Bad debts at Lloyds Banking Group PLC (LSE:LLOY) and other high street lenders could reach £47bn as the UK economy struggles, Credit Suisse has warned.
The FTSE 100 banks, which also include Barclays PLC (LSE:BARC), HSBC Holdings PLC (LSE:HSBA), NatWest Group PLC (LSE:NWG) and Standard Chartered PLC (LSE:STAN), could have to write off the loans over the next two years, the Swiss investment bank calculated under its worst-case scenario.
The estimates for what could happen in a severe recession was lifted from £41bn previously, following the Bank of England's central forecast last week that GDP would fall by around 0.75% during the second half of this year and continue declining in 2023 and into 2024 if interest rates remain on their current path.
"We move our UK domestic bank provision forecasts midway between a mild and sharp recession," the analysts said, with their range of potential losses increased to £31bn-£47bn from the previous £31bn-£41bn.
Analysts calculated that credit loss provisions in the severe recession would equate to 35% of pre-tax profit next year.
The severe recession scenario has been made more severe, akin to that seen in 1980-81, with a 4.3% peak-to-trough decline in GDP and an unemployment increase of 5.9% to 9.6%, with a more severe 30% fall in nominal house prices now factored in.
Looking at the banks as an investment, Credit Suisse said valuations remained attractive if interest rates remained "sticky" and a recession is midway between mild and sharp, given existing provisions already made by the banks.
As such its estimates and target prices remained resilient, with the analysts arguing that the "credit intensity" amid any decline in GDP "will be lower this time around".
On the current forecasts, UK banks offer an average potential upside of 37%, with 64% for UK domestic banks such as Barclays, Lloyds and NatWest.
The City analyst consensus is that UK banks are priced on a 2023 return on tangible equity of 12.0%, "and as such the sensitivity to provisions in our severe downside scenario in 2023 would reduce ROTE to 7.8% implying UK banks are pricing a severe recession with fairly sticky rates".