The main features of this set of results were the deterioration in the economic outlook over the quarter and the late-breaking impact of the “mini budget” announced on 23 September 2022, immediately before banks finalised their ECL calculations for the quarter.
Credit fundamentals and outlook deteriorated over the quarter. While the labour market remained very strong (albeit with some interesting analysis showing the drop in participation is due to retirement rather than illness) and car prices continued to be buoyant, the first signs of slowdown in the housing market emerged with YoY growth showing some sharp declines, some very small MoM falls, and a significant decrease in mortgage approvals. Affordability worsened with continued high inflation and rising base rates. Volatility in the yield curve also fed through to increases in mortgage pricing, hitting refinance affordability.
September money and credit data showed an interesting drop in credit card lending and a tick up in deposits - although the movements are not extreme – and continued de-leveraging by SMEs. The figures for next month will help establish whether the movement on consumer lending is a trend or a blip.
Against this backdrop, UK personal and corporate borrowers are continuing to defy gravity with strong asset performance and flows to delinquency still below pre-Covid levels.
As with previous late-breaking events (Brexit, Covid… risk and finance teams are getting well practiced at this!), there was a bit of a scramble to include the new view of the world as at 30 September into ECL balances following the release of the mini-budget. This led to a variety of approaches across lenders including: full refresh of scenarios and run through of models, or scenarios reflecting the pre-mini budget position and the late risk from the mini-budget reflected through PMAs, or keeping 2Q22 scenarios but skewing weightings to downside to reflect the deterioration in outlook.
After small declines in coverage over 1Q22 and 2Q22, 3Q22 saw a small uptick reflecting the downgrade in outlook. This was also reflected in cost of risk through the P&L, with the quarterly charge at pre-pandemic levels. The increase in ECL implied by the change in economic scenarios and their weightings was partially offset by some selective PMA releases, with some banks viewing that some of their “uncertainty” PMAs are now captured in higher model outputs, and the continued (but much reduced) retirement of Covid PMAs.
Banks are holding firm on their outlook for cost of risk, with loan losses trending toward through-the-cycle rates… albeit with appropriate caveats given the uncertainty in the outlook!
As usual, we have analysed the aggregate position of Barclays, HSBC, Lloyds, NatWest and Santander UK as a proxy for the wider UK banking sector. Given the lack of data reflecting the post mini-budget outlook we have kept this update quite brief!
1. Credit performance has remained benign and Stage 3 assets as a proportion of total loans are broadly stable. (The tick-up in 1Q22 was technical, relating to implementation of the new definition of default for IRB feeding through to definition of Stage 3 credit impaired.)
2. Stage 2 assets as a proportion of loans have increased reflecting the deterioration in economic outlook and concerns over inflation risk.
3. Coverage has shown a small uptick after small decreases in 1Q22 and 2Q22.
4. Cost of risk follows the same pattern as coverage and Stage 2, with an increase in 3Q22. Cost of risk in the quarter was at pre-Covid levels.
After the volatility of recent weeks, the press are now calling the resumption of “boring” politics and there is the prospect of an orderly Autumn Statement on the 17 November. Hopefully uncertainty will reduce and firms will be able to form a high-quality forward-looking view of credit risk prospects for year-end 2022... albeit the outlook in the Bank of England’s November Monetary Policy Report was rather gloomy.
The banks in our sample have given guidance for year-end 2022 that cost of risk for the year will be at-or-below the through-the-cycle level. On this basis, 4Q22 cost of risk may see a small increase... but this is difficult to assess because of uncertainty as to where economic expectations will settle over the next couple of months after the turbulence at the end of September, and some uncertainty as to how much of this was priced into individual firms’ ECL assessments at 3Q22.
As banks begin to prepare their 4Q22 ECL statements, the impact of high inflation and the new interest rate environment will continue to be a challenge for firms’ models with likely continued use of management judgement to mitigate model weaknesses. We may also be in a situation where delinquency rates have started to rise and model calibrations will need to respond accordingly.
As well as this, banks will need to be mindful of the themes in the PRA’s recently published Written Auditor Reporting thematic feedback. This is a great read for all lenders (and auditors!) with clear direction on the regulator’s expectations for high quality reserving practices.
Of course, as we have learned yet again in 2022, all this may be completely derailed by more unexpected “events” (with thanks to Rab Butler!).
You can also check out our previous blogs or contact one of the team who would be happy to discuss any of the topics covered.