The Lex Newsletter: jolly boating weather for lenders

Dear reader,

A rising tide lifts all boats, they say. It does not quite work for banks. Here, rising rates lift profits in proportion to how heavily lending features in the business mix. This was neatly illustrated in Lex’s analysis of half-year numbers this week.

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European banks sail in three main flotillas:

Flotilla One — retail and corporate lending with a few side hustles

Lloyds is a good example. Its main business is lending to Britons. UK base rates have risen 100 basis points to 1.25 per cent since the end of last year. Interest payments, the bulk of Lloyds’ revenues, went up 13 per cent to £6.1bn for the half year.

I’m ignoring impairments in assessing profits. You interject: “Why? Bad debts must be rising.” I say: “So what? Lloyds released a ton of pandemic reserves last time, muddying the water.”

Before write-offs, profits at Lloyds rose 34 per cent to £1.4bn. That’s one heck of an operational gearing effect. But NatWest did even better. Its 14 per cent increase in net interest income was reflected in pre-impairment profits as a 56 per cent increase to £2.6bn.

UK base rates are expected to rise another 100bp by next spring. UK retail and business lending is not a wildly competitive industry. So Lloyds and NatWest will make lots more profits.

This is interesting to me at a quasi-theological level. For more than a decade of ultra-low rates, I believed that European lenders could make decent money from their core franchises. There just was no evidence of this. Now there is. Praise be!

Flotilla Two — lending with an investment bank that messes up

A further miracle would be required to heal Credit Suisse. The Swiss lender is the current Sick Bank of Europe, which gives Deutsche and Commerzbank some welcome downtime from the role. Credit Suisse has drifted chaotically under overwhelmed helmsman Thomas Gottstein. He is leaving amid SFr1.1bn ($1.1bn) of litigation charges and a SFr442mn loss for the first quarter.

New boss Ulrich Körner has a restructuring plan that involves cutting back the investment bank partly responsible for reckless risk-taking. That leaves Barclays and BNP as the only large European banks still having a serious crack at investment banking.

Barclays did well from this during the pandemic. This week, it returned to previous (bad) form with £1.8bn in litigation and conduct charges. This reduced half-year pre-tax profits by 24 per cent. They would otherwise have been bolstered by rising rates too.

You may think it is unfair of me to ignore one row of impairments at Lloyds and NatWest while bemoaning another row of write-offs at Credit Suisse and Barclays. But the first set of provisions covers external economic jolts. The second set reflects something rotten in the culture of those banks.

Flotilla Three — wealth managers with lending thrown in

There does not appear to be anything much wrong with UBS or Julius Baer. Both Swiss institutions are primarily wealth managers, to which lending is an adjunct. Their woes are exogenous, in the form of tumbling asset prices. Percentage fees and commissions fall in parallel. Operating profits were accordingly flat at UBS for the quarter and dropped sharply at Julius Baer for the half year.

Even amid a rates rally, Lex likes UBS and Baer. We do not favour European banks, but neither business really qualifies as such. They are wealth managers with decent franchises. Both should benefit from growing cohorts of well-off people spawned worldwide by urbanisation, automation and rising inequality.

For the moment, they are stuck with asset price erosion. We focused on four aspects of that trend this week.

Down, down, deeper and down

Gold has fallen 15 per cent from a $2,000 per ounce high when Russia launched its full-scale invasion of Ukraine. We believe rising production costs and the growing appeal of yield-bearing securities will reduce the price further.

Cryptos are a benchmark of speculative exuberance in our book. Bitcoin has staged a recovery over the past fortnight because that is what the S&P 500 has done. Too late to save Voyager Digital, however. The US crypto platform filed for Chapter 11 protection earlier this month. An opportunistic cash bid from affiliates of Sam Bankman-Fried showed that the besom-haired crypto bro is really just a Wall Street vulture fund manager at heart.

Palm oil futures prices have crashed from $1,730 to under $900 a tonne. We expect further declines as Indonesia removes export bans. Indonesia and Malaysia have sold too much of the stuff. China’s zero-Covid policy has reduced consumption of fried food. The result is a glut of the orang-utan-unfriendly gloop.

Chinese property prices are expected to drop about a third this year, regardless of government attempts to lever in $150bn of fresh loans. For decades, western pundits have visited China, observed incomplete apartment blocks and said: “This looks like trouble.”

It just goes to show that if you stick to a contention for long enough, it will eventually be true for a while. But Lex still does not think the Chinese financial system will collapse as a result of property woes, which is typically the implication of those western pundits’ theses.

Safe as milk

According to parts of the UK media, the refrain of young people to almost any challenge now is: “You’re making me feel uncomfortable. I need a safe place where I will not be exposed to your micro aggressions.”

To be fair, I have only ever heard one young person say words to that effect. Moreover, it is pretty much how I feel about recent economic and financial news. Rising living costs are kicking the stuffing out of ad sales at Meta, Alphabet, Snap and Twitter. Drinks companies such as Diageo will struggle to sell expensive hooch. And political pressure is mounting on energy companies, as anatomised by FT City columnist Cat Rutter Pooley.

Where to hide? The first option is to become a manager of a UK rail service or rolling stock business. It does not really matter that train staff keep going on strike. The government pays fees for rail services these days. This is a job where financial risks and customer expectations are conveniently low.

A second possibility is to win appointment as chief executive of a large aviation-related business that is poised for cyclical recovery from a near-death experience. That is the achievement of Tufan Erginbilgic at Rolls-Royce. Good luck to him.

The third course of action is to become very good at playing football. Wages and transfer fees are inflation-proof. I just hope more of the money now rains down on women players such as England’s Alessia Russo. Her backheel into the Swedish goal on Tuesday night was priceless.

Enjoy your weekend,

Jonathan Guthrie
Head of Lex