Burden of proof lies with Big Five FTSE 100 banks as results season approaches

“NatWest ushers in the full-year results season for the FTSE 100’s Big Five banks on Friday and the other four follow in quick-fire fashion next week. As they prepare for the data deluge, investors will be looking to assess three things,” says AJ Bell investment director Russ Mould.

“First, whether earnings will drop as sharply across the UK’s Big Five as they did America’s Big Four at the end of 2023 (where combined net income fell 41% year-on-year in the fourth quarter). Second, whether this sets a trend that will mean lower earnings in 2024. And finally, whether the loss of profit momentum means the big lenders deserve to be so cheap on an earnings, asset and yield basis.

“And this matters because, on paper, the banks do look cheap. They all trade on multiples of forward earnings for 2024 that represent a discount of 50% or more to the FTSE 100. They all trade on a discount to historic tangible net asset (or book) value per share. And they all offer a dividend yield for 2024 that matches or exceeds that available from the FTSE 100, according to consensus analysts’ forecasts.

Source: Company accounts, LSEG Datastream data, Marketscreener, consensus analysts’ forecasts

“The banks are cheap because their shares have been terrible investments.

“The FTSE All-Share banks index, which will be dominated by this quintet, is down by 10% over the past year, slightly worse than a 4% drop in the FTSE All-Share itself. Worse, the FTSE All-Share banks index is no higher than it was in spring 2009, just as the world was staggering out of the Great Financial Crisis, and currently languishes 70% below its all-time high of early 2007.

Source: LSEG Datastream data

“This wretched showing comes back to several factors, including:

• The need to repair the damage after the crisis by shrinking themselves back to health and taking less risk
• Tighter regulation and the costs associated with the PPI scandal
• Competition from fintech rivals
• In some cases, sub-scale investment banks and their struggles in a torpid UK equity market
• And the margin-crushing impact of record-low interest rates

“In sum, the bad memories of the Great Financial Crisis of 2007-09 continue to dominate investors’ perception of the stocks. At best, the market does not seem to believe that current lofty levels of profitability can be maintained, because the Big Five FTSE 100 banks are going to generate record annual pre-tax profits between them in 2023, at least if analysts’ forecasts are anything like accurate (and frankly even if they are not).

“In 2023, the five firms are forecast to make an aggregate pre-tax profit of £51.6 billion, way higher than the pre-financial crisis peak of £35.8 billion in 2007.

Source: Company investor relations websites, Marketscreener, analysts’ consensus forecasts

“Admittedly, there is a wide range of performance on offer.

• Analysts expect HSBC and Lloyds to have made record pre-tax income in 2023, which may be why they trade on the highest multiples of net asset value (NAV)
• Standard Chartered is forecast to comfortably exceed the highs achieved before the Great Financial Crisis but undershoot the £4.4 billion peaks of 2011-12, with pre-tax income of £4.2 billion in 2023
• At £6.7 billion for 2023, Barclays is expected to nearly match the £7 billion pre-tax profits of 2006-2007 but is not seen reaching its subsequent high of £8.2 billion, earned in 2021 (helped in part by write-backs of loan losses taken in the pandemic-stricken year of 2020)
• And NatWest’s forecast pre-tax earnings for 2023 of £6 billion would still represent a big drop from the £9.9 billion peak recorded just before the smash in 2007

Source: Company accounts, Marketscreener, company investor relations websites, analysts’ consensus forecasts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“In aggregate, 2023 was a good year for the banks. There were no major scandals to force compensation payments. Net interest margins rose, at least in the early stages of the year, after a series of interest rate increases from central banks. The long-feared recession failed to arrive, so there was no major increase in bad loans provision. And the lenders continued to focus on costs.

“However, analysts do seem to think that 2023 may be as good as it gets, because aggregate pre-tax profits are seen as coming in flat-to-down in 2024 and 2025. They also believe that the Big Five’s total profits in the fourth quarter of 2023 will be less than the sum earned in the final three months of 2022, at £7.7 billion in total versus £9.1 billion.

Source: Company accounts, Marketscreener, company investor relations websites, analysts’ consensus forecasts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“Some of that shortfall is down to Barclays’ estimated £825 million restructuring charge but analysts and investors will be looking to three sets of figures with these fourth-quarter and full-year results to see what sort of trends are taking these banks into 2024, and whether they deserve to be as cheap as they appear or not.

“The first is loan and deposit growth, which has been weak so far in 2023 (even allowing for some asset disposals). Only Standard Chartered showed deposit growth in the first nine months of 2023 and aggregate loan growth has slowed right down too.

Source: Company accounts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“The second is net interest margin, where the combination of competition, an apparent end to interest rate increases from the Bank of England and public pressure may mean the peak is already behind us, and that will take a toll on profit. In the third quarter, net interest income across the Big Five was £18.1 billion, down from a peak of £19.9 billion in the fourth quarter of 2022.

Source: Company accounts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“The third is loan and asset impairments. The fourth and final quarter tends to be when the banks clean house, so it usually sees the highest impairments. The benchmark here is the £2.9 billion in losses booked in the final quarter of 2022 (and note that the pre-pandemic fourth quarter of 2019 came in at £1.9 billion).

Source: Company accounts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“After that, analysts will look to litigation and conduct costs. They have been modest of late, but it will be interesting to see if any of the lenders say something about the Financial Conduct Authority investigation into discretionary commission arrangements (DCA) in the car financing market. Lloyds in particular is a major player in car financing.

“Finally, attention will switch to cash returns. Each of Barclays, HSBC, Lloyds and Standard Chartered is expected to pay a higher dividend in 2023 than 2022 and to increase their payments again in 2024 – HSBC is also set to offer a special dividend of some 21 US cents a share after the sale of its Canadian operation. Total ordinary dividends from the Big Five are forecast to have reached £11.7 billion in 2023 – still below 2018’s levels and 2007’s pre-crisis high of £13.3 billion, although consensus forecasts suggest that a new high could be on the cards for 2024.

Source: Company accounts, Marketscreener, company investor relations websites, analysts’ consensus forecasts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

“Note also that all five FTSE 100 banks ran share buyback programmes in 2023, with a declared value of some £13 billion, second only in the sector rankings to Oil & Gas. Shareholders will doubtless be looking to see if these bumper returns are maintained in 2024 – estimated dividends and buybacks combined worth £24.7 billion in 2023 equate to around 12% of the five banks’ aggregate market capitalisation.”

Source: Company accounts for Barclays, HSBC, Lloyds, NatWest and Standard Chartered

These articles are for information purposes only and are not a personal recommendation or advice.