General election a lose-lose event for UK banks
Labour-led government likely to have most negative impact; bank earnings under pressure from legislative wave.
'The board has … asked management to commence work to look at where the best place is for HSBC to be headquartered in this new environment' – HSBC’s chairman Douglas Flint
Whatever the outcome of the general election, UK bank earnings are set to be hit by a raft of new legislation, and the prospect is already forcing HSBC and Standard Chartered to consider moving their headquarters to Asia.
From a rising bank levy and ring-fencing of operations, to the proposed capping of retail banking market shares, UK banks will face tough legislative challenges on numerous fronts after the May 7 election, with the bank levy already landing the hardest blow on earnings.
Equity analysts at Citi estimate that the current levy of 0.21%, increased in the last budget from 0.156%, of chargeable liabilities, has already hit listed UK banks’ profits by a minimum of 3%, a proportion that may well rise further should a Labour-led government emerge.
In its manifesto, Labour has argued, for example, for a further increase in the bank levy to support free childcare. In that case, Chintan Joshi, head of European bank research at Nomura, expects the levy to increase from £2.5 billion to £3.5 billion, which “will likely lead to a circa 4% cut to 2016 consensus earnings of UK banks”.
More worryingly, argue Citi’s equity analysts, such a rise in the levy could “therefore raise serious questions about whether it still makes sense for HSBC and Standard Chartered to remain headquartered in the UK”.
They say: “While it’s not our base case, we would not rule out the prospect of these banks looking to re-domicile in the event of a Labour victory.”
The levy affects all of the UK banks and building societies, as well as foreign banking groups operating in the UK, but it is the global banks with UK headquarters, such as HSBC and Standard Chartered, that are the hardest hit, as the levy applies to their entire global balance sheets.
Ronit Ghose, head of European bank research at Citi, estimates that HSBC (at the current levy) could pay $1.5 billion in 2015, equivalent to 9% of estimated full year group profits. For StanChart, Ghose says, the levy could amount to 13% of 2015 estimated net profit, increasing its effective tax rate to 36%, compared to HSBC’s 29%.
It is for this reason in the main that HSBC and Standard Chartered’s management are concerned and have in recent weeks intensified their efforts to vocalize this and once again articulate that all options are open.
[Ring-fencing is a] legislative reality which we believe
Carla Antunes-Silva, Credit Suisse
“The board has… asked management to commence work to look at where the best place is for HSBC to be headquartered in this new environment,” said HSBC’s chairman Douglas Flint at its AGM in London on April 24.
“The question is a complex one and it is too soon to say how long this will take or what the conclusion will be; but the work is under way.” The bank’s share price shot up in Asia as investors welcomed a statement for which many have been pressing.
Andy Halford, finance director of Standard Chartered, said on an analyst call for first quarter results on April 28 that the rise in the bank levy was “pretty significant” and that, even before new chief executive Bill Winters takes charge next month, the bank is keeping the option of moving its London headquarters out of the UK “under review”.
For the UK’s four largest banks – Barclays, Lloyds, HSBC and RBS – however, the cost of ring-fencing banking operations and proposals to cap retail banking market shares potentially present just as costly a challenge.
Ring-fencing is a “legislative reality which we believe a new government is unlikely to reverse”, says Carla Antunes-Silva, European bank equity analyst at Credit Suisse. She adds that under updated analysis the legislation would cost the four large UK banks between £1.4 billion and £1.8 billion from higher wholesale funding costs alone, equivalent to about 5% to 7% of total full-year 2017 profit before tax, and 2% for HSBC.
Antunes-Silva adds, moreover, that these figures do not include the higher operating costs and any TLAC [total loss absorbing capacity] requirements and leverage ratio considerations, which Credit Suisse expects would apply to the ring-fenced entities.
The other primary concern among UK banks is the Competition and Markets Authority review into personal current accounts and small and medium-sized enterprise business banking, and the Financial Conduct Authority’s review into investment and corporate banking services.
“Even without the politics of the situation, we believe that both reviews could have a material impact on the UK banks’ longer-term profitability,” says Nomura’s Joshi. “However, under a Labour government, we would be more concerned about politically driven outcomes.”
Labour has, for instance, indicated that it plans to do a “market-share test”, with the prospect of introducing market-share caps on retail banks, says Ghose. “Labour are also keen to create two new challenger banks. This places Lloyds and RBS at greatest risk of a forced break-up, based on their existing market shares of personal current accounts and SME lending respectively, with market shares of around 25% to 30%.”
Using the competition authority’s measure, Antunes-Silva says that in Credit Suisse’s extreme scenario where the big four UK banks’ combined market share of personal/current accounts drops from 71% to 40%, UK banks could lose circa 4% of 2017 earnings (with Lloyds unsurprisingly the most at around 7%).
However, the risks do not all lie with a potential Labour-led government.
“The longer-term risk of a Conservative-led consortium is an in/out referendum on Europe by 2017, stoking increased fears of Brexit,” says Ghose. “This could potentially have severe consequences for the UK banks, including reduced access to the single EU market if the current passporting rights cannot be renegotiated. This could potentially make corporate and investment banking untenable for global banks operating with a UK hub.”