It shouldn’t be a shock that the FTSE 100’s banks have reversed again more recently. The broader blue-chip index has clung onto the gains it generated during late March’s rally. Financial giants like Barclays (LSE: BARC) haven’t fared quite so well. And with good reason.
I’ve recently touched on why Lloyds finds itself in dire straits today. The prospect of the UK economy sinking at the fastest rate for hundreds of years in 2020 — not my words but the words of key Bank of England officials — naturally throws a shadow over the banking sector.
On Thursday, Standard & Poor’s downgraded its outlooks on a cluster of these financial giants following the coronavirus breakout too. The ratings agency cut its view on Footsie firms Barclays, Lloyds and Royal Bank of Scotland from ‘stable’ to ‘negative’.
Fresh fears for the FTSE 100 banks
Explaining the rationale behind its decision, S&P commented: “Even under our base case of an economic recovery starting in third-quarter 2020, we expect bank earnings, asset quality, and in some cases, capitalization, to weaken meaningfully through end-2020 and into 2021.”
The ratings experts added that there are “significant downside risks” to this base scenario. S&P argues that fresh government policy in response to the Covid-19 crisis may not be totally successful in averting permanent economic damage.
It also says government action provides additional room for the sovereign, for companies, and for individuals to increase their indebtedness. The body goes on to comment that the lifting of quarantine measures are likely to be slow and subject to setbacks, adding that “the longer the delay in the recovery of economic activity, the less sustainable this extra debt will be.”
For the banks then, S&P said the domestic loan loss rate could rise to 100 basis points in 2020. This is around five times the recorded level in each of the past six years. A predicted economic recovery next year would help the rate ease by around 67 basis points, the agency predicts. But this would still be north of the UK long-term average.
Don’t bank on Barclays
That S&P assessment highlights the huge challenges the British banking sector faces in the short term and beyond. It naturally raises more concerns over Barclays and the state of its balance sheet too.
Sure, the FTSE 100 bank may have hurdled most recent Bank of England stress tests. But this was on the understanding that Barclays would axe dividend payments, staff bonuses, and cut corporate debt coupon payments in the event of a UK economic meltdown. Those assessments were also concluded several months before the coronavirus crisis, and the threat of unprecedented economic damage emerged.
Dividends have fallen at Barclays, in line with Prudential Regulation Authority guidance. I worry that this development, even if followed by those other stress test requirements, would prove insufficient in the face of a painful and prolonged coronavirus-related hit to the economy. In my opinion, Footsie colossus Barclays carries far too much risk to be considered a sensible investment.
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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.