* Britain’s banks expect $22 bln in bad loans

* Pandemic, Brexit, interest rates drive underperformance

* Cost-cutting likely in face of rising loan losses

By Iain Withers and Lawrence White

LONDON, Aug 5 (Reuters) – Britain’s banks took a gloomier
view than almost all their European peers in their second
quarter earnings, as coronavirus fears, Brexit and low interest
rates caused them to bake tougher “worst-case” scenarios into
their risk models.

Investors had expected a torrid set of half-year results,
but Barclays, Standard Chartered, Lloyds
, NatWest Group and HSBC fell short of
these low expectations.

Provisions for potential loan losses across the five banks
topped $22 billion, blowing past analyst forecasts and
increasing selling pressure on shares already hammered by the
pandemic this year.

By contrast, France’s BNP Paribas and Credit
Suisse beat analyst forecasts, benefiting from bumper
trading volumes as well as relatively modest provisions.

HSBC and Lloyds were punished for poor results, with shares
in both banks plumbing their lowest levels in 11 and 8 years
respectively.

All five UK banks have under-performed, falling by between
42% and 55% this year compared to a 36% fall in the European
banking index.

“The UK banks are facing a more significant economic drop
than most Europeans as the UK has faced a bigger shock from the
COVID-19 pandemic, and that has fed through into provision
levels,” said Patrick Hunt, partner at consultancy Oliver Wyman.

The British economy is forecast to shrink 11.5% this year,
while the euro area contracts 9.1%, according to OECD forecasts
in June.

Other factors weighing on UK banks include a relatively
higher exposure to unsecured consumer lending, a larger drop in
central bank rates and the potential for a “no deal” exit from
Brexit transition arrangements at the end of 2020, analysts
said.

The roll out of further lockdowns across the north of
England in response to a rise in infections also threatens to
derail the country’s nascent economic recovery and damage bank
balance sheets further.

TOUGH CHOICES

NatWest and Lloyds gave guidance that loan-loss provisions
should be lower in the second half of the year, raising hopes
the country’s banks may have “kitchen sinked” provisioning and
got ahead of European rivals.

But they also warned the outlook could deteriorate further
and drastically downgraded their worst case forecasts for the
economy, predicting GDP drops of as much as 17% in 2020.

The heftier provisioning among British banks relative to
their European rivals was largely because the former
incorporated gloomier worst-case forecasts into their economic
models.

Lloyds, for example, said Britain’s GDP could tumble 17.2%
in a worst scenario compared with a 7.8% fall previously
modelled as the extreme downside case when the bank reported
results in April.

While European rivals did not disclose their models in as
much detail, Deutsche Bank allowed for a more modest
2 percentage point swing to the downside in German GDP from the
base case in its adverse scenario.

That disparity is reflected in the yields banks are paying
on their debt.

Deutsche Bank’s bonds maturing in August 2023
were trading at a yield of 0.03% on Tuesday, 38 basis points
lower than a comparable Barclays September 2023 note
. In January, Barclays’ yield was trading lower
than that of its German counterpart.

“Asset quality in the UK appears to be deteriorating faster
than in Europe and you are seeing that reflected in the bonds,”
said Filippo Alloatti, a credit analyst and portfolio manager at
Federated Hermes.

NatWest chief financial officer Katie Murray said the bank’s
worst case took account of both further lockdowns to control the
spread of the virus and a disruptive Brexit.

HSBC said its business in Britain, where it took a $1.5
billion charge against expected credit losses, had been
particularly hard-hit and it would look to accelerate
cost-cutting plans including redundancies.

Tom Merry, head of financial strategy at Accenture, said
banks are prioritising cost-cutting and readying restructuring
and debt collection operations – including improving credit risk
modelling to pick up on red flags – in preparation for a tough
second half.

Cost-cutting is likely to include further branch and office
closures, Merry said, with any investment spend ploughed in to
digital services.

“If there’s one good thing to come from this for banks it’s
that if they are able to accelerate digital transformation they
will be stronger out the other side.”
($1 = 0.7651 pounds)

(Reporting by Iain Withers and Lawrence White, additional
reporting by Abhinav Ramnarayan. Editing by Jane Merriman)