Key Takeaways
- U.K. banks' recent results highlighted a sharp year-on-year decline in revenues, and an even more acute rise in loan impairment provisions.
- We expect revenues to fall a little further in 2021, but earnings prospects are brighter as we have growing confidence that provisioning needs will fall substantially.
- That said, the fallout from the third COVID-19-related lockdown in the first quarter of this year has hit the U.K. economy hard, with a full exit from all related legal restrictions not slated until June 21.
- We would therefore only consider revising our negative outlooks on certain banks back to stable once we become more confident in the trajectory of the expected recovery and the scale of banks' ultimate loan losses.
One year on from the start of the first COVID-19-related national lockdown, the U.K. economy is smaller and in need of a quick and purposeful economic rebound. So too are domestically focused U.K. banks, as banking is ultimately a manifestation of the economy they serve. This is why their ratings outlooks are typically negative, which contrasts with the stable outlook on the three U.K. banks that focus on more dynamic international economies, or have large financial markets operations.
The recently published full-year 2020 results laid bare the negative financial impact of COVID-19 on all U.K. banks as earnings performance was poor. The results did, however, offer signs of a silver lining, rather than a threat, for U.K. bank ratings. First, fourth-quarter earnings were generally better than market consensus due to a marked decline in impairment charges. Second, banks resumed shareholder distributions as a sign of their confidence in the future, typically up to the temporary guardrail limits set by the Bank of England (BoE), and yet bank regulatory capital ratios further improved to new highs. And, third, banks opined that the need to further build provisions may well revert to historic norms in 2021, as the large provision built up in the first half of 2020 appears to them to be sufficient.
These rays of optimism, combined with the relative success of the vaccine rollout in the U.K., may yet contribute to outlook revisions to stable from negative in the coming months. But, ultimately, we take a long-term approach to our ratings analysis and are cognizant that the COVID-19-induced economic downturn accelerated the pre-existing challenges for bank business models from the low rate environment that has been a growing ratings focus across European banks.
The likely fall in U.K. bank revenues again in 2021 indicates that there is limited ratings upside in the medium term, particularly for banks with negative outlooks. And while balance sheets are relatively robust, this is not the case for some of the consumers and businesses they serve. With the finishing line of the third U.K. lockdown in sight, market questions focus on whether businesses will run out of cash just as the economy turns, and if they will manage to contribute to the much-needed recovery. Related to this, we are yet to see whether the general population has become more risk averse and if the extension of government spending will squeeze out private enterprise. These will be key rating themes that we will explore with bank management, along with the expanded digital and environmental agendas, and regulatory pressure for banks to support vulnerable customers.
Strong Balance Sheets Shore Up Ratings
The seven largest U.K. banks and largest building society generally reported poor financial results for 2020. This was despite payment protection insurance (PPI) charges no longer weighing on statutory earnings, as was the case in the 2011-2019 period (see chart 1). Indicative of the world of low rates and low loan volumes, banks' management teams have pushed back their return on tangible equity (RoTE) targets into the long grass, beyond our two-year outlook time horizon.
Chart 1
Encouragingly, there have been no announcements of new wide-ranging restructuring plans of note. In terms of ongoing restructuring, HSBC Holdings PLC (HSBC), which we downgraded in May 2020, has now completed the first year of a three-year restructuring plan. We note that it has modestly refreshed its plan to reflect the changed macroeconomic environment. Similarly, NatWest Group plc (NatWest) continues its long-running restructuring, with a further £800 million of strategic costs expected in 2021. It has also announced its intention to make a phased, multiyear withdrawal from its Republic of Ireland business, which contributed 5% of group revenues in 2020.
Like last year, we take a more positive view of banks' balance sheets based on the eight U.K. banks reporting:
- Comfortable and improved funding and liquidity profiles; our weighted-average stable funding ratio improved to 126% in 2020 from 118% in 2019, and our ratio of broad liquid assets to short-term wholesale funding improved to 2.2x from 1.9x.
- An improvement in regulatory capital ratios; on a weighted basis their common equity Tier 1 ratio (CET1) improved to 16.6% from 15.2%, while their leverage ratio increased to 5.5% from 5.2%.
- Little change in impaired loans; on a weighted basis their Stage 3 loans ratio remained satisfactory at 2.0%, up marginally from 1.7%.
Our view of U.K. banks' solid balance sheets already underpins their ratings and provides the foundation for management teams to improve RoTE from the low levels in 2020 (see chart 2). However, U.K. banks' equity valuations are generally poor, with price-to-book valuations ranging from 0.4x-0.7x. In our view, this demonstrates investors' awareness of the profitability issues that arise amid low interest rates. It also highlights the ongoing direct impact of the pandemic, a lack of meaningful credit growth across asset classes, and the unproven ability of the U.K. economy to demonstrate strong and purposeful economic growth since the 2008 financial crisis. U.K. banks are not alone in this respect--the median price-to-book for the listed banks within the top 100 European banks, excluding those in the U.K., is only 0.6x.
Chart 2
This report covers the U.K.'s eight largest banking groups--Barclays, HSBC, Lloyds Banking Group PLC (Lloyds), Nationwide Building Society (Nationwide), NatWest, Santander UK Group Holdings PLC (Santander UK), Standard Chartered PLC, and Virgin Money UK PLC. The ratings on four of the bank holding companies carry a negative outlook, as a direct consequence of our negative view of economic risk in the U.K. banking industry. However, on Feb. 26, 2021, we revised the outlook on Barclays PLC and related entities to stable from negative.
Table 1 highlights the headline results for the six largest banking groups (each with a December 31 year-end). Our analysis in this report includes HSBC and Standard Chartered, even though the former generates the majority of its revenues outside the U.K. and the latter almost all of it. In table 1, we exclude bank holding company Virgin Money UK, which has a Sept. 30 year-end, and Nationwide, whose year-end is April 4, and whose performance we analyze to Sept. 30, 2020.
Table 1
Headline 2020 Results For Major U.K. Banks | ||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Barclays | HSBC* | Lloyds | NatWest | Santander UK | Standard Chartered* | |||||||||
(Mil. £) | ||||||||||||||
Total assets | 1,349,514 | 2,182,736 | 871,269 | 799,491 | 299,064 | 577,142 | ||||||||
% change versus 2019 | 18.4 | 6.5 | 4.5 | 10.6 | 3.7 | 6.1 | ||||||||
Operating revenue | 21,772 | 40,411 | 15,418 | 11,165 | 3,958 | 11,643 | ||||||||
% change versus 2019 | 0.4 | (11.4) | (15.6) | (7.0) | (5.1) | (5.0) | ||||||||
Noninterest expenses | 13,539 | 24,544 | 8,756 | 6,768 | 2,487 | 8,105 | ||||||||
% change versus 2019 | (0.1) | (4.3) | (5.9) | (3.4) | (4.8) | (3.4) | ||||||||
Preprovision operating income | 8,233 | 15,867 | 6,662 | 4,397 | 1,471 | 3,539 | ||||||||
Pretax profit | 8,141 | 19,977 | 8,960 | 5,004 | 1,557 | 3,870 | ||||||||
Net interest income/average earning assets (%) | 1.16 | 1.35 | 1.89 | 1.59 | 1.38 | 1.19 | ||||||||
Noninterest expenses/operating revenues (%) | 62.2 | 60.7 | 56.8 | 60.6 | 62.8 | 69.6 | ||||||||
New loan loss provisions/average customer loans (%) | 1.43 | 0.84 | 0.93 | 0.92 | 0.30 | 0.86 | ||||||||
Gross NPLs/customer loans (%) | 2.7 | 2.0 | 3.0 | 1.9 | 2.0 | 3.6 | ||||||||
Stage 3 ECL allowance/gross NPLS (%) | 40.8 | 36.5 | 18.6 | 38.3 | 13.2 | 51.7 | ||||||||
Customer loans (net)/customer deposits (%) | 72.0 | 63.2 | 97.7 | 78.8 | 110.2 | 62.4 | ||||||||
Common Equity Tier 1 ratio (%) | 15.1 | 15.9 | 16.2 | 18.5 | 15.2 | 14.4 | ||||||||
U.K. leverage ratio (%) | 5.3 | 5.5 | 5.8 | 6.4 | 5.1 | 5.2 | ||||||||
*HSBC Holdings PLC data and Standard Chartered PLC reports in U.S. dollars. Data converted to British pounds. ECL--Expected credit losses. NPL--Nonperforming loan. Source: S&P Global Ratings database and ratio definitions. |
Income Dropped Sharply, Impairment Charges Rose Further Still
The 2020 results of the eight largest U.K. banks reveal the following common themes:
Net interest margins fell
Each bank reported lower net interest margins (NIMs) than in 2019, although mortgage-biased lenders pointed to the benefits of improved new mortgage business pricing and volumes as the year drew to a close (and BoE data shows this continued in January 2021). Key drivers were the 65bp cut in the BoE base rate in March 2020 and the sharp decline in high margin consumer credit balances, among other factors. After a combined £4.5 billion fall in 2020, or down 7% year on year, we expect net interest income to be lower in aggregate in 2021 as the impact of lower rates persists and structural hedge income reduces as a result of lower swap rates.
Upside potential appears unlikely in 2021, but could arise if there is a stronger-than-expected recovery in loan volumes, particularly consumer credit. The latter continued to fall in absolute terms in January 2021 (balances are now down 9% year on year) and we expect demand to remain muted for the remainder of the first half of 2021. The BoE has asked banks to operationally prepare to administer negative interest rates by August, but we still see this policy as a contingency measure that is unlikely to be implemented.
Noninterest income fell further still
In 2020, the combined noninterest income of the eight banks fell by around £6.4 billion, or 12% year on year, as customer activity reduced and fee income dropped owing to regulatory changes and COVID-19-related support measures. Only Barclays managed to offset these trends, with noninterest income rising by £1.4 billion in 2020 owing to a strong year for trading income. For retail- and commercial-focused banking groups, we don't anticipate a meaningful recovery in noninterest income in 2021, while several banks' strategic push to grow their wealth and advice businesses appears unlikely to deliver a meaningful earnings contribution in the short term.
Control of operating expenses was a bright spot
All banks reported lower or flat operating expenses. Excluding changes in conduct charges and other nonrecurring expenses, the combined £3.2 billion reduction in operating costs, down 5% year on year, was modest relative to the £10.9 billion (or 9%) decline in income. The fall in operating expenses partly reflected lower business activity and less scope for ancillary expenses such as T&E, but also the benefits of previous restructuring and the effects of the shift to digital banking. For example, Lloyds stated that 85% of products were originated via digital channels in 2020, up 17 percentage points over the past three years. We typically expect to see further small reductions in absolute cost bases in 2021 even while banks continue to invest heavily in ongoing rapid technology change. One small benefit in 2021 will be the reduction in the U.K. bank levy, which from this year is chargeable on banks' domestic activities rather than their global balance sheets. This change particularly benefits HSBC and Standard Chartered.
Large-scale restructuring costs were typically absent in 2020
With the exception of HSBC, NatWest, and Virgin Money, large-scale restructuring costs were typically absent in 2020. We think that restructuring costs will remain an earnings factor across all banks as a function of post-COVID-19 working arrangement rationalization and investment needs.
Loan loss ratios tripled
On a weighted basis, the eight banks' reported loan loss rates tripled to 90bps from 30bps. In absolute terms, higher credit impairment charges were the key factor weighing on earnings relative to prior years, reaching a combined £22 billion in 2020 versus £7.4 billion in the prior year. Revised IFRS9 economic assumptions and increased stage 2 balances, rather than observed credit deterioration, were the key drivers. A key determinant of impairment charges in 2021 will be the length of the current national lockdown and the degree to which unemployment rises. We are also cognizant of the potential for single-name exposure risks, notably among U.K. retailers, passenger transport, and hospitality companies. Nevertheless, those lenders that have stated their loss rate guidance imply a much more favorable outcome than in 2021. International exposures in Hong Kong and elsewhere in Asia appear to be performing better.
Conduct and litigation charges were minor, for once
There was a combined PPI release of £275 million in 2020, which contrasts sharply with a charge of around £6.3 billion in 2019. Standard Chartered was the only bank to be unaffected, as it has never had any related U.K. exposures. In contrast, we note that Virgin Money booked a further PPI charge of £49 million in its three months to Dec. 31, 2020 trading statement, which will weigh on its full-year 2021 earnings. Encouragingly, other conduct and litigation charges were low for the second straight year. At £1.3 billion, similar in aggregate to 2019, these charges reflect the more typical annual run rate that we expect from now on. They may also reflect the benefits of the significant change in culture and compliance investments by the banks over the past decade.
Ring-fenced bank data provides insights on domestic performance
Finally, analyzing the data of the five principal ring-fenced banks can offer a better insight into domestic banking performance, as it excludes non-permitted areas such as international lending or financial markets. On a weighted basis, we estimate that the ring-fenced banks' pre-provision income fell by around 20% in 2020. Moreover, profit before tax fell by around 60%, reflecting their doubling in impairment charges, more than offsetting the absence of PPI charges.
Muted Fourth-Quarter Performance
Group revenue growth was typically negative in the fourth quarter of 2020, both quarter on quarter and year on year (see table 2). The principle exception was Santander UK, which reported an improvement in revenues on the back of product repricing and improved mortgage volumes. Other banks reported similarly favorable U.K. mortgage income trends.
Barclays' fourth-quarter markets income was its lowest in 2020, though still up 19% on the same period in 2019. Similarly, HSBC's global markets income was up 13% year on year. In contrast, Standard Chartered reported a slight fall in its fourth-quarter financial markets income compared to the same period in 2019.
On a constant currency basis, data for both HSBC and Standard Chartered were better than those reported.
Table 2
Reported Quarterly Revenue | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
(Bil. £ unless stated) | Q4 2019 | Q1 2020 | Q2 2020 | Q3 2020 | Q4 2020 | Quarter over quarter (%) | Year over year (%) | |||||||||
Barclays PLC | 5.3 | 6.3 | 5.3 | 5.2 | 4.9 | (5.1) | (6.8) | |||||||||
HSBC Holdings PLC* | 13.4 | 13.7 | 13.1 | 11.9 | 11.8 | (1.4) | (12.1) | |||||||||
Lloyds Banking Group PLC | 4.1 | 4.0 | 3.5 | 3.4 | 3.6 | 5.7 | (13.1) | |||||||||
NatWest Group PLC§ | 3.1 | 3.2 | 2.7 | 2.4 | 2.5 | 4.6 | (17.3) | |||||||||
Santander UK Group Holdings PLC | 1.0 | 1.0 | 0.9 | 1.0 | 1.1 | 5.9 | 4.8 | |||||||||
Standard Chartered PLC* | 3.6 | 4.3 | 3.7 | 3.5 | 3.2 | (9.1) | (11.1) | |||||||||
*Earnings reported in USD. §For NatWest in Q419 we have excluded £1,169 million foreign exchange recycling gains reported in revenue. Source: Company reports. |
Banks Have Pushed Back Their RoTE Targets
Banks have pushed back RoTE targets across the board, mainly due to the lower rate environment rather than a more material weakness among the banks. A bank's achievement of its return target is not a ratings driver per se, but it often validates our view of the bank's business position and supports stable management and strategy. Moreover, earnings are a key factor in our analysis of a bank's capital position.
Barclays
Barclays left unchanged its greater than 10% RoTE target, over time. Excluding conduct and litigation, Barclays' reported ratio was 3.4% in 2020, down from 9.0% in 2019. Management pointed to its expectation of a meaningful year-on-year improvement in RoTE in 2021.
HSBC
HSBC pushed back its RoTE target to greater than or equal to 10% over the medium term (defined as three-to-four years) from its previous target of 10%-12% in 2022. HSBC reported RoTE on an adjusted basis of 3.1% in 2020, down from 8.4% in 2019. HSBC has refreshed its existing strategic plan with an increased focus on cost control. That said, in 2020 HSBC made progress with key elements of its restructuring.
Lloyds
Lloyds lowered its 2021 RoTE expectations to 5%-7% (on a new calculation basis). On this basis, Lloyds reported an RoTE of 2.3% in 2020, down from 6.6% in 2019. On the previous basis, Lloyds had been expecting to achieve RoTE of 10%-12% in 2020, but on this basis the outcome was a mere 3.7%.
NatWest
NatWest was loss making in 2020, although a reported return on attributed equity of over 10% at its Retail Banking division points to the group's long-term potential. NatWest's reported RoTE, excluding foreign-exchange recycling gains, was 4.7% in 2019. NatWest states that it targets a RoTE of 9%-10% by 2023.
Standard Chartered
Standard Chartered has maintained its RoTE target of above 10%, but now only expects to achieve an RoTE of 7% by 2023. This compares to its previous expectation that it would achieve RoTE above 10% in 2021. In 2020, Standard Chartered's reported RoTE was 3.0%, down from 6.4% in 2019.
Our U.K. Economic Forecast Offers Some Hope
A key driver of the U.K. economy in 2021 and beyond is the success of the COVID-19 vaccine rollout. Through March 7, over 22 million people--or 42% of the adult population--had received their first jab. The government intends to vaccinate the whole adult population by the end of July. The ending of all related legal restrictions is slated for June 21 based on the commencement of the second round of vaccinations starting later this month.
Fiscal and monetary initiatives have supported employment levels to date. For example, through Feb. 15 the combined cost of the job retention (furlough) scheme and self-employed grants exceeds £73 billion. These and other initiatives have helped keep the rise in unemployment rate to 5.1% from 3.8% prior to the pandemic. Of note, around 4.7 million people were on furlough at the end of January, up from 4.0 million at the end of December as the third Lockdown kicked in. We now expect the unemployment rate to peak at 6.7% in the fourth quarter of 2021.
Similarly, credit support for businesses now exceeds £85 billion through Feb. 21. The largest scheme is "bounce back loans" for small businesses; banks have lent £45.6 billion, for which the government has provided the lender with a 100% guarantee. The first interest payments come due in a few weeks' time, but the scheme is favorable to borrowers with maturities of up to 10 years. The remaining schemes received an 80% guarantee. The Chancellor has announced that a new Recovery Loans scheme will commence in April, replacing the existing schemes, and will remain open until December 2021, with an 80% guarantee to lenders.
The Chancellor's March 3 budget provides an additional fiscal boost of £65 billion over the next two years, principally in the year to April 2022. Taken together with the direct support for the economy provided in response to COVID-19 to date, this represents around £352 billion of total fiscal support across 2020-2021 and 2021-2022. One way the government is seeking to reduce the budget deficit over time is an increase in the corporation tax rate to 25% from 19% from April 2023. However, the Chancellor stated that there will be a review of the current 8% bank surcharge in order to avoid the combined tax rate on bank profits being too high.
We now forecast real GDP growth of 4.3% in 2021, with an acceleration to around 7% in 2022, which, if consummated, would be the highest post-war U.K. GDP growth rate (see table 3). This would help to offset the contraction of 9.9% in 2020. On paper, this suggests an economic performance that was worse than most European and other OECD economies worldwide. There are two key reasons for this. First, the U.K.'s share of consumption in GDP is much larger than that of many of its peers and moreover, the share of face-to-face consumption within consumption is also higher. Second, the U.K.'s Office for National Statistics (ONS) uses a more sophisticated approach to measuring public sector output than other statistics institutes, by estimating how much activity takes place, rather than by simply taking into account how much money was spent. This approach partly explains why the U.K. should also see relatively stronger cumulative growth over this year and next, as the ONS continues to apply the same method as the economy recovers.
Table 3
Base-Case U.K. assumptions | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|
2019 | 2020 | 2021f | 2022f | 2023f | ||||||||
Real GDP, % change | 1.4 | (9.9) | 4.3 | 6.8 | 2.2 | |||||||
Bank of England base rate* (%) | 0.8 | 0.2 | 0.1 | 0.1 | 0.1 | |||||||
CPI inflation (%) | 1.8 | 0.9 | 1.3 | 2.0 | 1.8 | |||||||
Unemployment rate* | 3.8 | 4.5 | 6.3 | 5.5 | 4.4 | |||||||
*Average for the year. e--Estimate. f--Forecast. Source: S&P Global Ratings. |
The mortgage market remained relatively strong in January 2021. According to BoE data, there were 99,000 mortgage approvals in January, continuing the strong data trend since last summer, and is well above the monthly average in the six months to February 2020 of 68,000. Similarly, the number of housing transactions in January 2021 was 24% higher than the same month in 2020. Adjusting for the transaction slump during the initial lockdown in the Spring of 2020, annual housing transactions are set to be their highest since 2007.
According to the ONS, house prices rose by a robust 8.5% in 2020 aided in part by a temporary relaxation of stamp duty, but also changing housing needs to reflect altered working arrangements. The Chancellor's announcement that the stamp duty relaxation will now continue to September, rather than end in March, suggests the housing market may remain solid in the near term.
Peer Analysis
The eight largest U.K. banks lag their international peers in terms of relative BICRA economic risk and historical earnings, but capital, asset quality, and funding and liquidity are at least in line with the peer group. In the following sections, we compare the eight largest U.K. banks across selected metrics and show the weighted average for the eight banks compared with seven international peers. We chose these international peers to reflect a variety of geographies and business models.
Profitability should pick up this year
U.K. banks' earnings were much weaker in 2020 than in 2019, which itself was a relatively weak year. The twin drivers were lower income and higher loan impairments, offset in part by lower costs and reduced exceptional charges. Across the top four U.K. banks, in aggregate, exceptional items represented a minor proportion of their operating revenues in 2020, down from a high 13% in 2019. The latter was largely led by PPI charges and a $7.3 billion goodwill impairment at HSBC (see chart 3).
Chart 3
Net interest income to revenues. Reported NIMs have been on a downward trend across U.K. banks (see chart 4). Indicative of the significant role of investment banking, Barclays has the lowest reliance on net interest income, while its NIM is higher, reflecting its larger and higher-margin consumer credit loan book than its U.K. peers (see chart 5). On a weighted-average basis, U.K. banks rely more on net interest income than the peer group (see chart 6).
Chart 4
Chart 5
Chart 6
Noninterest expense to revenues. U.K. banks rank slightly lower than the international peer group despite their efforts to better manage their operating efficiency (see charts 7 and 8). While the U.K. weighted-average noninterest expense-to-revenues ratio weakened to 62% in 2020 from 58% in 2019, some international peer banks also demonstrated a decline. Partly due to its scale and bias toward mortgage lending, Lloyds comfortably has the lowest efficiency ratio among U.K. banks, a status we expect it to maintain. The metrics for Virgin Money are somewhat distorted as its ratio in chart 7 excludes the impact of its significant merger-integration charges.
Chart 7
Chart 8
Impairment charges to revenues. This metric was typically in the single digits since U.K. loan loss rates fell below their long-term average from 2014 until 2019. Low loan losses had been U.K. banks' silver lining as they partially offset the negative effect on revenues from the low interest rates. In 2020, however, this changed as banks revised sharply their expectations of future credit losses. U.K. banks' weighted ratio of loan impairment charges to revenues increased to 21% in 2020 from 6% in 2019. The impact of impairment charges was less at mortgage-biased lenders, such as the building societies, as residential property markets have held up better than might have been expected. Relative to some of the international peer group, we think that U.K. banks have been more proactive with their conservative build by applying conservative assumptions in the first half of 2020 and then applying post model management adjustments to avoid provision releases in the fourth quarter of 2020. (see charts 9 and 10).
Chart 9
Chart 10
Operating income after loan loss provisions to revenues. U.K. banks' pre-tax profit margins, that is excluding exceptional items, compare adequately to those of their international peers (see charts 11 and 12).
Chart 11
Chart 12
Capital ratios are likely to drift lower in 2021
On a regulatory basis, U.K. banks' common equity Tier 1 (CET1) remained robust in 2020, well above regulatory minimums, and in each instance were higher than the prior year. On a weighted basis, the CET1 ratio improved to 16.6% in 2020 from 15.2% in 2019. Leverage ratios typically improved too. U.K. banks were allowed to resume shareholder distributions, subject to restrained temporary guardrail limits imposed by the regulator (see table 4). There were no material changes of note to CET1 targets, which typically remain in the 13%-14% range, other than HSBC stating that it targets 14%-14.5%, albeit with a long-term aim to get below 14%.
Table 4
Shareholder Distribution Returned In 2021 | ||||||
---|---|---|---|---|---|---|
Recent Announcements | Amount | |||||
Barclays | 1p per share dividend and intends to initiate a share buyback of up to £700 million | £875 million | ||||
HSBC ($) | 0.15c per share dividend | $3,055 million | ||||
Lloyds | 0.57p per share dividend | £404 million | ||||
NatWest | 3p per share dividend. Target 40% payout and at least £800 million per year 2021-2023 | £364 million | ||||
Standard Chartered ($) | 9c per share dividend and announced a share buyback of $254 million starting imminently | $538 million | ||||
*Data for HSBC and Standard Chartered in cents. |
We expect banks' CET1 ratios to be lower this time next year. First, the 2020 ratio included a benefit to exclude software assets from the deduction of intangibles, typically around 30bps. The BoE is consulting on a plan to reverse this on-shored EU rule and maintain the previous requirement of excluding software assets, which we assume will take effect later this year. Other regulatory capital headwinds include the pro-cyclical impact from credit migration on RWAs, a reduced benefit from regulatory IFRS 9 forbearance, and increased pension contributions by some banks. We also expect capital distributions to increase as banks works towards their target CET1 range.
We have yet to calculate S&P Global Ratings' globally comparable end-2020 risk-adjusted capital (RAC) ratios for each of the U.K. banks. However, based on our preliminary view of the data, we do not expect that the final ratios will deviate from our current rating expectations. We also note that quality of capital is a more important factor when the RAC ratio is close to one of our thresholds. We base this ratio on adjusted common equity to total adjusted capital. The U.K. weighted average of 82% in 2020 ranks below that of the international peer group. Virgin Money has the lowest ratio among U.K. banks, at 76%. Based on the U.K. banks' modest planned net hybrid issuance over the next two years, as per their fixed-income investor presentations, we expect them to marginally improve this metric.
Asset quality will deteriorate
The stock of impaired loans remains manageable with a weighted stage 3 ratio of about 2.0%. To put this into context, U.K. banks nonperforming loan ratio for the worst performing large U.K. banks peaked at around 11% post the 2008 financial crisis. The current benign impaired loans metrics across all the banks demonstrate the power of low debt-servicing costs for both retail and wholesale customers, and the benefits of fiscal support, which has, to date, suppressed unemployment and insolvencies. Direct international comparisons are not straightforward, but our nonperforming loans ratio for the peer group ranges from 0.5% to 4.0%.
The real asset quality story lies in Stage 2 ratios, which provide better color on potential problem loans. For the four largest U.K. banks, which have the most diverse loan books, Stage 2 loans increased to 14%-21% of total loans in 2020, up from 8%-11% the year before. The proportion of Stage 2 loans that were over 30 days past due at Dec. 31, 2020 was small, ranging from 0.2% to 0.8% of total loans, and little changed from a year ago (see chart 13).
Chart 13
In addition to drilling down into Stage 2 loans by asset class, and banks' macroeconomic assumptions, we also focus on relative provision coverage. We note that provision coverage increased substantially in 2020 (see chart 4). For the four largest banks, the ratio of total provisions to total loans increased to a range of 1.4%-2.4% from 0.8%-1.8% the year before. To put this into context, this metric was in the 0.8%-1.3% range in mid-June 2008. Coverage appears suitably high for the higher-risk consumer credit portfolios. For example, Barclays stated that provisions covered 12.3% of its total consumer credit book, up from 8.1% the year before.
Chart 14
A key determinant of banks' ultimate losses through this credit cycle will be the performance of vulnerable corporate sectors and large, single-name exposures. Sectors dependent on discretionary spending represent a manageable proportion of loan portfolios and banks hold sizable provisions against them, but there is scope for further material charges if the economic recovery is delayed (see chart 15). Parts of the retail sector were struggling before the pandemic due to changing consumer tastes and habits, and the COVID-19 lockdowns tipped some major names into administration.
Chart 15
Funding profiles are favorable and liquidity is high
Compared to their international peer group, U.K. banks generally have more favorable funding profiles, with less reliance on short-term wholesale funding and lower loan-to-deposit ratios. U.K. banks also maintain high liquidity balances, which comfortably cover maturities of wholesale funding.
Like international peers, U.K. banks saw a surge in deposits in 2020. BoE data states that this trend continued in January 2021; the net flow of household deposits was £18.5 billion, which compares to the monthly average of £4.8 billion in the six months to February 2020. We expect this trend to persist through the first half of the year before gradually easing once lockdown ends.
The BoE has also been supportive of the banking system, most especially of the smaller lenders, with a new Term Funding Scheme which remains open until Oct. 31, 2021. At March 3, £76 billion had been drawn under the new TFSME, with a maturity profile typically aligned with that of government-guaranteed lending. While large, this issuance has largely refinanced funding from the previous TFS scheme.
The final 2022 minimum requirement for own funds and eligible liabilities (MREL) are now known and U.K. banks are well placed to meet these. We therefore expect issuances in 2021 to be lower than in prior years and to typically relate to refinancing.
Net customer loans to customer deposits. Standard Chartered and HSBC rank highest on this traditional funding measure, reflecting their relatively strong deposit franchises in certain international markets. Mortgage-biased U.K. lenders rank lower. On a weighted-average basis, U.K. banks compare well with their international peers (see charts 16 and 17).
Chart 16
Chart 17
Short-term wholesale funding/funding base. U.K. banks have relatively modest reliance on short-term wholesale funding. (see charts 18 and 19).
Chart 18
Chart 19
Finally, U.K. banks' S&P Global Ratings-calculated funding and liquidity metrics compare favorably to those of their peers (see chart 20).
Chart 20
Recent Rating Actions
Since our last report card on U.K. banks in August 2020 (see U.K. Banks’ Creditworthiness Will Be Tested As Fiscal Support Ebbs published Aug. 13, 2020), we have taken the following rating actions:
- In February 2021, we revised to stable from negative the outlook on Barclays PLC and its subsidiaries, including Barclays Bank PLC and Barclays Bank UK PLC, as we think that Barclays is better positioned to maintain credit metrics consistent with the current ratings as the credit cycle plays out.
- In January 2021, we affirmed our ratings on Virgin Money and maintained a negative outlook. However, we raised the ratings on the operating bank Clydesdale Bank PLC to 'A-' from 'BBB+', reflecting further progress by Virgin Money in raising additional loss-absorbing capacity (ALAC) buffers.
Table 5
Rating Components For Rated U.K. Financial Institutions | ||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Core opco long-term ICR/outlook | Business position | Capital & earnings | Risk position | Funding & liquidity | Group SACP/SACP | Type of support | No. of notches of support | Holdco long-term ICR/ outlook | ||||||||||||
Major U.K. banks | ||||||||||||||||||||
Barclays plc* | A/Stable | Adequate | Strong | Moderate | Avg/Adequate | bbb+ | ALAC | 2 | BBB/Stable | |||||||||||
HSBC Holdings plc*§ | A+/Stable | Strong | Adequate | Strong | Above Avg/Adequate | a | ALAC | 1 | A-/Stable | |||||||||||
Lloyds Banking Group plc* | A+/Negative | Strong | Adequate | Adequate | Avg/Adequate | a- | ALAC | 2 | BBB+/Negative | |||||||||||
Nationwide Building Society† | A/Stable | Adequate | Strong | Adequate | Avg/Adequate | a- | ALAC | 2 | N/A | |||||||||||
NatWest Group plc* | A/Negative | Adequate | Adequate | Adequate | Avg/Adequate | bbb+ | ALAC | 2 | BBB/Negative | |||||||||||
Santander UK Group Holdings plc* | A/Negative | Adequate | Adequate | Adequate | Avg/Adequate | bbb+ | ALAC | 2 | BBB/Negative | |||||||||||
Standard Chartered plc* | A/Stable | Adequate | Strong | Moderate | Above Avg/Strong | a- | ALAC | 1 | BBB+/Stable | |||||||||||
Virgin Money UK plc* | BBB+/Negative | Moderate | Adequate | Adequate | Avg/Adequate | bbb | ALAC | 1 | BBB-/Negative | |||||||||||
Other rated U.K. banks | ||||||||||||||||||||
AIB Group (UK) plc | BBB/Negative | Weak | Strong | Weak | Avg/Adequate | bb+ | Group | 2 | N/A | |||||||||||
FCE Bank plc | BBB-/Negative | Weak | Strong | Adequate | Below Avg/Adequate | bbb- | Group | 0 | N/A | |||||||||||
Handelsbanken plc | AA-/Stable | N/A | N/A | N/A | N/A | N/A | Group | N/A | N/A | |||||||||||
*These scores reflect the group credit profile construct. §The operating company rating shown here relates to HSBC Bank PLC and HSBC UK Bank PLC. †For Nationwide we include a negative comparable notch adjustment within its ratings construct. ALAC--Additional loss-absorbing capacity. ICR--Issuer credit rating. N/A--Not applicable. SACP--Stand-alone credit profile. In each case the anchor is 'bbb+'. Source: S&P Global Ratings. |
We believe there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
Related Research
- U.K. Recovery: Delayed But Stronger, March 9, 2021
- Barclays Outlook Revised To Stable On Relative Resilience To Pandemic-Related Stress; Ratings Affirmed, Feb. 26, 2021
- Cost Control, Economic Rebound Put Standard Chartered On Recovery Path, Feb. 25, 2021
- NatWest's 2020 Loss And Robust Capital Ratios Reflect Pandemic-Related Stress And Continued Restructuring, Feb. 19, 2021
- Capital Resilience Alone Won't Stabilize European Bank Ratings In 2021, Feb. 3, 2021
- Low-For-Even-Longer Interest Rates Maintain Margin Pressure On European Banks, Feb. 2, 2021
- Clydesdale Bank Upgraded to 'A-' On Increasing Loss-Absorbing Capacity; Virgin Money UK Affirmed; Outlook Negative, Jan. 22, 2021
- U.K. Bank Rating Actions Won't Wait For The Bank Of England's 2021 Stress Test Results, Jan. 20, 2021
- U.K. Banks Face A Bumpy Road To Earnings Recovery In 2021, Jan. 11, 2021
- Banking Industry Country Risk Assessment: United Kingdom, Nov. 17, 2020
This report does not constitute a rating action.
Primary Credit Analyst: | Nigel Greenwood, London + 442071761066; nigel.greenwood@spglobal.com |
Secondary Contact: | Richard Barnes, London + 44 20 7176 7227; richard.barnes@spglobal.com |
Research Contributor: | Ankit Jalan, CRISIL Global Analytical Center, an S&P affiliate, Mumbai |
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