Financials Unshackled Issue 18: Weekly Banking Update (UK / Irish / Global Developments)
Perspectives & Snippets on UK / Irish / Global Banking Developments
The material below does NOT constitute investment research or advice - please scroll to the end of this publication for the full Disclaimer
Good evening - and welcome to the latest edition of Financials Unshackled! This note looks ahead to what’s coming next week in a UK & Irish banking developments context and covering select key newsflow from this week.
The note is divided into five sections: i) Calendar for the week ahead; ii) Results Recap (key synopsis of results / trading updates / etc. published in the last week); iii) UK Highlights (other key UK sectoral and company developments in the last week); iv) Ireland Highlights (other key Ireland sectoral and company developments in the last week); and v) Other Highlights (select key developments in a Global / European context as well as a smattering of critical economics / property / politics updates).
I hope you enjoy reading it and all feedback is welcome - you can reach me directly at john.cronin@seapointinsights.com.
Calendar for the week ahead:
Wed 13th Nov (11:00 BST): Central Bank of Ireland (CBI) Retail Interest Rates (September 2024)
Wed 13th Nov (14:00 BST): Secure Trust Bank (STB) Capital Markets Event - Commercial Finance
Thu 14th Nov (07:00 BST): Metro Bank (MTRO) 3Q24 Trading Update (for the three months to 30th September 2024)
Thu 14th Nov (10:00 BST): Funding Circle Holdings (FCH) General Meeting
Results Recap (AIBG, OSB, VANQ, Shawbrook)
AIB Group 3Q24 Trading Update: Firing on all cylinders
AIB Group (AIBG) issued its 3Q24 trading update for the three months to 30th September 2024 on Tuesday 5th November. In overall terms the statement - and the subsequent earnings call hosted by the CEO & CFO - struck a very upbeat tone with continued positive financial performance trends seen in 3Q, an upgrade to FY24 net loan growth guidance to +5-6% y/y (from +4% y/y) given YTD experience and outlook, confirmation on the earnings call that guidance for c.€4.0bn of net interest income (NII) in FY24 is “conservative” and that the outcome is expected to be >€4.0bn (with strong confidence in NII resilience in outer years due to recent actions taken to materially extend the duration of the structural hedge, meaning significant lesser swap maturities in FY25/26), reaffirmation of all other FY24 guidance, and continued strong capitalisation and liquidity.
Medium-term targets were also reaffirmed with the CEO remarking that “We are implementing our strategy at pace and remain on course to deliver sustainable returns to our shareholders guided by our medium-term target of a RoTE of 15%”. I remarked in my preview note that these medium-term targets are easily within AIBG’s reach in my view - indeed, management was challenged on the call about what consensus could be missing given consensus estimates are for a higher FY26 RoTE despite modelling income numbers that appear to sit a little below implied guidance. The CEO made it clear in response to this question that management is not in the business of refreshing medium-term targets on a high frequency basis.
A few other key take-aways were: i) loan growth was broad-based across the business units - and deposit balances have continued to grow (and the pace of shift to term has slowed considerably); ii) very clear message from the CFO on the call that a clinical focus on headcount will be key to costs containment going forward (which is suggestive of further efficiency initiatives as well as, arguably, a veiled threat to unions in the context of upcoming wage agreement negotiations); iii) the CFO’s remarks that management had already anticipated the weakness in retail and office (secondary stock particularly) CRE exposures and had provisioned accordingly - with the CEO going on to note that there has been no deterioration in early warning indicators; iv) a SRT trade is nearing completion with an expected c.20bps of CET1 capital ratio benefit and this transaction is likely to be the first of a multi-year programme with AIBG likely to be more ambitious in terms of structuring and sizing going forward.
Given share price strength it will be interesting to see if government presses forward next week to execute another placing transaction. Today’s closing stock price of 534c is 8.4% ahead of the price at which the last placing was executed, which should give the Finance Minister confidence to transact provided there is no material selling pressure early next week.
More detail on the trading statement is set out in my note of 5th November, which you can access here - and I also set out further detailed perspectives in my note of 6th November, which you can access here.
OSB 3Q24 Trading Update: Still cautious, but relief-inducing for investors
OSB Group (OSB) issued its 3Q24 trading update for the three months to 30th September 2024 on Wednesday 6th November. In overall terms it wasn’t the dampest of updates and, given investor sentiment has been so weak in recent times, it was well received by the market and the stock price is up c.5% week-on-week.
Some key highlights are worth flagging. Underlying net loan growth guidance was very slightly downgraded from c.3% y/y to slightly <3% y/y but, apart from that, all pre-existing FY24 guidance was reaffirmed. The preservation of net interest margin (NIM) guidance, in particular (at c.230-240bps), soothed concerns. However, the statement did note that “The Group continues to evaluate customer behaviour in the reversion period throughout the fourth quarter and will assess this as part of the usual year-end process” (a broadly similar cautionary tone was struck within the 1H24 update) which means the market is still ‘on watch’ for a prospective material adverse (‘one-off’) EIR adjustment at year-end - but the risk of such adjustments lessens over time as the following statement within the update makes clear: “The potential future impact of Precise Buy-to-Let customers spending less time on reversion will reduce significantly over the next two years as these mortgages reach maturity”. Indeed, in the event that there is a further adjustment at year-end, it is likely that it would be the final one - and the order of magnitude is unlikely to be enormous in my view given that management, who are very likely to be approaching such matters conservatively in the wake of the 2023 wobble I would say, didn’t feel compelled to adjust at 3Q. It was also positive to observe the continued relatively benign 3M+ arrears trends as well as learn that the secured loan book benefited from a small impairment release in 3Q.
More detail on the trading statement is set out in my note of 6th November, which you can access here.
VANQ 3Q24 Trading Update: Chugging along fine; still in ‘wait and see mode’ in relation to expected complaints volumes
Vanquis Banking Group (VANQ) issued its 3Q24 trading update for the three months to 30th September 2024 on Thursday 7th November. No great surprises in the update though the stock price remains depressed, having sold off further in the wake of the “Hopcraft” judgment - though, notably, VANQ has never entered into discretionary broker commission arrangements.
The key highlights of the update were: i) gross customer interest-earning balances (IEBs) stable q/q at £2.25bn, with Second Charge Mortgage balances growth offsetting reduced Vehicle Finance balances and a marginal contraction in Credit Card balances; ii) net receivables +4% q/q reflecting the reduced impairment allowance now required on the Vehicle Finance portfolio; iii) decent growth in retail deposit balances from £1.94bn at end-1H24 to >£2.1bn at end-3Q24 (notably, retail funding now accounts for c.89% of total funding, which is an enormous turnaround (of benefit from a margin standpoint) when one thinks back to the pre-Covid funding structure); iv) NIM down marginally by c.20bps q/q to 18.6%, reflecting lending mix effects; v) on track to deliver the previously announced £60m of gross cost savings by end-FY24, on track for a further £15m of savings by end-FY25, and £23-28m through the Gateway technology transformation programme (which is expected to be completed by mid-FY26); vi) complaint costs remain broadly in line with expectations and are forecast to increase by 50% y/y in FY24, driven by a material increase in Financial Ombudsman Service (FOS) fees owing to increased complaints from Claims Management Companies (CMCs) - though the statement goes on to note that, to the extent that the revised FOS fees charging proposals are enacted, they are expected to reduce CMC complaint referrals to the FOS; and vii) the Tier 1 ratio was -110bps q/q to 18.7% owing to the statutory loss in 3Q (including transformation and other exceptional costs) and higher RWEs.
Elsewhere, VANQ reiterates that it is not subject to the current FCA Motor Finance Review and, following refinement to documentation and processes, the Group continues to conduct Vehicle Finance lending through intermediaries who have commission disclosures in line with the standard required in light of the recent Court of Appeal judgment. Click here for the RNS.
Shawbrook 3Q24 Trading Update: Loan growth continues to strengthen; positive outlook soundings
Shawbrook Bank issued its 3Q24 trading update for the three months to 30th September 2024 this morning. The business continues to report favourably in the context of all of the key metrics that are disclosed in the update.
Key highlights for me were: i) net loans +c.6% q/q to £15.1bn, driven by strong net lending volumes across its core specialist real estate and SME markets; ii) deposits growth of c.£200m q/q to £15.2bn; iii) arrears ratio broadly stable q/q at 2.8% (c.2.9% in 2Q); iv) strong capitalisation with an end-3Q CET1 capital ratio of 12.6% (flat q/q) and an end-3Q total capital ratio of 15.5% (-40bps q/q). The statement also reminds readers that Shawbrook announced, on 30th October, a £399m securitisation of loans originated by Bluestone (click here for that RNS) and the closing comment made by CEO Marcelino Castrillo points to optimism in the outlook for the bank: “As we look ahead, we continue to see promising opportunities for expansion and value creation across our core markets, including SME and Real Estate. The combination of an exceptional customer franchise, a more stable macroeconomic outlook and increasing customer confidence means we are well positioned to continue to deliver on our strategic ambitions throughout the remainder of 2024 and beyond.”. Click here for the RNS.
UK Highlights
Motor finance debacle remains in the spotlight
I reported in my note of 5th November that Fitch, the credit rating agency, has cautioned that some large UK banks could face the risk of a credit rating downgrade on account of potential redress costs related to the motor finance debacle, noting that: “The ruling materially increases the likelihood of a redress scheme to compensate customers, which could have large financial implications”.
To recap, the Court of Appeal ruled on Friday 25th October that motor dealers acting as credit brokers owe a fiduciary duty to their customers - and that lenders will be liable for dealers’ non-disclosures. This is a considerably ‘higher bar’ than that imposed by prevailing regulatory requirements, thereby potentially putting lenders ‘on the hook’ for substantial liabilities. Indeed, this development has come amidst an ongoing FCA review into whether motor finance customers have been overcharged because of the past use of discretionary commission arrangements (DCAs) - for which analyst estimates in relation to total associated industry costs ranged from £6-16bn (before the unexpected “Hopcraft” case judgment).
The industry is clearly in a bit of a tailspin since the Court of Appeal judgment and it is unclear at this point what the potential redress bill could look like - or whether the decision could be reversed upon appeal to the Supreme Court (with any such appeal unlikely to be heard for c.12 months from what I gather). Lenders have undoubtedly been recalibrating loan agreements in recent days in the wake of the judgment which might see lending activities recommence in the relative near-term - but, with that said, some lenders are likely to be re-evaluating whether they want to continue to play in this space given the seemingly changed risk profile. There also appears to be contagion risk for other consumer lending activities (e.g., premium finance) - although I would note that the FCA’s Mortgage Conduct of Business Rules ought to mean a very low risk of contagion in a mortgage lending context given the very clear disclosure requirements applicable to mortgage credit intermediaries set out in the rulebook (click here for latest version of MCOB and I would direct you to digest the contents of MCOB 4 and MCOB 4A if interested in learning more on this). Indeed, while the judgment is concerned with the duty of care owed to “consumers” (click here for the judgment) it does beg the question as to whether exposures in certain intermediated non-consumer lending sectors (e.g., small business finance) could also emerge as a result of the decision. It will be very interesting to see what the FCA and/or Treasury has to say on the debacle and what actions either or both party may take - and I would expect that we will learn more in this respect in short order.
An article in the FT on Wednesday notes that the industry has indeed held emergency talks with Treasury and the FCA to arrive at a solution and that some lending has indeed resumed as loan contracts have been recalibrated to disclose the amount of commission paid by the finance providers and how it was computed. The article flags contagion risk and cites comments made by Jamie Patton, MD at Johnson Law Group, who notes that the overall financial impact for the banking industry could be as bad as if not worse than the PPI scandal (based on his reported average claim value estimates of £1,200-1,500 per relevant loan contract on DCAs and £400 on fixed fee commissions). While Nikhil Rathi, FCA CEO, reportedly remarked last week that the regulatory body is awaiting the outcome of a Supreme Court hearing before taking further action, that could be a long time coming and one suspects that the Treasury and the FCA will have something to say well before then. All eyes on when we might see some intervention from these bodies.
My note of 6th November also ran through some numbers to illustrate that the totality of the market value erosion stemming from motor finance / contagion concerns in the case of Close Brothers Group (CBG), the most affected lender, appears to be well north of £1bn already (since the FCA announced its Motor Finance review in January). You can access that note here.
Mortgage pricing pushing upwards
Useful data made available by Rightmove earlier today (click here for it) shows that average mortgage pricing has pushed up in the last week by close to c.10bps on higher LTV (85%+ LTV) product, by c.2-6bps on 75% LTV product - though lower 60% LTV product bucks the trend with prices falling by c.3-6bps week-on-week. These price moves come in the wake of rising swap costs pursuant to the 30th October Budget, with government borrowing in the spotlight. Indeed, yesterday’s commentary from the BoE in relation to a now higher inflation outlook (relative to recent expectations), as well as the (interrelated) tail effects attributable to the Budget, will find its way into mortgage pricing over the coming week(s) I suspect. The tables below, extracted from Rightmove’s update earlier today provide a useful snapshot of current average prices. Rightmove’s weekly mortgage tracker from earlier in the week can also be accessed here.
Ireland Highlights
My latest article for the Business Post provides synopsis of key trends in the Irish banks’ trading updates - as well as an, until now, unreported development in Ireland / Europe in a deposit-gathering context
The latest piece that I penned for the Business Post (published today and which can be accessed here) sets out a summary of the key trends that we observed in the Irish banks’ 3Q trading updates. I also flag that, while it hasn’t yet been reported in the media outside of South Africa, it is worth flagging that Ruth Leas, chief executive of Investec, commented on July 31 that the bank is exploring the possibility of a European banking licence to support existing and new client activities in mainland Europe – with Ireland suspected to be a potentially ideal launchpad given Investec’s 25-year history in this market.
Bank of Ireland reported to have agreed a sale of c.€800m of UK consumer loans
Bloomberg reported on Monday that Bank of Ireland (BIRG) has agreed to dispose of a portfolio of c.€800m of UK consumer loans, according to sources. Citigroup is understood to be arranging the financing for the deal through a securitisation arrangement, using the loans as collateral. The loans will be split into several tranches, according to the press report - with GoldenTree Asset Management said to be intending to acquire the junior tranche(s). Click here for the article.
This press report does not come as a great surprise given that the BIRG CFO noted on the 1H24 earnings call that it expected to exit personal lending in 2H24. Indeed, BIRG announced, on 5th December 2023, that it had extended its partnership with the UK Post Office for a further five years to a minimum end date of 2031 but that the partnership would no longer focus on providing Post Office branded mortgages or personal loans - and went on to note that it had also agreed with the AA to conclude its partnership with that business in recognition of “the strategic objectives” of BIRG (click here for that RNS). BIRG further noted, within that RNS, that it has historically originated the vast majority of its UK unsecured loans through these two partnerships - so, it could be argued that the writing has been on the wall for some time in terms of its UK personal lending portfolio.
Business Post article on AIB Group employee costs
Following the AIB Group (AIBG) CFO’s comments on Tuesday’s 3Q24 earnings to the effect that a clinical focus on headcount will be key to costs containment, the Business Post ran an article on the topic. The article lifts a quote from a S&P report from July on the Irish banks more broadly, as follows: “Despite Irish banks' strong focus on efficiency, expense in absolute terms grew significantly over the past two years, owing to staff increases required to onboard a large number of clients transferring from exiting banks, the introduction of health and other benefits as well as variable pay to employees, and ongoing investments in IT systems and automation aimed at improving cost efficiency…Enhancing cost efficiencies through optimisation of operating structures is critical for Irish banks to sustain robust profitability, especially as interest rates return to normal levels”. Indeed, it does appear that much of the increase in AIBG headcount associated with the onboarding of new customers has not yet been reversed (though I could stand corrected on this as it is not possible to disaggregate specific employee cohort movements based on public data), it does suggest that there is some room for natural staff cost reductions in the months and year ahead. The message that I took from the AIBG CFO’s comments were that headcount optimisation will be a key focus for FY25 - though clearly the pace of lending growth does exert some pressures in the opposite direction. I would add that employee costs are likely to be under the microscope at Bank of Ireland (BIRG) as well - with its 3Q24 IMS noting that “The Group continues to maintain tight control over its cost base while absorbing inflation and continuing to invest in strategic growth and simplification opportunities”. On PTSB, its recent 3Q24 trading update noted that “management remain committed to reducing costs in absolute terms over the coming years”, which will be critical if the bank is to trend towards an adequate level of returns over time. Click here for the article.
BPFI reports soaring personal loan drawdowns
Banking & Payments Federation Ireland (BPFI) reported on Monday that personal loan drawdowns were +18.8% y/y in 2Q24 to €641m (an increase of >50% since 2Q22), the highest quarterly level of lending by value (and volume) since the series began in 1Q20. The y/y growth in values was strong across all three categories: i) car finance +18.9% y/y to €224m; ii) home improvements lending +17.5% y/y to €202m; and iii) other lending +20.1% y/y to €214m. Click here for the press release and here for the report. These are positive trends in terms of listed lenders’ loan growth - at strong yields and RoRWAs.
Other Highlights
BoE cuts base rate but cautions on inflationary outlook
The Bank of England (BoE) cut base rates by 25bps to 4.75% yesterday, as expected - but issued a note of caution on the inflationary outlook, noting that the Budget is provisionally expected to boost CPI inflation by just under 0.5% at the peak. A statement in the Monetary Policy Report notes, however, that the outlook for inflation remains uncertain and that monetary policy will need to remain restrictive with that in mind: “Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee continues to monitor closely the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting.”, which is not unhelpful in a bank earnings capability vein I would add (though lower expected GDP growth and concerns in relation to wage growth are impactful in the opposite direction). It’s also worth flagging that the Monetary Policy Report observes that the reduction in swap rates has begun to feed through to household loan and deposit rates with passthrough progressing in line with expectations thus far (see section 2 from p.40-45). Click here for the Monetary Policy Summary and minutes of the Monetary Policy Committee meeting of 6th November and click here for the Monetary Policy Report.
Irish General Election set for Friday 29th November
The Irish Taoiseach (Prime Minister) Simon Harris has triggered the start of the 2024 General Election after he announced today that he will request a dissolution of the current Dáil (Irish Parliament). The General Election is set to be held on Friday 29th November, and judging by latest polls - as well as betting markets - a rerun of the current coalition government appears to be the most likely outcome (perhaps, minus the Green Party). Such an outcome is likely to be welcomed by investors given the stability it would denote.
ECB finds that the credit quality of European banks’ CRE portfolios is visibly deteriorating
The ECB published a system-wide analysis of commercial real estate (CRE) exposures and risks earlier in the week, which analyses the complex linkages between CRE markets and the financial system (click here for the publication). The main highlights for me were: i) credit quality is visibly deteriorating, with the NPL ratio doubling since the start of the most recent monetary tightening cycle - with both Probability of Defaults (PDs) and Loss Given Defaults (LGDs) both on the rise on account of the market downturn; ii) approximately one-third of banks’ lending exposures to non-financial corporates (NFCs) is collateralised by some form of CRE assets - and eurozone (EZ) banks have c.€1.3 trillion in outstanding loans to CRE investors; iii) despite the aforementioned big numbers, CRE loan portfolios account for just 6% of EZ bank assets and credit quality deterioration in CRE portfolios is therefore unlikely to threaten the solvency of the banking system - especially considering EZ banks’ healthy capital positions; iv) with that said, exposures are not evenly spread across banks and a tail of smaller specialised banks with larger exposures (>10% of total assets), accounting for c.13% of EZ bank assets may experience stress; v) non-banks are also exposed - insurers have total exposure of c.€48bn to EZ CRE companies and private credit may also play a role in lending to CRE markets; and vi) c.€490bn of CRE-related debt instruments have been issued by EZ sectors.
Detailed interview with Claudia Buch, Chair of the Supervisory Board of the ECB
The ECB published the transcript of an extensive interview with Claudia Buch, Chair of the Supervisory Board of the ECB, with four newspapers earlier this week. A few key highlights: i) higher bank profitability may not be sustainable and “Banks should thus use the opportunity of higher profits to improve their financial and operational resilience, invest into IT infrastructure and cyber resilience”; ii) the banking sector has sufficient capital headroom to cope with the increased capital requirements (of c.8-9% on average across the eurozone (EZ) banking sector) related to the Basel 3.1 final reforms package - maintaining the line that there will be no relaxation of the ECB’s position following recent moves to curtail the impact in both the US and the UK (to hammer this point home, Buch also notes that “On average, US capital requirements are higher, in particular for globally systemically important banks and because of the less frequent use of internal models in the United States”); iii) she notes that, while cross-border mergers are one way for banks to respond to increased competitive pressures, the ECB is neutral in an in-market consolidation versus a cross-border transaction context: “We stick to the clear criteria to assess mergers, while recognising the potential benefits and risks of cross-border diversification”; iv) Buch notes that she hopes that “….the banking union can advance under the existing proposals without any specific event needing to happen first. We already have common supervision, and non-performing loans have declined – these are two key preconditions for a European deposit insurance scheme (EDIS)”; v) there is still a need to address some gaps in the context of the bank-sovereign nexus “…such as the ratification of the European Stability Mechanism (ESM) and a framework for the provision of liquidity in resolution…In addition, EDIS would further weaken the bank-sovereign nexus by diversifying the resources of the deposit insurance fund, thus reducing potential reliance on national sovereigns. Diversification and less dependency on national funds would provide a clear advantage.”; vi) on credit quality: “We observe vulnerabilities in areas particularly affected by higher interest rates, such as commercial real estate. It’s not just about the flexible rates and bullet loans, but also the shift in demand due to remote work. This risk has been known for some time, prompting us to focus intensely on commercial real estate. We have been working closely with highly exposed banks to understand and mitigate these risks. Recent data show a decline, on aggregate, in non-performing loans, with slight upticks in recent quarters, particularly in commercial real estate and lending to small and medium-sized enterprises.”; and vii) she notes that one long-standing deficiency at many banks is risk data aggregation (this comment was in answer to a question on deficiencies in climate risk assessment - with Frank Elderson, notably, speaking on this topic recently). Click here for the transcript.
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