UK banks put aside Brexit risk

Having performed poorly in 2018 there was little confidence that the UK banking sectors fortunes would improve in 2019.

Concerns about Brexit, a slowing global economy, and the prospect of interest rates moving lower had all the ingredients of a challenging year, particularly since the UK was expected to leave the EU at the end of March.

The European banking sector was also expected to remain a challenge, even though the European Central Bank was finally ending its €2.5trn asset purchase program having started it all the way back in 2015.

Despite the underperformance of 2018 the underlying performance of UK banks in terms of their day to day business on a domestic level hasn’t been that bad, with decent profits in 2018, with the trend continuing into the first half of 2019.

On the downside investors still had the same concerns about rising consumer credit, further provisions for PPI, as well as continued pressure on margins as a result of narrowing rate differentials, but overall the UK banking sector has been able to cope quite well with the uncertainty that has been a hallmark of 2019, and three extensions to the Brexit deadline.

In Europe there has been some progress on the problem of bad loans, however the economic slowdown seen throughout the region this year has meant that progress has been glacial, with the budget stand-off between the European Commission and the Italian government still unresolved as we head into 2020.

This has meant that progress on cleaning up the banking system elsewhere in the region has taken longer to put into place with the banking system in Greece still struggling to find ways to recapitalise itself, without wiping out its capital buffers.

Germany’s biggest bank, Deutsche Bank has continued to navigate its way from one crisis to the next with new CEO Christian Sewing trying to extricate the bank from various scandals involving money laundering, as senior board members came under scrutiny from regulatory officials.

The share price for Deutsche fell back to new multi-year lows earlier this year with management continuing to cut jobs and costs in order to return the bank to a sustainable business model. There has been continued talk of a possible merger with Commerzbank, a ridiculous notion given the size of the two banks.

For all the supposed benefit a merger would give, both parties would have to undergo extensive due diligence, which might uncover all manner of hidden horrors. This is perhaps why the merger fell through, in that all the assets and liabilities would probably have had to be marked to market.

In any case the resulting bank would be an even bigger problem for the German taxpayer as opposed to two big ones. A merger also wouldn’t resolve the underlying problem of a German banking sector hamstrung by negative rates, as well as too many banks, and too many branches.


Source: Bloomberg

In terms of overall performance the European Banks index (green line) has outperformed its UK counterpart despite the problems of Deutsche Bank, however that’s not as positive as it looks given that the sector traded close to a seven year low in August this year.

Despite the Brexit uncertainties UK banks had until last Thursday broadly traded sideways for a lot of this year, albeit with a slightly negative bias. This changed last Friday with a sharp spike and while the share price performance has been underwhelming, the overall performance in the round has once again been encouraging, despite some weak spots as a result of another round of PPI provisions.

Another drag on UK bank share performance has been the insistence of the Bank of England that they hold more regulatory capital in respect of recent rises in consumer credit, particularly in car loans and credit card debt, as well as making sure they have adequate buffers for a disruptive Brexit.

This year the price performance of all the major banks has been much better, however that needs to be set into the context of a 2018 that saw all of them all fall by between 10% and 20%.

Source: CMC Markets

HSBC has been one of the worst performers, hurt not only by the slowdown in China, along with underperformance in the US and Europe, but the unrest in Hong Kong has also hit its business model.  The replacement of CEO John Flint during the year appears to have been a reaction to concerns that the bank has lagged behind its rivals in cutting its cost base and getting rid of its dead wood.

Royal Bank of Scotland has also struggled this year, and is now under new management with Alison Rose taking over from Ross McEwan as CEO, while the best performer has been Standard Chartered Bank as that bank moves forward with CEO Bill Winters turnaround plan. Even here we have seen disquiet as shareholders push back on the size of Winters pay package, at a time when CEO and management pay strategy comes under ever increasing scrutiny.

Royal Bank of Scotland has certainly had worse years, however when you look at the share price it’s been one of limited progress, though management did manage to finally draw a line under a whole series of legacy issues in 2018.

In the nine months ended 30th September profits attributable to ordinary shareholders came in £1.7bn, despite a Q3 loss of £315m, largely due to a £900m write down in respect of further PPI provisions. This was still a significant improvement on the same period a year ago and most divisions showed some decent resilience in their overall business models.

The only weak spot was NatWest Markets which underperformed due to falling bond yields impacting its ability to turn a profit. Core income fell sharply in Q3, a decline of 44.4% from a year previously, highlighting the challenging interest rate environment. Q4 should be better given that rates have risen, while the yield curve has also steepened a little as well.

Lloyds Banking Group

Despite the risks around a no deal Brexit Lloyds has doubled down on its exposure to the UK economy, buying Tesco’s mortgage book for £3.7bn and its share price performance this year has been better than it was in 2018.

It still had to make yet another large provision in respect of PPI, taking the total sum set aside to over £20bn since the financial crisis, after setting aside another £1.8bn in Q3, on top of £550m in the first part of the year.

In terms of profitability the picture was still positive with profits year to date just below £2bn, down from £3.7bn a year ago, but even with the higher PPI provision these were still a little bit short, due to tighter margins

The bank has also been cutting costs as it embarks on a digital shake up, with these falling by £140m.

Last year Lloyds was perceived as being the one of the most vulnerable to a Brexit induced shock, however concluded that it was still well placed to ride out a disorderly scenario. This year’s findings found that the bank was much more resilient, but the Bank of England did warn that the banks’ ability to ride out any shock was highly dependent on its ability to cut dividends and cut coupon payments at very short notice.


There does appear to be light at the end of the tunnel for CEO Jes Staley’s attempts to turn around the fortunes of Barclays.

One of the worst performers last year, it has fared better this year, with profits and revenues showing significant improvements. This has allowed Jes Staley to push back on activist investor Edward Bramson of Sherborne Capital who earlier this year failed with an attempt to gain a seat on the board, and who wants management to divest the underperforming investment bank.

Profits after tax for the half year came in at just over £2.47bn, over double from the same period a year ago. This improved in Q3 to £3.26bn though this also included another £1.4bn PPI provision, bringing the total number since the financial crisis to an eye watering £11bn.

The direction of travel for net operating income was disappointing, coming in at £9.8bn, down from £10.3bn, however this has been a familiar theme for a lot of banks this year.

As far as the investment bank is concerned Q2 was a much better quarter as FICC income rose to £920m, the best quarter in quite some time, pushing revenues up to over £1.8bn for the half year, while equities also did quite well, turning over £517m, the best quarter since Q2 last year, and helping push profits here up close to £1.2bn, for H1. 


HSBC has been the worst performer amongst UK banks this year riven by management on manoeuvres with the ousting of John Flint, because of perceptions he wasn’t cutting hard enough.

New interim CEO Noel Quinn seems more keen to wield the axe, announcing thousands of job losses at the beginning of October, with most of the losses expected to happen in Europe and the US. Its Asia operations saw reported profit before tax rise 4% to $4.7bn in Q3, with Hong Kong surprisingly resilient despite all of the unrest this year.

In the nine months to date profits rose 4% to $17.2bn, however its operations elsewhere have acted as a drag. The UK business has seen PPI provisions increase to $1bn, while the global markets division saw revenues fall by 13% to $4.5bn, from $5.2bn. Wealth management has also been a key growth area, seeing a rise of 5% over the same period a year ago.

In terms of revenues for the entire business the bank remains on target to hit its revenue target of $55.3bn for the year, which would be a 3.2% decline on last year, however its operating expenses are on course to increase by 3%, a situation that new acting CEO Noel Quinn seems keen to address.


It’s been a slightly better year for UK banks than was the case last year, however concerns about the domestic economy, and another Brexit deadline could well introduce more uncertainty in 2020.

That doesn’t look likely now that the risks of a Labour government and its radical manifesto have been consigned to the dustbin of history for the next five years at least. It now looks likely that the withdrawal agreement will make it through Parliament next month and we will leave the EU at the end of January. The next key risk will be around whether the UK has to apply for an extension to the transition period, once the withdrawal agreement has made its way through the UK parliament.

The biggest risk to profitability next year is the prospect of more Brexit stalemate as well as another Bank of England rate cut, after two policymakers called for a 25bps rate cut at the most recent meeting.

The UK economy still looks in reasonable shape at the moment with rising wages and low unemployment, however it is still vulnerable to a sustained downturn, even if political gridlock now finally appears to have dissipated.

Now that we look set to move on to the next stage of Brexit negotiations we might see some pent up demand unleashed as businesses take advantage of any progress or clarity with respect to the UK’s future trading relationship with the EU as well as the rest of the world.

The next few days and weeks are likely to be a key pre-determinant of the next move up or down, with a positive Brexit outcome likely to prompt a strong rally in bank share prices.

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