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Based on US Q2 earnings, I’d watch this UK bank stock and avoid the rest

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This week, US banks have begun announcing their second-quarter earnings results. The largest of those banks have sent mixed signals. The important information for UK investors is the bumper profits in fixed income trading and the huge increase in loan loss provisions. Based on this data, I think that Barclays (LSE: BARC) is the bank stock that will perform the best when it releases its earnings. However, HSBC Holdings (LSE: HSBA) should not be far behind. 

Loan loss provisions represent the money that banks have set aside in preparation for loans that they are expecting to be defaulted on or not paid in full. Due to the coronavirus, these provisions are going to be very high. In the US, JP Morgan Chase alone has set aside $34 billion this year.

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In the UK, bank stocks are not as prepared for this huge loss. In the first quarter, UK banks set aside a lot less money than US competitors. Analysts expect the total UK domestic credit losses to be nearly £19 billion in 2020 alone, which is much higher than the current total provisions across the major banks. 

Barclays set aside £2.16 billion in the first quarter for loan losses, which was more than all its major competitors except HSBC. Every UK bank stock will have to report more provisions, but Barclays and HSBC should benefit from the larger sums that they have already set aside. 

Smaller and less leveraged retail banks will also offer an advantage this year, as they will have fewer loans outstanding. Out of the four major UK-listed bank stocks, HSBC and Barclays have the best loan to deposit ratio. This means that their losses should be smaller when compared to their held accounts. 

Barclays also has the largest fixed income trading team, which should help the bank profit handsomely this quarter. Meanwhile, HSBC will probably also perform well as its trading team is only slightly smaller. The other bank stocks have no trading teams of a notable size, which could cause them to have very negative results. 

Out of the UK listed bank stocks, I would avoid Lloyds Banking Group and Royal Bank of Scotland Group . They both set aside significantly less money in quarter one for bad loans, and they have much higher loan to deposit ratios and notably smaller trading teams. I believe that these banks will have results more in line with Wells Fargo, which fell 5% on its earnings release. 

I’d bet on Barclays to have the best performance out of all UK bank stocks, but HSBC should also have results in line with JP Morgan and Morgan Stanley. Either of these UK bank stocks could be worth an investment before results day, in my opinion (Barclays reports on the 29th of July and HSBC reports on the 3rd of August). 

It is important to note that both these bank stocks have other problems that could override any positive results. Other Fools have delved deeper into these problems, for HSBC, and Barclays. In the coming weeks, both bank stocks could also begin to price in US earnings. This makes any attempt to profit off of these results rather risky, but it could also be highly profitable.

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Charles Heighton owns shares in Barclays. The Motley Fool UK has recommended Barclays, HSBC Holdings, 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.

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