The banking sector has been under huge scrutiny recently, but the latest round of UK banking results came with no nasty surprises. High-profile banking bailouts in the US and Europe have weighed on the entire global banking sector, however not all banks are equal. There were several important takeaways from recent UK bank results.
Key takeaways
- Issues facing US banks aren’t causing stress elsewhere.
- UK-listed banks have strong capital levels.
- Interest rate tailwinds look to be fading.
- The economic picture is improving, outlook for bad debt was broadly better than expected.
This is not the US – and that's a good thing
Recent weeks have seen the largest US banking failures since the 2008 financial crisis. Three mid-sized US banks have been down and sold by US regulators – Silicon Valley Bank, Signature Bank and First Republic.
Troubles in the US have largely been related to uninsured deposits and unrealised losses on banks' balance sheets because of bond investments that saw their value plummet against rapidly rising interest rates. This caused concern with depositors, who then pulled their funds and a run on those banks followed.
What caused the US banking crisis and what could come next?
So far, we’ve not seen this happen in the UK. There’s a very important difference between the reporting process for UK banks and mid-sized US banks. In the US, capital ratios (used by investors to judge solvency) don't consider unrealised losses. In the UK, they do, which paints a much better picture of the actual state of play.
That doesn't mean UK banks are immune to similar pressures, but the good news from recent results is that the capital levels of the major UK-listed banks are strong. So much so that Standard Chartered, Lloyds, NatWest and Barclays are all returning excess cash to shareholders through ongoing buyback programs. As ever, returns are never guaranteed.
Dividends vs share buybacks – what investors need to know
Have interest rates peaked?
The rapid pace of interest rate hikes has wreaked havoc on bond portfolios, ultimately contributing to the high-profile demise of three US banks. However, it's been a tailwind for income. Especially banks with a strong foothold in traditional lending.
Net interest margin is the main measure used to assess the profitability of lending and borrowing operations. One of the common themes from first-quarter results was the idea that interest rates are close to, or at, their peak.
That's not to say the benefits will disappear. Rates are likely to stay high enough to support interest income for at least the rest of the year – potentially ticking slightly higher still. But the pace of increases is slowing, and customers will be demanding more from their cash accounts which will eat into how much profit the banks can make.
Banks like Lloyds, NatWest and HSBC are more exposed to the changing interest rate environment than more diversified players like Barclays and Standard Chartered.
The economic outlook is improving
Recent bank reporting periods have been dominated by talk of worsening economic conditions and the associated charges (impairments) taken in preparation for bad debt. However, it feels like the latest set of results might have marked a turning point.
Impairment charges were largely better than analysts expected across the board, and materially lower than the previous quarter. To put it in context, the fourth quarter of 2022 saw the five banks on our research coverage list record around £4.7bn of impairments. In the quarter just gone, that dropped to £1.2bn. That doesn’t mean default levels will improve, but the trend of default expectations getting materially worse looks to have paused.
The improved outlook, and lower impairment charges, helped give a welcome boost to earnings. We tend to lean on the side of optimism about the outlook for the rest of the year when it comes to debt defaults. There's no doubt pressure, but consumers look resilient, and default levels are steady. Of course, any sudden changes to the current economic trajectory would increase strain.
So, where do we sit?
We think the strong capital positions and helpful interest rate environment should hold UK-listed banks in good stead over 2023. Banks with more diverse income streams could offer a bit of shelter should interest rates begin to flatline and maybe even fall toward the end of the year. We're also supportive of banks with a good history of keeping costs in check, given inflation continues to be a challenge.
Largely speaking, we see issues over in the US as being isolated to that market. The recent dip in valuations of UK-listed banks could offer an opportunity. Investors must be aware, though, the benefits from higher interest rates look to be easing, and any economic shocks would hit the banking sector more than others.
This article isn’t personal advice. If you’re not sure what’s right for you, ask for advice. Investments and any income from them can fall as well as rise in value so you could get back less than you invest.
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