UK bank sector Q3 results season

Bank shares have remained volatile during recent political turmoil, but there are reasons to back the sector ahead of latest earnings releases.

The recession resilience of Britain’s biggest banks will be the focus next week when Lloyds Banking Group (LSE:LLOY) and other lenders reveal results from a remarkable quarter for the UK economy.

The highlighting of capital and liquidity buffers will be in sharp contrast to the narrative of three months ago, when NatWest Group (LSE:NWG) sent its shares soaring by unveiling bumper shareholder returns as banks benefited from the margins impact of rising interest rates.

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Since then, the economic outlook has deteriorated and the UK is mired in a political crisis that continued today when Liz Truss resigned as prime minister after just 45 days in office.

Her pro-growth agenda had initially been regarded as a potential positive for UK bellwether Lloyds, but that was before details of her chancellor’s unfunded tax cuts caused mayhem for UK financial markets and sent mortgage rates soaring.

Amid this ongoing squeeze for household finances, and with Britain heading for recession in 2023, banks are faced with having to make greater credit impairment provisions in forthcoming results. Their own funding costs are now also much higher, offsetting some of the earnings uplift from the past year’s long-awaited rise in interest rates from record lows.

In addition, the possibility that chancellor Jeremy Hunt will target the sector for higher taxes as part of an effort to fill the £40 billion gap in the public finances creates further uncertainty.

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The message from the industry next week is likely to be that balance sheets are in much stronger shape to withstand the expected economic downturn. In addition, underwriting standards have tightened and the proportion of low-risk, prime residential mortgage lending should underpin asset quality.

Fitch Ratings said today: “The banks have built up strong capital and liquidity buffers and reported strong profitability in recent years, which should help absorb the impact of the recession in 2023.”

The agency expects impaired loan ratios to increase in 2023 but to remain below 3% across UK banks' gross loans overall, with the biggest impact likely to be in unsecured retail and SME loan portfolios. Despite this resilience, Fitch warns that economic policy uncertainty and volatile market conditions will increase “second-order” risks for banks.

The overall message of UK banks is likely to be similar to the one from Wall Street in recent days, where lenders revealed they are well capitalised and ready for what JP Morgan described as “significant headwinds”.

The UK reporting season begins with third-quarter figures from HSBC Holdings (LSE:HSBA) on Tuesday, before Barclays (LSE:BARC), Lloyds and NatWest take turns over the following three days.

Year-on-year comparisons are likely to be difficult because the release of Covid provisions flattered figures in 2021. But the Times said today that Britain’s four biggest banks are set to rack up profits of £33 billion this year, compared with about £25 billion in 2019.

The newspaper said City analysts expect Lloyds to unveil third-quarter profits of £1.8 billion, with an annual figure forecast to be £7.2 billion. The figures for NatWest are £1.3 billion and £5 billion respectively, with Barclays seen at £1.8 billion and £6.9 billion.

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When the banks reported their second-quarter results in July, NatWest and Lloyds raised their full-year guidance after leveraging the benefits from higher rates.

Net interest income, which is the difference between the revenues generated from loans and the expenses associated with deposits and other liabilities, rose by double digits year-on-year for all four of the major lenders in the quarter. This performance led to NatWest announcing a special dividend of 16.8p equivalent to 7% of market cap.

Expectations that banks will have less room for shareholder returns have contributed to the recent pressure on valuations, with shares in the sector down by around 14% over the past month. Lloyds stood 1.5p higher at 42.1p, with NatWest up 5.7p to 236.8p and Barclays up 2.2p at 146.5p in the wake of the prime minister’s resignation.

Earlier this month, Deutsche Bank highlighted “buy” recommendations on Lloyds and NatWest, noting price targets of 64p and 380p respectively, and said there were also potential big upside for Virgin Money UK (LSE:VMUK) and Standard Chartered (LSE:STAN).

Its banking analyst pointed out that the loan loss sensitivity of UK banks to falling house prices was now much lower, and that recent regulatory changes also meant that risk weighted assets were not so exposed to house price fluctuations.