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UK banks' loan loss provisions soar in face of pandemic

Major British banks made provisions against loan losses of more than £7.5 billion in the first quarter in the face of the coronavirus pandemic, nearly 6x the amount set aside in the same period last year.

But even this may be just a small sign of things to come, said S&P Global Ratings, which estimated that systemwide U.K. domestic credit losses will rise to £18.5 billion in 2020.

"While that is our current base-case estimate, we believe that losses may be higher still," Ratings said.

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Other key measures of banks' health have been affected by the pandemic, too.

The cancellation of 2019 dividends across the board, though only at the prompting of the regulator, should have boosted common equity Tier 1 ratios as capital was retained. Most large U.K. banks registered a year-over-year increase.

But Barclays PLC noted in an earnings call that, in its case, its quarter-over-quarter CET1 ratio declined, impacted by a sharp increase in risk-weighted assets from increased client activity and market volatility, and drawdowns by borrowers on credit facilities.

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Return on equity, a measure of profitability, was hit hard as interest rates were slashed to record lows in the face of the virus. Some banks took an optimistic view — Barclays saw its ROE plunge but retained its target of a group return on tangible equity of above 10%.

U.K. banks' liquidity coverage ratios, which measure the ability to withstand cash outflows, were in better shape than many European peers going into the pandemic. That said, Barclays, Royal Bank of Scotland Group PLC, Santander UK Group Holdings PLC and Standard Chartered PLC all saw year-over-year declines in their liquidity coverage ratios, with StanChart suffering the sharpest drop.

Expected losses

But perhaps the most revealing measure of banks' performance in the current environment is expected losses in the face of the pandemic. Here, each of the main banks has calculated their loan loss provisions using different models.

New IFRS 9 accounting rules aimed at ensuring banks are more transparent — the rules are a response to the financial crisis when bank losses surprised investors to damaging effect — mean banks should account for loan losses earlier but if their forecasts are more optimistic, that may not reflect reality

S&P Global Ratings noted that when banks have granted customers payment holidays on mortgages or credit cards, these are regarded as IFRS performing loans and so are subject to a 12-month expected credit loss allowance rather than the lifetime expected credit loss allowance required for stage 2 or 3 loans.

Furthermore, the Bank of England spoke with top banking executives to advise them not to "kitchen sink" provisions in the first quarter, after seeing global banks post big increases in reserves for potential defaults because of the pandemic, according to the Financial Times. The central bank was worried such actions would choke lending.

RBS, Barclays

RBS CEO Alison Rose said while unveiling first-quarter results that the bank considered it too early to estimate the scale of the economic impact of the pandemic as there was no consensus among forecasters on the impact of the lockdown or the effectiveness of the government’s response.

The bank's first-quarter impairment charge was £802 million, including £628 million related to what it called its "multiple economic scenario overlay." This, it said, aimed to capture the historic variability and distributions of economic risks.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

But analysts questioned RBS' approach to preparing for the impact of COVID-19, noting that the 19.7% house price index decline assumed by the bank did not feed through into its underlying loss assumptions.

Katie Murray, the bank's CFO, said the economic overlay was a way of ensuring RBS' actual experience of the unfolding crisis was reflected as accurately as possible.

Barclays, too, said it had taken significant additional impairment even though its credit metrics did not yet reflect the full effect of the pandemic. It made a £2.16 billion loan loss provision, with CEO Jes Staley saying the bank used "a very challenging forecast" through its credit models.

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This included estimates of peak unemployment levels and troughs in GDP with unemployment forecast to reach 6.7% this year with economic output of negative 8%. On May 7, the Bank of England forecast that Britain's economy would contract by 30% in the first half of 2020, with unemployment likely to reach 9%.

Barclays' finance director, Tushar Morzaria, said the bank's pre-crisis run rate of impairments was £400 million to £500 million a quarter.

Lloyds, HSBC

Lloyds Banking Group PLC's loan loss provisions of £1.43 billion in the quarter were based on a different scenario, with a base case for GDP at negative 5%. The bank said its IFRS 9 economic scenarios had deteriorated significantly and although consensus expectations were for a V-shaped recession, its severe economic scenario would generate £7 billion of expected credit losses, £2.1 billion higher than the base case.

The bank's chief financial officer, William Chalmers, stressed that IFRS 9 was a forward-looking measure.

"There are two factors that we need to pay attention to. One is whether the economics change and whether our base case changes with it, and clearly if it does then you will see that forward-looking charge be modified accordingly," he said. "And the second is the absence of perfect foresight."

Of the four main high street banks, HSBC Holdings PLC provided the biggest range of expected credit losses, from $7 billion to $11 billion, depending on which of its scenarios for the economic effects of the pandemic proved accurate.

"There's a wide range of potential outcomes including the risk that the upper end of the range may increase," said CFO Ewen Stevenson at the bank's first-quarter results presentation.

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