UK bank sector annual results preview

Following mixed performances in the sector, our head of markets tells us what upcoming results may bring.

On 9 November, the first revelation of a Covid-19 vaccine saw financial markets spike sharply higher, especially in sectors seen as beneficiaries of a return to something like economic normality.

For the banks, this translated into share price hikes across the board which have largely remained intact, although every bank stock remains lower than it was a year ago.

But is a “coiled spring” effect on the cards?

Should the rollout of the vaccine lead to a quicker-than-expected economic recovery, it could result in provisions for bad debts being significantly lower than those announced by the banks last year, which ran to tens of billions of pounds. 

For example, in its third quarter, NatWest (LSE:NWG) set aside a further £254 million for bad debts, compared to an expected figure of £630 million, bringing the cumulative total to around £3.2 billion. The bank guided that the full-year provision should be towards the lower end of the range previously advised, namely £3.5 to £4.5 billion.

Any releases of these conservative provisions (as seen in the recent US banking season) would be taken as a positive step.

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In addition, the announcement that dividend shackles would be lifted for the banks was positive for income-seeking investors. While there is no guarantee of an immediate return to the levels which had previously been seen (see table below), a return to dividends could nonetheless prove to be an additional attraction.

Source: interactive investor as at 9 February 2021. Past performance is not a guide to future performance

Of course, the metrics will receive scrutiny. These range from the strength of the capital cushions, the Return on Capital, the Net Interest Margin and the cost/income ratio.

Headwinds remain for the sector in light of historically low interest rates, which put severe downward pressure on margins. At the same time there could be a spike in bad debts, although not perhaps to the level which the banks had previously anticipated, if the end of the pandemic leaves a trail of unemployment and fiscal poverty behind it.

At the same time, since the great financial crisis of 2008, bank stocks have tended to veer into trading stocks territory as opposed to the long-term investments traditionally seen, amid much heightened volatility.

Even so, the banks have had time to shore up their balance sheets and capital buffers in a way which places them in their strongest period for over a decade.

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Stock specifically, Barclays (LSE:BARC) is the preferred sector play given its universal banking model and geographical diversification, while the market consensus for Standard Chartered (LSE:STAN) has recently been raised to a ‘buy’ on its exposure to recovering Asian economies.

Meanwhile, Lloyds Banking Group (LSE:LLOY) remains cautiously well regarded.

Long since seen as a barometer of the UK economy, the fact that Brexit can now be viewed in the rear-view mirror is a positive development. There are, of course, challenges to come as the removal of government support schemes likely leads to a spike in unemployment, which in turn could result in some loans going sour.

However, in terms of the balance sheet, the capital cushion is around a comfortable 14.6% and an as yet unused PPI (payment protection insurance) provision of £745 million could be released in part or in full after all claims have been settled. The bank’s major presence in the digital space, where a recent 4% increase in users took the overall number to over 17 million, positions Lloyds well both in terms of the likely future direction of banking, while also enabling further expansion at a lower cost.

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Overall, this leaves investors with much to ponder as the full-year reporting season approaches.

However, with valuations at multi-year lows, and with surplus capital and higher resilience adding to the mix, the return of the banks as an investment destination may yet be upon us.