Third quarter relief for UK banks and Deutsche

• UK banks get some breathing space before Brexit hits
• Barclays benefits from global reach
• PPI continues to haunt
• RBS set for its umpteenth loss

The biggest-UK-focused banks are weathering Brexit Britain for now. It’s no coincidence however that Barclays—the most internationally exposed—is set to outperform rivals in the third quarter.

Well-sourced internal soundings point to demand for mortgages and business loans slipping only slightly since the referendum.

That confounds expectations of a significant downturn in lenders’ main revenue streams.

Senior bank executives are reported to still see risks to future earnings pointing to the downside, based on the view that deeper structural impact to the UK economy will be seen once Britain begins the process to formally leave the EU.

Prime Minister Theresa May has said the Article 50 procedure will be ‘triggered’ no later than March.

Even so, confident signals by banks ahead of third quarter results will be a relief for investors who remain braced for further declines in net interest income and dividend risks from a hit to the economy and record-low interest rates.

Further out, whilst growth is likely to slow in the third quarter, economists now expect the economy to avoid the recession many originally predicted.

Barclays’ Brexit breakthrough

By our reckoning, Barclays, stands the best chance of delivering a strong quarter, given that it has retained the kind of overseas-focused investment banking business that Royal Bank of Scotland and Lloyds Banking Group exited.

International revenues give Barclays the same benefits as many other FTSE 100 groups following the collapse of the pound.

Whilst Barclays shares were 16% lower in the year to date on Tuesday, they had still done better than Lloyds’s 25% fall, and RBS’s almost 40% decline.

Additionally, from our point of view, enhancements to Barclays’ third-quarter performance, from what it calls “other net income”, are being underestimated. Many of these “other” income items would be more commonly regarded as exceptionals.

That means there may be little let-up in earnings volatility at the margin in coming quarters.

• For now though, we note the bank has confirmed a £535m pre-tax gain from the sale of Barclays Risk Analytics and Index Solutions Ltd.
• We also note the bank’s latest liability management drive has encouraged a handful of City brokerages to pencil in an additional paper gain of as much as £150m in Q3 2016.

These should leave “other net income” for Q3 above the average £460m forecast compiled by Barclays itself.

In turn, the Barclays-compiled consensus for underlying profit before tax of £1.295bn also looks beatable in our view.

Incidentally, that figure is lower than (quite comparable) Earnings before Interest and Tax (EBIT) consensus of £1.75bn published by Thomson Reuters.

Either way the market could react with as much enthusiasm to a Barclays underlying earnings ‘surprise’ as it did to the bank’s better-than-expected second-quarter results.

Barclays’ third quarter revenues are expected to slip 21% to £4.77bn according Thomson Reuters, whilst pre-tax profit is seen 22% higher at £933m.

As usual, a barrage of one-off factors will both aid and hinder the bottom line.

The biggest risk to Barclays Q3 results, albeit a remote one, at the moment, is that the bank may book a penalty for substantial redress in a misconduct case, particularly at the US Department of Justice.

Lloyds and RBS earnings could have been worse

All UK banks’ earnings will continue to be dented by the series of  ‘one-off’ hits that has beset their earnings for almost a decade.

All are likely to increase provisions to compensate customers who were mis-sold payment protection insurance (PPI). We also expect pension pots to be topped up to offset the hit from lower bond yields.

We think Lloyds will set aside a further £750m-£1bn in PPI provisions, bearing in mind the Financial Conduct Authority’s extension of a deadline for compensation claims by a year.

Lloyds’ and RBS’s income will be weaker than Barclays’ in line with the economic volatility seen in Britain since late June which will have directly impacted Lloyds, Britain’s biggest mortgage lender and RBS, which also depends on the UK for sales but has deeper legacy issues.

RBS’s trailing 12-month Return on Common Equity has been negative since the financial crisis hit home, whilst Lloyds’ is modestly positive.

RBS is expected to report a loss of £231m, partly because of ongoing restructuring and litigation charges.

Lloyds Bank is forecast to report a third-quarter EBIT of £2.175bn compared to £2.129bn in the same quarter a year before.

Deutsche’s investment bank could save its quarter

The other bank whose earnings will be no less in the spotlight this week, for obvious reason, is Deutsche.

It will announce Q3 earnings on the morning of Thursday 27th October. This comes after a trying period for the bank, when it was presented with a whopping $14bn fine by the US department of Justice for miss-selling mortgage backed securities during the financial crisis, and its share price has plunged 40% so far this year.

The bank insists that it will negotiate a lower penalty.

The bank is expected to report a €610m loss, however, some analysts have forecast DB’s loss at more than €2bn.  Anything higher than €1bn could spook the market as it may raise concerns about the bank’s financial viability, and could lead to another sell-off in its shares.

Analysts are expecting revenues for Q3 of €7.2bn, down from €10.1bn in Q2, and earnings per share are expected to decline to €0.32 from €0.51 in Q2.

There could, however, be a couple of glimmers of hope for Deutsche Bank in this quarterly update.

Firstly, pre-tax income could jump to €582m from a loss of €152m in Q2. The risk is to the upside, as DB’s investment banking division could see an increase in profits on the back of recent unprecedented market volatility due to the UK’s Brexit vote and the prospect of a US interest rate increase.

The market will also be looking for an update regarding the bank’s negotiations with the US Department of Justice.

If there are any signs that its $14bn fine will be reduced then this could also boost the share price. On balance we think that investment bank revenue could be better than expected; however, if the bank signals that it is looking to scale back its IB activities, particularly in the US, then we may see any share price rally curtailed prematurely, as investors grow concerned that the bank is selling its cash cow.