UK banks face earnings pressure in 2024 as rate tailwinds die down

UK bank earnings are expected to decline in 2024 as the positive effects of central bank rate hikes fade and a weakening economy weighs on asset quality.

The country's four largest banks — Barclays PLC, HSBC Holdings PLC, Lloyds Banking Group PLC and NatWest Group PLC — are expected to book lower return on equity (ROE) in 2024 after strong 2023 results, S&P Capital IQ consensus estimates show. NatWest will see the largest drop in projected 2024 ROE, of 22% year over year, followed by Lloyds, whose ROE is expected to decline by 13.8%. Barclays and HSBC are set to book smaller declines of 4.6% and 5.7%, respectively.

All four banks are also expected to report lower net income for this year, with their aggregate net income projected to fall to some £31 billion in 2024 from about £34 billion in 2023, according to current Capital IQ consensus estimates.

The main factors affecting UK lenders' profitability in 2024 will be continued net interest margin (NIM) compression and an uptick in loan loss provisions, S&P Global Ratings said in a Jan. 4 sector commentary. UK bank NIMs have been declining since June 2023 due to deposit migration and low spreads on new mortgage lending — trends that are expected to persist in the first half of 2024 and then ease, the credit analysts said.

Tighter margins

Barclays, Lloyds and NatWest downgraded their NIM targets several times during the first three quarters of 2023 because of heightened competition for deposits as clients shifted to higher-rate products amid rising key interest rates. Competition for mortgages has also intensified with several big banks, including Barclays, Lloyds' mortgage arm Halifax, and HSBC, cutting rates on fixed-rate mortgages in the first two weeks of January.

The mortgage rate cuts were triggered by a fall in market swap rates in December 2023, which was driven by investor projections for quicker-than-expected Bank of England (BoE) interest rate cuts in 2024, the Financial Times reported Jan. 9. Banks base their fixed-rate mortgage pricing on swap rates, which reflect market expectations for future interest rates.

– Access analyst consensus estimates for Barclays, HSBC, Lloyds and NatWest on CapIQPro. – Access the Peer Analysis template on CapIQPro.

Current market expectations suggest the BoE would start cutting rates in the second quarter of 2024, with the base rate seen falling to 3.75% by the end of the year, Bank of America equity analysts said in a Jan. 5 note. This suggests 150 basis points of cuts from the current base rate of 5.25%, compared to the previously expected 25 to 50 basis points of cuts throughout 2024. As a result, UK bank NIMs are expected to continue falling until the third quarter of 2024, the analysts said.

NIMs at Barclays, Lloyds and NatWest are expected to decline in 2024 and rebound in 2025, remaining below the 2023 levels but above margins booked in 2022, Capital IQ consensus estimates show. HSBC's NIM is expected to decline further in 2025, but remain above its 2022 level.

Net interest income at all four big UK banks will follow a similar trend to NIMs, falling in 2024 with a slight recovery in the following year, the data shows.

A year of 2 halves

Bank earnings in 2024 are expected to remain "healthy" albeit lower than in the previous year, the Ratings analysts said. Income from banks' structural hedges — containing liabilities that are stable or less sensitive to short-term interest rate changes — will be a tailwind for margins in the second half of 2024. Banks are also likely to target further cost cuts to compensate for the weaker margins, the analysts said.

Lloyds is the only bank expected to report higher non-interest expenses in 2024, while expenses are seen falling at Barclays and HSBC, and stabilizing at NatWest, Capital IQ data shows.

Lloyds and NatWest had previously said they expect negative deposit and mortgage pricing effects to continue to weaken NIMs in the first half of 2024 but hope for stabilization later in the year when higher structural hedge yields kick in.

Analysts see some of the deposit and mortgage pricing-related pressures on bank NIMs moderating later in 2024. The shift to higher-rated fixed-term deposits is already slowing as interest rates on term deposits have fallen and the most rate-sensitive balances have already migrated, the Ratings analysts said.

Mortgage spread compression is expected to ease in 2024 and turn "mildly positive" in 2025 for most big UK banks as the BoE rate cuts revive mortgage demand and the bulk of existing loans reprice to higher rates, the BofA analysts said. Ratings has estimated that about 55% of UK residential mortgage loans have already been repriced since the BoE's first rate hike in later 2021, given that most of the loans in the market are fixed for two to five years.

Banks' credit losses are expected to stay close to historical averages in 2024, yet weaker-than-anticipated economic growth or market volatility around this year's UK general election could put more pressure on asset quality, the Ratings analysts said.

Loan loss provisions across the big four UK banks are expected to rise in 2024 and moderate somewhat in 2025, the Capital IQ data shows. Lloyds is the only bank expected to book higher provisions for 2025, according to current consensus estimates.

The big four UK banks will report their full-year 2023 results next month, starting with NatWest on Feb. 16, Barclays on Feb. 20, HSBC on Feb. 21 and Lloyds on Feb. 22.