Big banks remain unloved after third-quarter reporting season

Although HSBC is ending the FTSE 100 megabanks’ third-quarter results season with a flourish in the form of its third share buyback of the year, lukewarm figures or cautious outlooks on lending margins (or both) from Standard Chartered, NatWest, Barclays and Lloyds mean the big lenders remain unloved,” says AJ Bell investment director Russ Mould.

All five trade on earnings multiples that represent a big discount to the FTSE 100 and four of them offer a premium dividend yield. Markets clearly believe there are substantial risks attached to the earnings and dividend forecasts – even if no increase in aggregate profits is expected in 2024 – and are demanding higher returns (by paying low prices and farming high yields) to compensate themselves for those dangers.

Source: Company accounts for historic book value per share figures, Marketscreener, consensus analysts’ forecasts, Refinitiv data

“None of the Big Five trade at a premium to net asset value (NAV) and where a one-times multiple of book value could be seen as a floor when the good times are rolling and return on tangible equity is consistently in the double-digits, it could become a valuation ceiling if markets feel more difficult times are on the way.

“Using price-to-book multiples as a yardstick, markets seem to think the US banks are in a much better position, since only Citigroup of the big four Main Street banks trades at a discount to NAV. This presumably reflects greater investor confidence in America’s economic outlook than that of the UK, or China for that matter, given the importance of that country to HSBC and Standard Chartered.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts, Refinitiv data

“Even then, the US banks all trade on single-digit price/earnings (PE) multiples at a time when the S&P 500 trades on around 19 times forward earnings for 2023, according to research from S&P Global, so they are not immune from the suspicion that a sandbagging from financial markets or the global economy or both may be just around the corner.

“The FTSE 350 banks index has actually been more resilient than the Philadelphia KBW Banks benchmark, at least until recently. The US lenders have yet to recover their poise after the quick-fire failures of Silicon Valley Bank, First Republic Bank and Signature Bank in the spring (the second, third and fourth biggest bank collapses ever in America) and the US Federal Reserve’s Bank Term Funding Program does not seem to be inspiring maximum confidence.

Source: Refinitiv data

“In both cases performance seems to rest heavily on one megabank – HSBC in the UK and JPMorgan Chase in the USA – to again suggest investors are wary of the sector. This is understandable at a time when interest rates are rising. Although this can help net interest margins, this trend can also lead to an increase in sour loans and the sort of financial market volatility that can crimp deal flow at investment banks, as fewer firms launch initial public offerings or major merger and acquisition deals.

Source: Refinitiv data

“Worries over unrealised losses on sovereign bond holdings are also weighing on the US lenders, to again reflect concerns over rising interest rates and whether the US Federal Reserve will ultimately tighten policy by too much for too long – something which history suggests is more than likely.

“The US Federal Deposit Insurance Corporation (FDIC) reports that, as of the end of June, American banks are sat on $311 billion on unrealised losses on held-to-maturity securities. The good news is accounting rules mean they no longer have to mark-to-market and book those losses each quarter. The bad is that any unexpected run on deposits could force banks to liquidate to raise cash, thus crystallising those losses (rather as happened at Silicon Valley Bank in the spring). If the banks can hold the securities – which include a lot of US Treasuries – until maturity, then all may be well, but these potential losses are sitting in plain sight and so are the risks.

“For the UK banks, the market seems more worried about a peak in net interest margins and the prospect of rising loan losses.

“For the moment, loan losses seem to be under control, as, in aggregate, they are no higher in Q3 2023 than in Q3 2022, at some £2.5 billion across HSBC, Barclays, Standard Chartered, NatWest and Lloyds. The fourth and final quarter will be a bigger test, as this is when the lenders tend to clean house more thoroughly.

Source: Company accounts

“However, the combination of political pressure, competition and consumers’ ability and willingness to shop around for the best deals on deposit accounts and loans does seem to be putting a cap on net interest margins, after the resurgence from the lows of late 2020.

Source: Company accounts

“Aggregate net interest income across the Big Five FTSE 100 banks fell quarter-on-quarter for the third time in a row in Q3 2023, to £18.1 billion. That is still £5.4 billion higher than in Q3 2021, but it is some £2 billion below the peak of Q4 2022, so if bad loans increase and investment banking operations falter (at those who have them) then that could accentuate the impact of falling income.”

Source: Company accounts

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