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Brexit adds to the pressures UK banks face

UK banks have never fully recovered from the damaging effects of the financial crisis, and the Brexit vote has only added to the pressures they are facing. The focus will be on the outlooks that the likes of Lloyds Banking Group, Barclays, HSBC and Royal Bank of Scotland give when they report latest earnings in coming days. 

Bank of England
Source: Bloomberg

The second-quarter results are unlikely to show any impact from the Brexit vote, but the outlooks are likely to mention it heavily. There are already reports that Royal Bank of Scotland and its Natwest subsidiary have warned business customers in the UK that they could face being charged to hold cash at the banks. That’s being seen as a warning to the Bank of England that there will be consequences to any reduction in the central bank’s base rate.

If, as expected, the BoE responds to any economic weakness following the Brexit vote with an interest rate reduction, then bank margins will be squeezed further. The bank rate has been at a record low of 0.5% since March 2009, but further rate cuts are on the cards in the wake of the UK’s decision to leave the EU.

It is unlikely that the BoE will join the European Central Bank and Bank of Japan in introducing negative interest rates. BoE Governor Mark Carney, for one, is known not to be a fan of negative rates and it isn’t clear whether the policies are working in the eurozone or Japan.

The UK banks are also facing a Brexit hit from the property market. They’re big lenders in the commercial property sector, which is under strain since the vote, while the likes of Lloyds Banking Group, RBS and Barclays will be potentially hit by lower mortgage lending as the residential market also slows.

All of this means further pressure on future growth prospects, and some of the banks are likely to respond by further cost-cutting. Lloyds, for example, is already in the process of cutting £1 billion from its cost base, and could announce a more aggressive programme. The UK government has already stalled its sale of its remaining 9% stake in Lloyds, and the bank is also expected to delay plans to hike dividends for its investors.

Lloyds daily chart

Still, Lloyds is expected to report pre-tax profit of £2.35 billion for the first-half of 2016, up from £1.19 billion a year earlier when it had to add £1.4 billion to its compensation bill for mis-selling PPI.

RBS continues to suffer from a long-lasting hangover in the wake of the financial crisis. It’s facing a new penalty of as much as $13 billion in the US relating to the sale of mortgage bonds before the financial crisis. It also has a pressing need to spin off 315 UK branches – this was an EU requirement of the bailout RBS recieved during the financial crisis.

Over at Barclays, the focus will be on its efforts to sell-off its African business and shrink its investment banking operations. The bank had a weak first quarter as its investment banking arm was hit by tough trading conditions, but it could benefit from the pick-up in fixed income trading that has helped bolster second-quarter results at the US investment banks.

HSBC, and Asia-focused Standard Chartered are less exposed to the impact of the UK vote to Brexit. In fact, Standard Chartered is one of Goldman Sachs’ top picks in the sector due to its non-UK focus. HSBC is set to report lower earnings per share and revenues due to the sale of its Brazilian business and further restructuring costs. Its dividend will also be closely watched amid doubts that it can maintain its progressive policy at the current time.

Analysts are turning more positive about Standard Chartered under new Chief Executive Bill Winters. The bank has had a difficult couple of years due to the Asian slowdown, but Winters has brought a new strategy that’s bolstered investor sentiment. First-half profits and revenues will likely be down on the year, but second-quarter figures are likely to rise from the first quarter. Progress on restructuring, cost savings and expenses will all be in the spotlight.

Virgin Money was the first UK-listed bank to report. It is a much smaller bank than the FTSE 100 giants, but its reduced net interest margin guidance for 2016 could be a sign of things to come. Chief Executive Jayne-Anne Gadhia said she expects the BoE’s interest rate to fall from 0.5% and remain at a lower level for three years or more. Virgin also said it has deferred plans to start lending to small firms in light of the EU referendum result and will also be keeping tighter control of costs.

Its results for the first-half – underlying pre-tax profit rose 53% on the year in the first-half to £101.8 million – beat expectations thanks partly to a boom in credit card lending. Its shares were up by more than 7% on the afternoon of the results, although they are still down by almost a quarter since the Brexit vote.

All UK bank shares have tumbled since the Brexit vote due to the concerns over the potential impact. Lloyds is down by 23%, and RBS down by 24%. Some analysts now say the sell-off was overdone and Macquarie raised both stocks to ‘Overweight’ earlier this month. In fact 14 analysts have Lloyds at 'Buy', compared with 9 at 'Hold' and 6 at 'Sell'. There are seven buys for RBS, 11 holds and eight sells, while for Barclays there are nine buys, 14 holds and four sells.

It is clearly a mixed picture for the UK banks, and the Brexit vote has only highlighted the risks they face.

UK bank reporting dates (07:00am London time unless stated):

Tuesday 26 July: Virgin Money Holdings

Wednesday 27 July: Metro Bank, Shawbrook Group

Thursday 28 July: Lloyds Banking Group

Friday 29 July: Barclays

Wednesday 3 August: HSBC (05:00am London time), Standard Chartered

Friday 5 August: Royal Bank of Scotland

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