mark. If delivered, that’d be up from 2.5% seen at the end of the last financial year.

If rates carry on rising, as the Bank of England has suggested, interest income should get another push higher next year. For every 0.25% rise in the UK base rate, interest income’s projected to rise £150m in the following year.

Looking past the higher provisions, third quarter income was up 13%, offsetting a 9% rise in costs. This highlights the group’s underlying strengths.

There are no doubt dangers ahead in the short term, arguably more so for Lloyds than its peers with more diverse income streams. But if the UK economy can avoid a worse than expected recession, Lloyds should be placed well to benefit from a higher-rate environment.

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Barclays – moving on from a run in with the SEC

A couple of things stood out for us from Barclays’ results. It’s hard not to start with the higher impairment charges relating to a weaker economic outlook in the UK.

Barclays recognised a charge of £381m over the quarter, up from £120m the year before. That wasn’t as high as some of the other banks. This was largely due to Barclays’ diverse income streams and lower exposure to the UK and China, meaning profit before tax had room to grow 6% to £2.0bn.

The UK only accounts for just under a third of total income, but that doesn’t mean Barclays is immune to weakness in the home economy. Consumer activity fell, as borrowers are paying down their debt and taking on reduced loans as the economy weakens. For now though, net interest income is still on the rise as the rising-rate environment is more than offsetting weakness in lending.

Barclays International, which houses a massive investment bank, drives most of the group’s income and offers diversification away from traditional lending.

Trading income has benefited from market volatility over the year so far, up 33% to £6.5bn, and offers the chance to benefit during uncertain times. Though, trading income dropped 12% over the quarter and is likely to face some tough comparable periods when we move into the first six months of 2023.

We’d be remiss for ending without a mention of the recent governance concerns, relating to the mishandling of US securities. Management confirmed the issue has now been resolved, and suggested the total financial impact was broadly in line with previous guidance – putting the cost at around £1bn.

While this blunder is unfortunate and embarrassing, we don’t see it as a complete derailment of the investment case.

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HSBC – FTSE 100 giant pushes further into Asia

HSBC had by far the highest impairment charge put through results, with profits taking a $1.1bn hit. Though, at 9% relative to total income, that puts it in between Lloyds (15%) and Barclays (6%).

The group’s preparing for economic uncertainty and the continued weakening of mainland China's commercial real estate sector. Stripping that out for a minute, underlying pre-tax profit was 8% better than analysts expected, coming in at $6.5bn.

HSBC has a large Asia focus, the region made up over half of the group’s $6.5bn of underlying profit in the quarter. Plans to further increase exposure in Asia are continuing, the latest step being the re-classification of retail banking operations in France – the accounting equivalent of sticking up a for sale sign.

The group put a $2.4bn charge through third quarter accounts, as the expected sales proceeds are lower than the value it’s been recorded at on the balance sheet. There’s also talk of shipping off a 100% stake in HSBC Bank Canada too.

Refocus is welcome, but doesn’t mask the immediate challenges. Weaker stock markets put pressure on wealth management fees, which fell 10% over the quarter.

There’s also pressure on the group’s capitalisation ratio (CET1), sitting at 13.4%. That’s below the minimum target of 14%, impacted by the reclassification of the French businesses and losses on share investments. There’s work to be done to both keep costs in check and grow revenue if it wants that back within target range.

As with both Lloyds and Barclays, higher interest rates helped net interest income jump 30% to $8.6bn. The group’s projecting full year net interest income of $32bn, rising to $36bn for 2023. Management reiterated plans to pay out 50% of earnings over 2023/24, meaning shareholders are set to benefit from more favourable interest rates in the short term. But there are no guarantees.

HSBC’s diversification is a positive. But we’re wary of the increased Asian exposure while the region remains in a sensitive state, both from an economic and political standpoint.

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