Britain's Struggling Banks Show the U.K.'s Economic Weakness

(Bloomberg Opinion) -- The U.K.'s biggest banks have come a long way since the financial crisis, when taxpayers had to rescue them to the tune of tens of billions of pounds. They're certainly stronger, with comfortable capital buffers, as they head into what could be the worst recession in three centuries.

But with the future of the economic rebound still far from certain, they're having to set aside huge sums of cash to cover the potential loan losses. With rock-bottom interest rates squeezing profit margins, and the terms of Brexit still not finalized, it's little wonder investors are staying clear.

Shares in Britain's “big four” — HSBC Holdings Plc, Barclays Plc, Lloyds Banking Group Plc and the recently rebranded NatWest Group Plc — have all performed worse than their European peers this year. Lloyds and NatWest, the most exposed to the U.K. economy, have seen more than half of their market values wiped out, leaving them not far off the lows of the financial crisis. Banco Santander SA, which runs Britain's fifth-largest bank, last week wrote $7.2 billion off the value of its U.K. offshoot.

One reason for the investor anguish is the potential hit to lenders' balance sheets from companies and households that won't be able to repay their borrowings because of the Covid lockdowns. HSBC Chief Financial Officer Ewen Stevenson on Monday told Bloomberg Television that the U.K. is one of the weakest economies he can see globally.

Analysts are expecting provisions across the four banks to total $27 billion this year, with HSBC making up more than a third of that. For perspective, they earned slightly less than $19 billion combined last year. Banks elsewhere in Europe — big lenders to small and medium-sized companies — have been making similar writedowns, but so far the U.K. finance industry seems to be in a worse spot.

When reporting second-quarter earnings last week, several U.K. lenders said the provisions reflected a slower economic rebound and higher anticipated unemployment. State-controlled NatWest now estimates that British joblessness could top 9%. That would exceed the 8.4% rate at the peak of the financial crisis.

The bankers' conservative assessments are warranted. According to the National Institute of Economic and Social Research, a think tank, unemployment will rise to almost 10% later this year once the government's furlough scheme ends at the end of October.

U.K. banks are especially sensitive to the jobs market because so much of their business is consumer-based. There is a high correlation between unemployment and delinquencies across unsecured lending and credit cards, for example. Mortgages are another critical business, and analysts at Deutsche Bank AG say borrowers' ability to repay is affected exponentially once unemployment rises past 8%. Deutsche estimates that losses at six U.K. lenders could reach 59 billion pounds ($77 billion) over two years if joblessness hits 10%.

The drop in interest rates will also hurt, denting revenue and margins, and putting more pressure on costs. Then there's Brexit. The possibility of Britain leaving the European Union without a deal features in banks' most extreme scenario planning, but it still wouldn't be a happy event during a global pandemic. And while there was a surge in British retail sales in June, a survey of households showed consumer confidence remained weak in July even before Britain started tightening lockdowns again.

It's a good thing capital isn't an issue —  for now. The banks expect their buffers to come under pressure, but the big four all reported an improvement in their common equity Tier 1 ratio in the second quarter, thanks in part to regulatory changes. That will help them weather the storm, but the situation is bleak.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Elisa Martinuzzi is a Bloomberg Opinion columnist covering finance. She is a former managing editor for European finance at Bloomberg News.

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