UK banks beat forecasts but not market lethargy

The UK banks beat market expectations by 13 per cent in the June quarter on better income, better pre-provision profit and substantially better credit quality.

Better results weren't confined to the international banks either as - excluding HSBC and Standard Chartered - the three large domestic banks reported 7 per cent better pre-provision profit and 25 per cent lower loan losses for 15 per cent higher earnings.

Yet the good result did absolutely nothing for bank share prices with post-results share performance lacklustre and seemingly uncorrelated with the results.

This is the view of UBS UK analyst Jason Napier, who beefed up his earnings-per-share forecasts for the British banks by 5 per cent for this year and up to 3 per cent for subsequent periods.

“Much of the outperformance in the first half, driven as it was by loan losses, did not translate into a more upbeat view on charges for the outer years," he said. “It shows investors are not seeing near term earnings beats as a catalyst for a re-rating and appear unwilling to commit further capital to the UK banks

“In short, current outperformance is delinked from future expectations.”
 

Three themes

The three themes Napier highlighted within the results are margins, costs and bad debts. After the 2017 first quarter margin aberration, in which the UK domestic's margins rose, the subdued outlook for the industry margins was again reinforced in these results.

Lending competition remains high, he noted. So far, firms have used the re-pricing of deposits and a shift in mix to cheap BoE liquidity to hold the line.

“With cheap BoE money ending in Feb 2018 we think mortgage rates have likely seen their lows but are skeptical that spreads will rise next year as lenders return to a more normal funding mix."

Second quarter results were blighted by significant costs for credit insurance refunds and material provisions for restructuring linked to efficiency efforts and ringfencing in particular. The regulator has set a deadline of next August for people to make claims over mis-sold payment protection insurance.

"With the industry-lead marketing campaign due to begin at the end of this month we'd expect noise on the topic to increase," Napier argued.

"But unless the recent High Court decision to deny a motion brought by We Fight Any Claim is over-turned, we think PPI as a key issue for sector capitalisation and dividends may be finally consigned to the past in the foreseeable future."

This brings total below the line charges for UK conduct claims to £143 billion since 2008, 47 per cent of current sector asset value.
 

Upgraded outlook

Second quarter loan losses reported between 9 per cent and 46 per cent lower than market expectations, underlining the view that credit quality is holding up.

"Remember that in the last downturn house prices were, at their worst, down 19 per cent year-on-year at one stage. And, industry loan loss charges peaked at 12 basis points for mortgages," said Napier.

“So, it is with good reason that the market is focused on the outlook for unsecured charges which rose to 10 per cent and 7 per cent in personal lending and cards in the last cycle: multiples of current levels."

However, according to Napier, there is nothing in the first half results to suggest that the impact of higher inflation and sluggish wage growth is putting stress on credit quality.

“Our estimates for all the banks assume things get worse in the coming years, driven by our higher unemployment view," he said. “What we did learn with results, however, was that better than expected loan losses will be ignored or - worse - treated as confirmation of how much worse things can get from here.

“Another quarter of resilient charges is unlikely to be a catalyst for a re-rating.”

Moody’s has upgraded its outlook for the UK banking industry back to 'stable' - from 'negative' last June - citing firm's ability to cope with the tougher operating environment coming their way.

In a recent report, the ratngs agency said while the “tougher operating environment” will erode banks' revenues, profitability and asset quality, their credit profiles will remain healthy due to their improved capital positions, strong loan quality and robust liquidity and funding.

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