Bank Watch: UK revival comes with weak returns
Banks’ next challenge: keep growing
The biggest London-listed banks come in two basic flavours: those with an almost exclusive focus on domestic consumers, and those with little—or in one case—no ties to British retail lending at all. On the face of it then, the common theme of recovery across Barclays, HSBC, Lloyds Banking Group, RBS and Standard Chartered looks remarkable – or at least it does on a cursory look. Lenders’ return to health is by no means uniform, and disparate conditions among dominant UK financial institutions may carry the seed of future setbacks. For one thing, it’s simply a fact that at most of these banks, returns are not growing fast enough to cover their cost of capital. In practice that does not portend imminent crisis. But it does mean growth spurts can be more difficult to sustain.
StanChart’s peak quarter
Take Standard Chartered which on Wednesday reported one its best quarterly profits for almost three years, but with revenues of $3.9bn that narrowly missed the market's expectations. Moreover, the group fell somewhat short of an 8% return on equity target, even helped by a low tide for losses and improving capital. The group has amongst the lowest exposures for institutions of its size to potential revenue-boosting trading operations. StanChart thereby illustrates the concern that big banks may have seen a peak for income and contained costs. StanChart’s larger rival HSBC, which also makes the bulk of its revenues overseas will release its first quarter report on Friday 4th May. It is likely to produce figures that show its recovery remains on track but beyond that, progress towards faster growth that could underpin continued shareholder disbursements remains uncertain. The group wrapped up its latest buyback last year and has yet to announce a new programme. For now, HSBC has opted to allocate some of its ample excess capital to strategic initiatives, announcing in February that it would spend $5bn-$7bn on these. After notching Return on Tangible Equity (RoTE) of 9.3% in Q4, HSBC could even reveal that it hit its 10% target in Q1, though exceptional occurrences will almost certainly rob the group of that goal on an underlying basis. Again, that would underscore that despite strengthening retail and wealth franchises, the lender could still be nimbler.
Consumer credit cool-down eyes Lloyds, RBS
The outlook for Britain’s more retail-facing banks remains just as convoluted, and for these, BoE data out this week showing consumer lending fell off a cliff in March add to the sense of new headwinds. For RBS, which reported a solid rise in attributable net income a week ago, with lower costs, the timing of the consumer credit cool-down is more than unfortunate. This year, even after achieving a 9.3% RoTE in Q1, it faces at worst the complete wipe out of annual earnings from an expected U.S. Dept of Justice fine. With £6bn in excess capital, that wipe-out will pare back RBS’s Tier One capital ratio of 16.4% only slightly. And on the other side of the DoJ penalty and a disposal of the government’s 71% holding, the assumption that dividends can resume in 2019 remains reasonable. However, in Q1, loan impairments increased in line with news that consumers were becoming more cautious. Margin for error and for unforeseen economic disruption is razor thin.
RBS’s closest but much larger cousin, Lloyds Banking Group, has even higher exposure to UK economic uncertainties, even with a 23% profit rise in Q1 to £1.6bn. But it's operating costs rose 2% to £2.008bn in Q1, suggesting Lloyds could cut it fine to meet a target of £8bn for the whole of 2019. A cost to income ratio of 45% in the same year also continues to look a stretch, whilst capital was largely static net of dividend accrual in Q1. Together with Lloyds’s dominance of Britain’s loans markets and conservative stance, the bank's relatively healthy conditions look incompatible with faster shareholder returns.
Barclays’s thin edge
Barclays differs from its domestic rivals due to having held on to operations like trading and a presence in regions deemed to carry higher risk. Its investment bank reported a near £1.2bn profit in the first quarter, up almost 50% on the year. Aside from market gyrations, lower costs also helped. However, trading momentum failed to offset declines in the group’s UK retail business, which like rivals also suffered from increased bad debt and rising operating costs, and a legacy misconduct charge meant Barclays had to report the latest in a string of statutory losses. Given that market-related activities are by nature variable, the edge they offer Barclays’s investment case may be marginal.
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