Banks Q4 earnings preview: Banks' fortunes improve as interest rates rise

UK banks earnings will kick off this week. NatWest will be the first of the UK high street banks to go under the microscope, whilst HSBC, Britain’s largest bank, Lloyds and Barclays report next week.

The results come as the banking sector has had a strong start to 2022. The FTSE 350 banking sector has rallied 15% so far this year, outperforming the broader market. The FTSE 100 has risen just 1.5% in the same period. When looking at the sector’s performance since December, the banks sector trades 20% higher against a 6.5% increase in the FTSE100.

The marked rise in the share price has come since the BoE started hiking interest rates in December, swiftly followed by another hike in February. The higher interest rate environment, along with expectations of further rate hikes to come, and a rebound in loan demand are expected to keep Britain’s big lenders buoyant and guidance upbeat.

The big four are expected to report total profits of £34 billion, with Lloyds and Barclays forecast to report their highest earnings in decades.

Here's what to watch:

Net interest income

Overall banks are expected to show signs of improving profits, thanks to rising net interest income. Higher interest rates, mean higher borrowing costs, widening the difference between what banks pay depositors and the amount they charge borrowers.

Loan demand is expected to be strong as the solid recovery from the COVID crisis has meant that customers are confident enough to take on debt and spend well, helping to generate a strong income for UK banks. The UK labour market is solid and the UK economy grew a robust 1% QoQ in Q4. The housing market remained strong which will support the big high street lenders such as Lloyds..

Loan loss reserves

The release of reserves, put aside for bad loans which never materialized in the pandemic, were released across last year, boosting profits at the banks. The release of those bad loan reserves is not expected to continue across 2022.

Costs

Costs will be more in focus than usual as inflation in the UK hit a 30 year high of 5.1% in December. Everything from the cost of paper to wages have been rising. Costs for IT upgrades and digitalisation could be in focus.

Share buybacks & dividends

The removal of restrictions preventing UK banks from distributing capital distributions is also a positive for the banks. Through the pandemic the BoE placed restrictions on the banks' ability to payout in order to protect their capital. With this restriction no longer in place, attention will be firmly on dividends and share buyback programmes.

A taster of what's to come:

NatWest

NatWest will report on February 18. What a difference 12 months can make! After reporting a £351 million loss a year ago - NatWest is expected to swing into a £4 billion profit. Attention will be on cost cutting and whether Alison Rose's 4% cost cutting target was reached. This could be a tough challenge given surging inflation & wages. NatWest, as the most UK focused bank has the most to gain from the BoE rate hikes. Could we see the share buyback programme lifted to £2 billion? The taxpayers stake in the bank has fallen to 52% and could fall further as NatWest privatises itself.

HSBC 

HSBC will report on February 22. Only 20% of HSBC's profits are generated in the UK. More than 50% come from Asia, where China's new security law is a constant headache for the bank. However, HSBC should reap benefits from facilitating global trade and rising interest rates globally. Profits are expected to get a boost to $19.2 billion, up from $8.8 billion a year ago. HSBC's share price has outperformed its sector peers recently after the nightmare that was 2020.

Barclays

Barclays will report on 23 February under CS Venkatakrishnan, who replaced Jes Staley, but intends to continue with the strategy of an investment bank in UK & US and a large high street operation in Britain. Big banks in the UK are investing heavily in technology and staff, boosting consensus. Pressure will be on Barclays to keep up, which could attract criticism over here.. Consensus estimates are for profits of £8.1 billion, this would mark the highest level in recent history, helped by a change to accounting rules. 

Lloyds

The actual results, which are expected to show record profits of £7.2 billion, could play second fiddle to the new chief executive Charlie Nunn's strategic review and his big plan for the bank going forward. As Britain's biggest lender and given its UK focus, investors will want to know where the growth opportunities sit. A share buyback programme in the region of £1 - £1.3 billion is expected.