When Mark Carney put a rocket under the FTSE 100 on Thursday with his pronouncement that interest rates were likely to be cut to tackle the economic fallout from Brexit, there was one sector of the stock market that remained in the doldrums.
While the governor of the Bank of England was making life a misery for savers – who have already tolerated record-low returns for the near-eight years since the banking crisis – he was also sending a miserable message to the banks.
The headline “lower for longer = bad” in a research note published by analysts at Deutsche Bank last week sums it up. Low interest rates makes it harder for banks to make a profit on the difference between the rates that are paid on savings and the rates that can be charged on loans.
On top of that, a slowdown in the UK economy is being predicted – Goldman Sachs cut its forecasts for growth to 0.2% last week. There are also expectations that the housing market will slow and unemployment will rise, pushing up bad debts – all of which makes for an uncomfortable environment for high-street banks. The risk is that strategies drawn up by bank bosses – already trying to adapt to the digital era – will have to be torn up, with more job cuts and branch closures as a new wave of cost-cutting measures bite hard. Dividends to shareholders are being described as “toast”.
Last week’s share prices illustrate this: while the FTSE 100 index is up since the referendum, Royal Bank of Scotland’s shares are down 32% while rival bailed-out bank Lloyds is off 25%, as is Barclays. The so-called challenger banks aiming to take on the established players on the high street have also had a torrid time – Virgin Money, for instance, is down 30%. Global banks such as HSBC and Standard Chartered have fared better; HSBC is up since the historic vote.
Philippe Bodereau of the bond investor Pimco believes the falls are justified. “Lower interest rates, slower loan growth and rising credit losses all feed into lower forecasts further earnings,” he says. Even before Carney warned about interest rates, analysts at Bernstein had declared that Barclays and RBS were “almost uninvestable”. Ratings agency Moody’s has warned 12 UK banks and financial institutions could face a credit downgrade.
Crucially, unlike eight years ago, no one appears fearful for their very survival. Jes Staley, seven months into his new job as chief executive of Barclays, told Bloomberg share prices were crumbling because of concerns about profits. “We got no sense of concern about our capital nor liquidity, and properly so, but there is a concern about our earnings,” Staley said.
He was adamant that Barclays should not change his strategy of focusing on being a transatlantic business with an investment banking arm.
The Brexit shock is hitting the banking sector while it is already in the midst of a reorganisation – prompted by the 2008 financial crisis – to meet a 2019 deadline to “ringfence” retail banking businesses from investment banking operations. Barclays is among those in the throes of this task.
It is also hitting before George Osborne has managed to sell off the taxpayer’s remaining 9% stake in Lloyds and 73% stake in RBS.
At Lloyds, whose focus is entirely on the UK, at least 45,000 jobs have gone since the financial crisis, and more pain could yet be felt. “We expect the bank to cut costs aggressively; on top of the current cost plans, we expect a leg-up in cost reductions around the commercial banking operations,” said analysts at Bernstein.
As far as RBS is concerned, the experts believe Brexit pushes any chance of it paying its first dividends since 2008 even further into the distance. Analysts at Deutsche suspect this could become a problem for all the banks. “We think management teams will have limited incentive to deliver significantly higher dividends while the Bank of England is likely to be cutting growth forecasts and/or interest rates. It is also unclear at this stage if the regulator will be willing to sign off large dividend payouts/buybacks, given the environment,” the Deutsche analysts said.
The Bank of England’s view will become clearer on Tuesday when it publishes its half-yearly assessment of risks to the financial system. Carney has already said banks are holding more capital and more liquid assets than before the crisis. He has also acknowledged that low interest rates cut profits so much that it could reduce banks’ willingness to lend. However, Jayne-Anne Gadhia, chief executive of Virgin Money, put a more positive gloss on low interest rates, telling the BBC’s Today programme last week that they should stimulate the economy, which would help the banking sector.
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