UK banks: another set of numbers to disguise the rot

·4-min read
Lloyds (PA Archive)
Lloyds (PA Archive)

This week sees the UK Bank reporting season begin. Lloyds, HSBC, and Barclays look set to produce decent numbers and limited losses on post pandemic recovery. The outlook is positive, the regulator will allow them to increase dividends, and there is higher income potential from rising interest rates.

On the other hand, banks exist under the cosh of economic reality. The threat of recession in the UK is pronounced – exacerbated by global supply chain crisis and risks of policy mistakes. The worst outcome for banks would be stagflation resulting in exploding loan impairments.

Lloyds is the most vulnerable to the UK economy – hence it’s underperformed the others. The fear is policy mistakes by the Bank in raising interest rates too early, or by government by raising taxes and austerity spending, will hit business and consumer sentiment hardest, causing the stock prices to crumble back towards its low back in Sept 2020 when it hit £24.72. It’s got the largest mortgage exposure – but no one really expects a significant housing sell-off.

If you believe the UK’s economic potential is under-stated, then Lloyds has the best upside stock potential among the big three. If the economy recovers strongly, Lloyds goes up. If it stumbles, then so will Lloyds! And if that happens, I’d be tempted to think about buying it lower.

Barclays is a more difficult call. It’s a broader, more diversified name. It retains an element of “whoosh” from its markets businesses – which have delivered excellent returns from its capital markets businesses fuelled by low rates, but it also runs a higher-than-average reputational risk for generating embarrassing headlines.

When the global economy normalises, higher interest rates will impact the fee income of all the investment banks, thus impacting Barclays to a greater extent than Lloyds. Barclay’s international business gives it some hedge against a UK economic slide.

HSBC is the most complex call. The UK banking operation is a rounding error compared to the Bank’s Hong Kong business. The bank is pivoting towards Asia, orbiting China and other high-growth Far East economies where it seeks to attract rising middle-class wealth. It’s underperformed due to a distaste among global investors for its China business, but also the perception it’s just too big a bank to manage effectively.

If its China strategy was to pay off, it will be a long-term winner. But that’s no means certain – Premier Xi Jinping’s crackdown on Chinese Tech threatens to morph into a China first policy, and the space for a strong foreign bank in China’s banking system looks questionable, even as the developing crisis in real-estate could pull it lower.

Whatever the respective bank numbers show this week, the banks will remain core holdings for many investors. Generally, big banks are perceived to be “relatively” safe. Regulation has reduced their market risk profiles, and strengthened capital bases since the post-Lehman unpleasantness in 2008 which saw RBS rescued by government. Conventional investment wisdom says the more “dull, boring and predictable” a bank is the more valuable it is perceived in terms of stable predictable dividends, sound risk management, and for not surprising investors. Strong banks are perceived to be less vulnerable to competition.

Since 2008 that’s changed. The costs of entry have tumbled. New, more nimble Fin-Techs like Revolut, digital challenger banks such as Starling, and cheaper foreign competitors, including the Yanks, leave the old established UK banks under significant threat. The future of banking is going to be about Tech and how effectively they market their online digital facilities.

This leaves the big UK banks looking vulnerable. They’ve failed to evolve into the new digital age. They haven’t built centralised data-lakes from their information on individuals or the financial behaviours of crowds to improve and develop their services and income streams.

The new generation of nimbler Fin Techs and Challengers can innovate product offerings with sophisticated new systems and software. In contrast, UK bank IT departments are engaged in digital archaeology. The best paid IT consultants are ancient coders brought into to patch 50 year-old archaic systems. Legacy systems leave the big banks with impossible catch up costs.

If the future of modern finance is a Tech hypersonic missile… British Banks are still building steam trains.

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