Banking: The UK versus Europe

Their relative share-price performances this year might suggest so.

The recovery of banking is more real in the UK than it is in the eurozone. There are clearer signs that the British banks are on the mend, not least as they finally finish their long years of litigation and conduct charges, principally over payment protection insurance.

HSBC and Lloyds have been the leaders of UK banking success in recent years. Lloyds in particular continues to impress. The bank doubled its profits to £1.3 billion compared to the previous year in its first-quarter 2017 results. Chief executive António Horta-Osório is upgrading profit targets as a result. It’s even managing to squeeze out a small improvement in net-interest margin, while maintaining a healthy cost/income ratio below 50%. 

Now the two other big UK banks, Barclays and RBS, have started to think beyond restructuring. Analysts at KBW upgraded their recommendation on long-suffering RBS to buy at the end of April, for example. UK banks have been able to build up capital, despite the onslaught of conduct charges, because the economy has been healthier, boosting borrowers’ repayment capacity and collateral values.

There are plenty of potential pitfalls, however, and not only in Brexit. If the UK is inching closer to a cyclical peak, it could show what is to come elsewhere – what the ECB and others should be looking out for. Take the buy-to-let segment of the mortgage market, where risks at names like Paragon, One Savings and Virgin Money spring to mind.  

Above all, consumer credit in the UK is growing at its fastest pace since 2005. The latest Bank of England stress test assumes bigger losses at banks from this than mortgages. Fierce competition has led to unsustainable practices, such as ever-lengthening free periods for credit-card balance transfers (now up to three and a half years). Lloyds’ rapid growth in this segment, including its pending £1.9 billion ($2.4 billion) acquisition of credit card business MBNA from Bank of America, pushes analysts at Berenberg to prefer RBS shares.

Given this kind of froth and still-high household leverage in the UK, it would be better for the UK banks if rates did not rise any time soon. Indeed, KBW reckons a 1% base-rate rise would cut UK bank profitability by 13%. That is in sharp contrast to the salivation at the prospect of higher rates among eurozone lenders like Commerzbank. 

The UK banks can earn their cost of equity at today’s interest rates. The same cannot be said for many in the eurozone. UK rates would rise from a slightly higher base, of course, although it is also to do with the structure of the banking sector. It was always going to be easier to turn around a bank like RBS, despite the huge size of that task, than to solve the German and Italian banks’ problems.

That said, first-quarter earnings season provided some cheerier news from a number of Europe’s leading banks. Notable among these were the two internationally-focused Spanish banks, BBVA and Santander. The former trumpeted its ability to deliver growth “in all areas” as profits jumped 80%. Net interest income rose 9%. The latter was able to tell a similar story, generating growth in nine out of 10 of its core markets. It’s notable that Spain, like the UK, has produced better-than-average economic growth in recent years. 

Even the beleaguered CEOs at two of Europe’s most challenged big banks, Credit Suisse and Deutsche Bank, were able to deliver a profit in the first quarter, although the scale of their decline was thrown into sharp relief when compared to the bumper numbers produced by the big US firms. Today, such comparisons have become redundant. 

But there is one European bank that’s delivering returns that would even make the likes of JPMorgan envious. Step forward KBC. Read about how chief executive Johan Thijs has turned a bailed-out bank into the return on equity champion of Europe.

European banking could do with more success stories such as this. At the moment it’s not easy to see where they will come from. Meanwhile British banks can begin to enjoy life again. They should also be wary of getting back into old – and bad – habits.