Shareholders in UK banks won’t need reminding of their sudden loss of income during the pandemic after the regulator put a stop to dividend payments.

With the country now forecast to go into recession and gloomy forecasts of up to a 30% drop in the housing market, could we be facing a similar situation in a year’s time?

The recent results from the big high street lenders were generally robust, as rising interest rates allowed them to grow their net interest margins without taking on undue risk.

While provisions for bad loans are rising, they are still well below the levels seen in previous downturns so the question is are shareholders being lulled into a false sense of security?

There was little to worry investors in the latest results from Virgin Money (VMUK), which saw strong growth in loans and deposits and raised its share buyback and final dividend.

In total, shareholder distributions for the year to September are set to reach £267 million or an impressive 57% of the bank’s earnings.

The message from chief executive David Duffy was that credit quality was ‘solid’ with low and stable arrears, and while some customers may struggle in the coming months the bank expected defaults to rise to no more than 0.3% to 0.35% of its loan book over the next year.

The company also said it would aim to pay out 30% of earnings next year and buy back up to £50 million of its shares, prompting a sharp jump in the stock price.

Analysts at Shore Capital predicted a round of earnings upgrades, describing the bank’s guidance for profits and dividends together with its return on capital target as ‘making a mockery’ of its current valuation.

Not everyone is so sanguine about the outlook, however, even big investors in the sector.

Alex Wright, manager of Fidelity Special Values (FSV), told Shares he had added to his banking holdings during the market volatility caused by the September ‘mini-Budget’ as the rising interest rate environment had made them more resilient to a recession.

However, Wright sees the banks having to raise their loan-loss provisions during a recession either of their own accord or under the Bank of England’s regular stress tests.

In the case of NatWest (NWG), for example, if there were a severe downturn which caused a 5% fall in GDP, a 20% fall in house prices and a 7% to 8% unemployment rate, the bank’s earnings would likely halve and therefore dividends could do the same, although Wright sees little chance of them being cut to zero altogether.

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