UK banks set for bumper profits despite mortgage market freeze

The UK’s biggest banks are poised to reap big profits from skyrocketing interest rates even as they pull mortgage products off the shelves, leaving savers with meager returns on their deposits.

The financial turmoil triggered by Chancellor Kwasi Kwarteng’s “mini” budget has had markets betting that UK interest rates could hit a high of 5.8 percent next spring, creating a bonanza for lenders. from high street who will make a profit from holding nearly £900bn of deposits at the central bank

“There will be an embarrassment of riches: Bank spreads will look very wide in the third quarter,” said one senior banker, describing it as “a cha-ching moment”.

The Bank of England has already raised interest rates to 2.25 percent from a record low of 0.1 percent during last year’s pandemic, in a bid to fight inflation.

The Big Four in the UK banks — Barclays, HSBC, Lloyds and NatWest — have roughly doubled their reserves in the last three years and had nearly £900bn in the central bank at the end of the first half of 2022, generating almost £20bn at rate current basis.

Each additional 10 basis point increase would add close to £1bn in net interest income a year.

£bn bar chart showing that the big banks have accumulated considerable BoE reserves

The boost to bank results came about as more than 1,600 mortgage products were withdrawn by lenders over the course of the week following market turmoil following the Kwarteng tax event, prompting the Financial Conduct Authority to contact banks as potential borrowers were left in the lurch.

High street lenders have also been unable to pass on their profits from rising base rates to savers, creating what one senior banker called a “two-tier market” as smaller competitors offered more competitively priced products.

Barclays pays 0.25 per cent on its daily easy access savings account from £50,000 up to £1 million, while NatWest’s instant savings account offers 0.4 per cent. By contrast, the Yorkshire Building Society, which is in the highest-rate best-buy table, pays 2 percent. Chase UK, JPMorgan’s digital bank, offers 1.5% on savings of up to £250,000.

For European and UK banks, the rapid rise in interest rates as central banks battle inflation marks a change in fortunes after a decade in an ultra-low rate environment and lagging behind its American peers.

Some 85 percent of the sector beat analysts’ estimates for second-quarter pretax profit as higher rates improved net interest margins, the difference between what a bank pays on deposits and what earn on loans and securities.

The largest national banks, NatWest, Lloyds and Barclays, are estimated to grow revenue by £12bn from 2022 to 2024, according to Jefferies. UBS analysts said a 0.5 percentage point rise in the yield curve would boost earnings before provisions by 3 percent to 4 percent for UK banks.

But shares of the UK’s biggest banks have fallen between 7 percent and 12 percent over the past month, pressured by the Russian invasion of Ukraine, supply chain problems and now uncertainty in the mortgage market.

There is a fear that borrowers may not be able to afford to raise rates above 5 or 6 percent. A senior banker said higher rates would hit housing demand as early as the fourth quarter of 2022.

In the short term, however, banks are “unlikely” to set aside significant bad-debt provisions in their third-quarter results next month despite these concerns, said Gary Greenwood, an analyst at Shore Capital.

He said this was because forecasts for unemployment and property prices, the two big drivers of the loan decline, were “pretty strong”.

The governments cap on home energy bills of £2,500 a year for the next two years also mitigated a potential strain on earnings. Jefferies analysts estimated that, without it, UK banks would have lost an average of 2 per cent of pre-tax profits.

Omar Keenan, co-head of European bank equity research at Credit Suisse, added that banks were starting with low default levels and had rapidly built up provisions during the pandemic; additional provisions would be made more incrementally.

“It’s a bit of a misleading picture,” he said. “Bank profitability has recovered due to higher interest rates, the delinquency rate has remained low and the balance sheet has improved due to Covid, but the outlook is weakening.”

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