Holly Black: Welcome to Morningstar. I'm Holly Black. With me is Niklas Kammer. He is an equity analyst with Morningstar in Amsterdam. Hello.
Niklas Kammer: Hi, Holly.
Black: So, you've been looking at the U.K. banks after their reporting season. One of the things I should imagine you had your eye on is bad loans and bad debt after the COVID crisis. So, what did you find?
Kammer: Yeah, bad loans and bad debt, loan loss provisions were the big topics for banks in 2020. And for us actually the Q4 numbers that came out were not that surprising. What was more surprising to us was actually the guidance given by the three U.K. banks that we cover and that was particularly because they are guiding now for loan loss provisions below what they believe are mid-cycle levels. So, if this is true, the banks really came out of this whole thing very unscathed. And what we think about is that really there is still some uncertainty in the system. But overall, banks tend to know quite well how their creditors are performing, and especially on this guidance that they've given, loan loss provisions they prefer to outperform. So, we think there's some confidence back into these numbers.
Black: And I know a lot of investors were disappointed that dividends were cancelled last year on the say so of the regulator. What's the outlook on that front?
Kammer: Yeah. So, the U.K. regulator obviously capped dividend distributions and they allowed now for banks to pay out 25% of their cumulative 2019 and 2020 profits, which all three banks made use of. But obviously, investors are looking for a proper dividend so to say. And we think it is likely that the regulator will revert to the standard capital framework by the end of the second quarter, and that the banks will revert to their pre-COVID distribution policies.
Black: And so, what's the outlook for the three banks that you cover?
Kammer: So, if we start with Barclays, Barclays really – our theory has played out quite nicely for them. They've bounced from a low and they're currently fairly valued. So, we think there is not a lot of opportunity left in this name. But we do see some opportunity in the more retail-focused banks, so NatWest and Lloyds. For NatWest, they're still in a heavy restructuring phase. So, we think that over time, as the quality of earnings and these restructuring charges run off, that the valuation gap between the current share price and our fair value estimate will close. And Lloyds is really a story on interest rates and where these interest rates are heading.
Black: And if we think about interest rates, we know the Bank of England base rate is still at record low, and there's even talk about it going negative, and that can really hurt this sector. What are you expecting?
Kammer: Yeah. So, negative interest rates, as you correctly point out, were a topic over the past weeks, but it has really changed over the past weeks now. So, if we look at market expectations, while the market previously was seeing that interest rates might go negative at the end of this year, expectations now are more towards a stable interest rate in 2021 and then actually a rapid increase in rates over the next five years. And that really benefits the more retail-focused banks like Lloyds in particular and NatWest. And we especially think in the case of Lloyds where there have been a lot of headwinds over the past years, kind of, protection insurance, Brexit, COVID and then negative interest rates that a lot of these headwinds have been in the rear view mirror now for the bank and negative interest rate was really the last big item that was holding valuation back. So, we would expect re-rating the stock in the near future.
Black: Niklas, thank you so much for your time. For Morningstar, I'm Holly Black.
