Mortgage debts and bust firms put UK banks’ profits under pressure

UK banks will be hoping there are no fresh crises around the corner as they prepare to reveal third-quarter profits this week.

It follows a turbulent period for the sector, which started in March, shortly before executives disclosed first-quarter results. Bosses watched in horror as a mini-banking crash led to the collapse of a string of US lenders including Silicon Valley Bank (SVB), and later Switzerland’s largest lender, Credit Suisse.

And just as fears of contagion subsided – helped in part by HSBC’s emergency takeover of SVB UK – another scandal was brewing closer to home. By July, the former Ukip leader Nigel Farage went to war with NatWest over plans to close his accounts at its private bank, Coutts.

The saga forced executives to pore over account closure policies and assure the government they supported free speech, and customer confidentiality, lest they face the same fate as Dame Alison Rose, who fell on her sword just days before the lender’s half-year results.

While executives had undoubtedly hoped for an incident-free run-up to their third-quarter earnings season, a financial wobble at Metro Bank this month meant they were pressed to consider another emergency rescue, this time of a high-street rival.

Metro, at least, found its saviour in the Colombian investor Jaime Gilinski Bacal. And although Lloyds, NatWest and Barclays are still circling Metro’s £3bn mortgage book, the crises of 2023 have proven that UK lenders cannot rest on their laurels: a point that shareholders are likely to drive home as they review the latest earnings reports from Britain’s largest banks.

NatWest, unsurprisingly, will face the closest scrutiny. While the government – still the largest shareholder with a near 39% stake – awaits an internal report over the Farage affair, investors will be focused on how the bank fared under its interim chief executive, Paul Thwaite.

Average analyst forecasts suggest there is room for optimism. Thwaite is expected to report a near 30% jump in third-quarter pre-tax profits to £1.4bn on Friday. That will partly come down to a rise in net interest income: a figure that measures the difference between what a bank pays out in interest on deposits and what it charges customers on loans and mortgages, and has risen significantly since the Bank of England started increasing rates two years ago.

The rise in NatWest’s net interest income to £2.8bn from £2.6bn this quarter is expected to offset about £277m put aside to cover potential defaults by customers, including mortgage borrowers squeezed by higher home loan payments and wider cost of living pressures.

But while mortgage arrears are definitely on the rise – albeit from historic lows – experts say high employment levels will ensure most borrowers can still afford to repay their costly mortgages. That leaves banks more able to absorb the costs of missed payments.

“Loan loss provisions will likely increase over the next few quarters from historically low levels,” said Filippo Maria Alloatti, head of financials at the investment manager Federated Hermes. “But we think organic capital generation can absorb this jump comfortably”

That helps explain the outlook for the UK’s largest mortgage lender, Lloyds Banking Group, which is expected to report a 20% rise in pre-tax profits to £1.8bn on Wednesday.

But the results at Lloyds will be flattered by the fact that it front-loaded its cash cushion and put aside £668m for potential defaults during the third quarter of 2022. Without a significant turn in the UK’s economic outlook, analysts expect Lloyds will be able to get away with putting aside roughly half that sum, about £336m.

However, with companies also struggling with higher costs and interest rates, there are lingering concerns that a larger number of business loans could turn sour.

Official data released last week showed the number of firms falling into insolvency across England and Wales rose 17% year on year in September to 1,967. “Company insolvencies are on the rise, and we want to see how this is affecting banks,” said Lloyd Harris, head of fixed income at the UK asset manager Premier Miton.

Still, this will not be the biggest concern at Barclays. Instead, shareholders will be looking for signs of a rise in dealmaking that could boost profits across its corporate and investment banking.

But while it recently took part in Arm’s $65bn stock market debut, analysts are still forecasting a drop in investment banking profits. That is likely to drag on the group’s overall earnings, which will also be knocked by a near 50% surge in money put aside for defaults. The Barclays group’s pre-tax profits are forecast to drop 8% to £1.8bn.

However, despite the string of recent crises, Alloatti believes British banks are still in rude health. “Generally speaking, the UK’s top four clearing banks – Lloyds, HSBC, Barclays and NatWest – will remain lower-risk and more profitable than others for years to come. We see their revenue growth projected well into 2024.”