UK banks’ earnings season is tough one to call

Wall Street’s biggest banks have reaped the rewards of a booming deal environment, the release of loan loss reserves and swelling deposits.

Goldman Sachs, Bank of America and JPMorgan all flexed their muscles as they kicked off US earnings season last week.

Now, it is the turn of their British pretenders, starting tomorrow with the only big UK bank that still has an investment bank on its books – Barclays.

A key question for investors combing through the lender’s results will be whether it has followed in the footsteps of its American competitors and ridden the wave of rampant deal making activity.

Besides Barclays, the composition of most UK banks is different from their Wall Street rivals, meaning their earnings will feed through from different types of business activity. 

Retail banking is their bread and butter. But, with the economic backdrop souring since the last crop of results, consumers have become more cautious about their spending, feeding into lower credit demand, a crucial source of revenue for the likes of Lloyds, HSBC and NatWest, who report next week.

“A lack of demand for new credit is a huge issue in terms of banks’ future profitability,” warns Danni Hewson, financial analyst at AJ Bell.

“Consumers are nervous, they’re waiting to see whether forward momentum can be maintained or whether issues like inflation or rising infection levels will halt the recovery in its tracks.”

The clouding economic outlook has also made UK banks more nervous, which could prompt them to hold back a bigger proportion of the reserves they set aside to deal with the expected wave of defaults triggered by the Covid-19 crisis. This is likely to mean the bump they receive will be weaker than that registered by the US banks.

The tapering of the stamp duty holiday has cooled mortgage lending, which will weigh down Lloyds’ earnings as it holds the largest share of the market.

Michael Hewson, chief market analyst at CMC Markets UK, said: “It’s quite likely, given the slowdown in the UK economy, that mortgage demand will have slowed as the various tax measures to support the housing market roll-off.”

HSBC is an outlier due to their strong presence in Asia. Its share price has had its wings clipped as a result of the Evergrande crisis and Chinese authorities cracking down on the economy. Investors will be keen to see if there is any mention of the impact of China’s real estate crisis on its bottom line.

Net interest margins (NIM) have been squeezed for years amid a record low interest rate environment, a source of discomfort for NatWest, which has one of the lowest NIMs in the sector.

Yield curves have been rising rapidly recently as financial markets bring bets on the Bank of England to hike interest rates to November, which will help lift NIMs for all the big high street banks. However, this is unlikely to have a material impact on long term profitability given the Old Lady will only raise rates in small increments.

Some banks may be frantically making last minute changes to their forward guidance after reports emerged Chancellor Rishi Sunak is poised to cut the bank surcharge.

Sunak delivers his budget next Wednesday. Big UK bank bosses will be keeping their ears to the ground.