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What the latest earning reports tell us about the UK banking industry
The annual reports for most of the big UK/US banks for 2019 are in as results season comes to a close. So what do they tell us about the state of the industry?
In the UK, these results were a bit of a mixed bag, but they were generally a continuation of steady profits and revenues for the Big Four – Barclays, Lloyds, HSBC and RBS: nothing explosive but nothing that jumped out as a huge warning sign of significant issues, either.
How refreshing is that messaging compared to a few years ago, when annual results were best consumed with a shot of single malt – especially given the implications to the wider economy of an underperforming banking sector.
Buuuuut we shouldn’t get too comfortable.
The way the year is panning out, at best 2020 will yield more of the same. At worst, though, the macro tailwinds are getting in place to deliver a smackdown on the banking industry that sends us into concussion.
The UK picture
In the UK, the Big Four’s Profit Before Tax (PBT) was generally positive. RBS’s PBT represented a 26 percent increase from last year, as it recognised its third year of consecutive profits demonstrating that there is gas in the tanker yet. Barclays (Group) also reported a positive PBT of nine percent, but this was more to do with strong US investment banking influence as international income rose by five percent (to £14.6 billion). In the UK, Barclays income actually fell to £5.9 billion (net).
The worst set of results were provided by HSBC and Lloyds. The latter is still exposed in a big way to Payment Protection Insurance (PPI) - paying £2.6 billion in fines last year. Lloyds’ total bill on the PPI scandal currently stands at a cool £22 billion… almost half the total of all fines dolled out since the scandal broke.
That contributed to a fall in profits vs 2018 (£4.4 billion vs ~£6 billion), although conversely, the standout figure for Lloyds was their cost-to-income (C:I) ratio – an industry-beating 48.5 percent.
The C:I ratio is regarded as an important metric in banking as it measures what your operating cost base is compared to your operating income. The lower the percentage, the less you have to spend to generate income – and at 48.5 percent, Lloyds are streaks ahead of the other big UK banks. By comparison, RBS’s C:I ratio improved to 65.1 percent (from 71.7 percent) driven in part by cost reductions of £310 million and Barclays went from 66 percent in 2018 to 63 percent in 2019.
Banks are big. And they take time to turn around
So where are the profits coming from for UK banks?
Despite talk of diversification of revenues, digital transformations, marketplaces, ecosystems and all the other buzzwords bankers and consultants will throw at you, olden is golden.
The industry's best friend is still Net Interest Margin (NIM), the difference between the cost of funding that a bank borrows (from various sources – wholesale markets, customer deposits, etc) and the total aggregate rate that it lends.
Now NIM has been under a bit of pressure recently as an extended low interest rate environment has contributed to a squeeze on margins. Currently the banks are earning at a range of 1.99 percent (RBS) through to 3.09 percent (Barclays). As more customers roll off of term mortgages and onto a lower variable rate (comparatively), it will be interesting to see how far NIM will be squeezed further.
The flood of low rate mortgage products, which has forced Tesco’s and Sainsbury’s to sell their back books, indicates that this trend is here to stay, although it could stabilise at a new normal. Regardless, income from NIM is down from 2018 across the board.
The picture from across the Atlantic: JPM rules the roost
US banks have faced similar issues – for instance compression on NIM forced JPMorgan to re-align earnings forecasts multiple times in 2019, before releasing a set of results that, within that context, blew the market away.
JPM’s earnings per share (which measures the profitability of a company by dividing a company’s profit by the amount of common stock issued) was at $10.72, up 19 percent on last year. That makes buying JPM shares an attractive proposition; prior to a Coronavirus-related market dip, its shares were trading at $137.
Why? Well, the earnings were good, but the underlying factors point to success in diversifying its revenue. JPM are just massive – with income over five times any of the UK banks with a diversified revenue stream that includes a huge income from traditional IB business (fixed income – 86 percent increase YOY and equity trading up 15 percent over the same period), as well as strong deposit accumulation over the year (up seven percent) that is especially impressive if you consider that Marcus was reported to have swept the market over the last 12 months.
For the other [US] players, 2019 proved to be a mixed bag
The key for JPM is that the credit card and auto loan businesses were strong performers, balancing a reduction in NIM income and a consumer business that only grew three percent. When an IB business works well, it works really well. The size of JPM and the funding and support it can provide new propositions will be a massive factor that will drive the success of their new digital-only UK proposition, which is set to launch this year. As mentioned on a recent episode of Fintech Insider, JPM’s presence in the UK is already vast (from a servicing and infrastructure perspective), which should have the UK Big Four slightly nervous over the next 18 months.
For the other players, 2019 proved to be a mixed bag. Citigroup’s overall net income rose to their highest levels since 2006 at a cool $19.4 billion for the year with an EPS of $8.04 for 2019, up 20 percent on 2018. Consumer banking revenues were up a modest but satisfying four percent year on year. For Wells Fargo, well, they posted negative growth in consumer banking operations - Wells’s consumer banking revenue is down 11 percent over the last five years - a worrying trend.
So what will 2020 bring?
At best, the UK banks will see some NIM stabilisation, cost-rationalisation programmes will see some operating cost cuts and things will probably look quite similar to 2019 (pending impact of additional PPI claims).
HSBC are going to look to their profitable Asian and Middle Eastern businesses, looking to ‘tighten’ their underperforming US IB business, while both they and RBS have committed to large job cuts to their investment banking businesses. Ultimately, though, things might look quite similar if all goes well. Banks are big. And they take time to turn around.
At worst, however, things could go haywire. Coronavirus could act as an accelerant to a wider global recession, in which the UK banks, who have a deep exposure primarily to Asia but also to other markets, rack up significant bad loans as first the travel industry and then others suffer significantly. Impairment charges could go through the roof and net profits are massively hit, causing significant implications for wider society not seen since the aftermath of the financial crisis in 2008. Share prices could be devastated.
For more info and a more in-depth discussion, check out the accompanying 11:FS Fintech Insider podcast, featuring all your favourite big banks and some challengers as well.