Rethink over rate cuts boosts UK banks

The first-quarter bank reporting season underlined the receding threat of multiple interest rate cuts this year. While bank margins endured some pressure from churning customer deposits, the broader picture looks positive enough that analysts have been either upgrading their forecasts, or at least saying that banks will at the minimum meet their own stated targets for the year. There seemed to be a note of cautious optimism, which contrasted greatly with the gloom of the past decade.

With the picture looking generally benign for banks based on stable interest rates and a gently rebounding housing market, the only real differentiator now is how well the institutions are faring operationally. There was a distinct impression that the banks with the fewest outside distractions were enjoying a greater share of the market limelight.

The good…

It must be quite jarring for executives at NatWest (NWB) to find themselves and their institution to be the object of praise, rather than condemnation. With a new chief executive in the hot seat following the ignominious exit of Dame Alison Rose, the bank can get on with business free of outside distractions.

The first quarter showed the benefit of long years of balance sheet surgery and the lack of controversy means that NatWest has become a bellwether for the banking market’s underlying performance. This was clear in the six basis point quarterly improvement in the net interest margin (NIM) across the institution's three operating units to 2.05 per cent.

Peel Hunt analyst Robert Sage summed up the general trend: “Lloyds (LLOY) reported a slowdown in negative NIM trends, Barclays’ (BARC) NIM rose 2 per cent and NatWest has now confirmed our view that the central case is for NIMs to resume an upward path during the year”.

The ugly, but effective…

Analysts delicately described Lloyds’ profit performance as “sub-optimal” in the first quarter as the bank missed consensus forecasts on margins and profit mix, while its traditional bugbear of stubbornly high costs also proved to be a drag. With a new regulatory headache to deal with in the Financial Conduct Authority’s investigation into historic car finance commission payments and the impact on consumers, the shares showed little reaction on presentation day. It was a timely reminder that change at Lloyds can be both slow and incremental.

That said, its net interest margin was a healthy 2.95 per cent, with signs that both deposit churn is slowing down and mortgage margins are definitively widening. In the medium term, that means the bank, with a £400bn loan book tied to the UK economy, is not going to struggle if the fundamentals are healthy.

The soaring eagle?

Barclays finally managed to leave the naughty step at its last results after promising shareholders £10bn of capital payouts, an increased dividend and to finally get on top of the issues that have blighted the bank, namely the capital intensive, highly volatile and currently minimally profitable investment bank. Its trading update confirmed yet again that the bank’s best performing division is its UK retail arm, encompassing both Barclays high-street branches and the Woolwich mortgage brand.

Barclays' first-quarter return on tangible equity (RoTE) of 12.3 per cent looked to be a move in the right direction, although analysts point out that for the group to consistently achieve a RoTE in the low teens, the bank must find an estimated £1bn of savings from the business. That will need to come from headcount and, with the investment bank badly underperforming on the key RoTE measure, this is the obvious place to look for reductions. With the board’s at times quixotic attachment to the investment bank business, it remains to be seen if a meaningful cull of currently underworked investment bankers will take place.

The bad in parts?

Apart from a colourful client base that has at times yielded awkward money laundering connections and a charge book that takes up a couple of pages of the annual report, HSBC (HBSA) has generally swerved most of the banking crises of the past 20 years thanks to its high-saving Asian clients and loans to Chinese businesses.

However, the growth assumptions that underlay a 'pivot' to Asia are now very much in doubt as China’s property market starts to mirror the Japanese slump of the early 1990s. Throw in a Chinese administration that appears belligerent and hostile to business and the prospect of HSBC moving its entire operation to concentrate solely on Asia looks increasingly distant.  

Indeed, the bank looks to be heading into an immediate era of uncertainty as its chief executive for the past five years, Noel Quinn, heads into retirement. The institution that he will view from the golf course is materially different from the Midland Bank where he started his career in 1987.

Despite complaints from shareholders, particularly Chinese insurer Ping An, Mr Quinn had retrenched from declining businesses in North America and Europe to concentrate more risk capital into backing its Asian operations, particularly in fast-growing wealth management, and he has arguably restored momentum to the group’s profits. Whoever takes over, and current finance chief Georges Elhedery seems to be the leading internal candidate, will have to decide whether concentration of effort, or diversification of risk through a wide geographic presence, is the best way forward.