By Sinead Cruise and Lawrence White
LONDON (Reuters) -Cuts to British mortgage rates this week are putting forecasts for bank profit margins under a spotlight, adding to pressure on a sector that has struggled to meet shareholder expectations.
Prices for many home loan products have fallen since July, amid speculation the Bank of England (BoE) might trim its 5.25% base interest rate earlier than expected as a result of supportive economic data, including a slowdown in inflation.
But the new year has heralded eye-catching drops in key mortgage rates, prompting some analysts to question whether banks can still meet forecasts for net interest margin (NIM), a closely-watched measure of how much they make from lending.
Analysts at Bank of America (BofA) on Friday cut their earnings estimates for 2024 for UK banks by between 7-12%, citing sharp falls in market interest rate expectations that will pressure banks’ profit margins.
Competition among banks for mortgage business and deposits is ramping up simultaneously, casting a pall over potential returns for bank shareholders, analysts said.
“We have probably reached peak profitability for most UK banks in H1 2023,” Laurie Mayers, Associate Managing Director at Moody’s Investors Service, told Reuters, pointing to assumptions of increased pressure on both mortgage and deposit margins.
Banks have already signalled that the boost to profits from central bank interest rate hikes, which began in 2022 after years of near-zero rates, may be waning.
But lenders are striving to maintain market share and many have been able to offer better rates because they can raise cheaper funding in the wholesale market, said Mike Read, director at broker Prospect Tree Mortgages.
Best buys are all now cheaper than at the same time last year, Moneyfacts data shows, with five-year loans below 4%, compared to a best available rate of 4.39% at the start of 2023.
HSBC on Thursday announced a 3.94% five-year fixed rate remortgage deal, and slashed 1% off its 10-year fixed rate loan to 3.99%. Rates on these products are below 4% for the first time since April 2023.
NatWest on Thursday informed brokers of rate reductions to many of its mortgages with effect from Friday, including cuts of 0.42 and 0.3 percentage points respectively on selected 2 and 5 year deals for house buyers.
Earlier this week, Halifax, part of Lloyds Banking Group, Britain’s biggest mortgage lender, slashed between 0.83 and 0.4 percentage points off its top two-year and five-year remortgages, after three sets of price adjustments across its product range in December.
“The level of competition between lenders has been further heightened by the stall in mortgage transactions which has left them fighting for both new and retained business,” Karen Noye, mortgage expert at Quilter, told Reuters.
Shares in Virgin Money and Barclays, which the BofA analysts said may struggle more in this environment, fell 2% and 1.35% respectively on Friday, underperforming the benchmark FTSE index which was down 0.9%.
NatWest and Lloyds, which the BofA analysts said should be more resilient, fell 0.5% and 1.3% respectively.
HIGHER PAYOUTS?
Ordinarily, rate cuts would lessen pressure on banks to pay handsome deposit rates to savers, but collectively UK banks must this year start to repay the BoE more than 180 billion pounds ($245 billion) it doled out to support pandemic-era lending.
As a result, customer deposits are set to become a more important funding tool, and growing or at least maintaining those deposit bases will be critical to replace the BoE funding.
“The maturity of the pandemic Term Funding Scheme will likely mean banks having to find more expensive sources of funding, including retail deposits, which will in turn likely put pressure on net interest margins,” said Laith Khalaf, head of investment analysis at AJ Bell.
Banks have so far shrugged off political pressure to raise deposit rates but as base rates start to fall again, analysts expect some depositors to migrate to rivals paying better rates.
That means banks’ NIM forecasts will be pinched from two directions, particularly if banks pass on lower rates to mortgage customers without being able to pay less to savers, said RBC Capital Markets analyst Benjamin Toms.
HSBC, for example, has boosted the rate it pays out on its online bonus saver account from 3.93% at the start of last year to 4% in January.
“I think it’s likely we will see a further downdraft in NIMs in the next couple of quarters provoked by mortgage margin compression,” said John Cronin, analyst at broker Goodbody.
(Additional reporting by Suban Abdulla; Editing by Alexander Smith)
